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MONETARY, CREDIT, AND FISCAL POLICIES HEARINGS BEFORE THE SUBCOMMITTEE ON MONETARY, CREDIT, AND FISCAL POLICIES OF THE JOINT COMMITTEE ON THE ECONOMIC KEPORT CONGRESS OF THE UNITED STATES EIGHTY-FIRST CONGRESS FIRST SESSION P U R S U A N T TO SEC. 5 (A) OF PUBLIC LAW 304, 79TH CONGRESS S E P T E M B E R 23, N O V E M B E R 16, 17, 18, 22, 23, A N D D E C E M B E R 1, 2, 3, 5, 7, 1949 P r i n t e d for the use of the J o i n t Committee on the E c o n o m i c R e p o r t U N I T E D STATES GOVERNMENT PRINTING OFFICE 99076 WASHINGTON : 1950 JOINT COMMITTEE ON T H E ECONOMIC REPORT (Created pursuant to sec. 5 (a) of P u b l i c L a w 304, 79th Cong.) UNITED STATES SENATE J O S E P H C. O ' M A H O N E Y , Wyoming, Chairman F R A N C I S J. M Y E R S , Pennsylvania J O H N J. S P A R K M A N , Alabama P A U L H . D O U G L A S , Illinois R O B E R T A . T A F T , Ohio R A L P H E'. F L A N D E R S , V e r m o n t A R T H U R Y. W A T K I N S , Utah HOUSE OF REPRESENTATIVES E D W A R D J . H A R T , N e w Jersey, Vice Chairman W R I G H T P A T M A N , Texas W A L T E R B . H U B E R , Ohio F R A N K B U C H A N A N , Pennsylvania J E S S E P. W O L C O T T , Michigan R O B E R T F. R I C H , Pennsylvania C H R I S T I A N A . H E R T E R , Massachusetts THEODORE J. KREPS., Staff Director Director GROVER W . ENSLEY, Associate Staff JOHN W . LEHMAN, Clerk SUBCOMMITTEE ON MONETARY, CREDIT, AND F I S C A L POLICIES HOUSE OF REPRESENTATIVES UNITED STATES SENATE P A U L H . D O U G L A S , Illinois, Chairman R A L P H E . F L A N D E R S , Vermont W R I G H T P A T M A N , Texas F R A N K B U C H A N A N , Pennsylvania J E S S E P. W O L C O T T , Michigan LESTER V. CHANDLER, II Economist CONTENTS Pa e Statement o f — £ Bopp, K a r l R., vice president, Federal Reserve Bank of Philadelphia— 27-75 Brown, E. E., chairman of the board, F i r s t National B a n k of Chicago. 247-264 Burgess, W . Randolph, chairman of the executive committee, National City Bank of New Y o r k 173-202 Clark, J o h n D., Council of Economic Advisers 531-544 Colm, Gerhard, Council of Economic Advisers 531-544 Considine, James W., comptroller, Reconstruction Finance Corporation 145-171 Cramer, Edison H., chief, Division of Research and Statistics, Federal Deposit Insurance Corporation 105-144 Dougherty, James L., general counsel, Reconstruction Finance Corporation t 145-171 Eccles, M a r r i n e r S., Board of Governors, Federal Reserve System__ 213-247 Foley, Raymond M., Administrator, Housing and Home Finance Agency 202-212 Grede, W i l l i a m J., chairman, Federal debt management committee, National Association of Manufacturers 356-386 Gunderson, Harvey J., director, Reconstruction Finance Corporation 145-171 Haas, George C., director, technical staff, Department of the Treasury 387-430 Harl, Maple, chairman, Federal Deposit Insurance Corporation 105-144 Johnson, G. Griffith, Fiscal Division, Bureau of the Budget 501-530 Kassalow, Everett M., executive secretary, Congress of Industrial Organizations 299-311 Keyserling, Leon H., Acting chairman, Council of Economic Advisers 531-544 Kline, A l l a n B., American F a r m Bureau Federation 336-356 Lawton, Frederick J., assistant director, Bureau of the Budget 501-530 Leland, Dr. Simeon E., professor of economics and dean of the College of Liberal Arts, Northwestern University 2-26 Lutz, Dr. H a r l e y L., tax consultant, National Association of Manufacturers 356-386 Lynch, Thomas J., general counsel, Department of the Treasury 387-430 McCabe, Thomas B., Chairman, Board of Governors, Federal Reserve System) 461-500 Pace, Frank, Jr., Director, Bureau of the Budget 501-530 Reeve, Joseph E., F i s c a l Division, Bureau of the Budget 501-530 Richards, F r a n k l i n D., Commissioner, Federal Hiousing Adm/inistration 202-212 Riefler, Winfield W., assistant to the Chairman, Board of Governors, Federal Reserve System 461-500 Robertson, J. L., Deputy Comptroller of the Currency 75-104 Ruml, Beardsley, vice chairman, research and policy committee, Committee for Economic Development 265-298 Ruttenberg, Stanley H., director of education and research, C I O 299-311 Smith, Russell, legislative secretary, National Farmers Union 317-336 Smithies, Dr. Arthur, professor of economics, H a r v a r d University 2-26 Snyder, Hon. John, Secretary of the Treasury 387-430 Sonne, H . Chistian, chairman of the board of trustees, National Planning Association 2-26 Sproul, Allan, president, Federal Reserve Bank of New Y o r k 430-460 Staats, Elmer B., Executive Assistant Director, Bureau of the Budget 501-530 Thomas, Woodlief, economic adviser to the Board of Governors, Federal Reserve System 461-500 m IV CONTENTS Statement of—Continued Thomson, J. Cameron, president, Northwest Bancorp., Minneapolis, Pa ^ e Minn 265-298 Warren, Ulysses Grant, A. S. Riecke & Co., investments, Philadelphia 311-316 Williams, Alfred H., president, Federal Reserve Bank of Philadelphia- 27-75 Supplemental statements: Statement on fiscal and credit policies by the Chamber of Commerce of the United States 544-548 Statement of W i l l i a m Green, president, American Federation of Labor 548-552 Satement of Conference of American Small Business Organizations, submitted by Fred A. Yirkus, chairman 552-555 Statement of Francis H . Brown well (retired), former chairman of the board of directors, American Smelting & Refining Co 555-568 Statement of F r a n k Lilly, Spokane, Wash., statistician, Mines Research Bureau 568-570 MONETAEY, CREDIT, AND FISCAL POLICIES FRIDAY, SEPTEMBER 23, 1949 UNITED STATES SENATE, SUBCOMMITTEE ON M O N E T A R Y , CREDIT, AND FISCAL POLICIES OF T H E JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. T h e subcommittee met, pursuant to call, at 10:35 a. m., i n the caucus room, Senate Office Building, Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senators Douglas (presiding), and Flanders; Representatives Patman and Buchanan. Also present: Senators J o h n J. Sparkman and Arthur V . Watkins and D r . Grover W . Ensley, associate staff director; M r . J o h n Lehman, clerk; and D r . Lester V . Chandler, economist to the subcommittee. Senator DOUGLAS. Gentlemen, I wonder if we might come to order. M r . Sonne, M r . Leland and M r . Smithies, please come forward. Among the functions of the Joint Committee on the Economic Report, which was created under the Employment A c t of 1946, are those of making a continuing study of matters relating to the Economic Report, and of studying means of coordinating programs i n order to further the policy of the act. I n line with these responsibilities of the committee, the Congress, i n M a y of this year, passed Senate Concurrent Resolution 26, authorizing and directing the joint committee to make full and complete studies of four very important subjects: First, the problem of investment; second, the problem of the effectiveness and coordination of monetary, credit, and fiscal policies i n dealing w i t h general economic policy; third, the problem of low-income families i n relation to economic instability; fourth, the problem of unemployment trends and their significance in current economic analysis. Senator O'Mahoney, the chairman of the joint committee, has appointed four subcommittees to make these studies. T h i s subcommittee, dealing w i t h the second subject, namely, monetary, credit and fiscal policies, includes, i n addition to its chairman, Senator Flanders and Representatives Wright Patman, F r a n k Buchanan, and Jesse P. Wolcott. W e have, of course, invited all members of the full Committee on the Economic Report to attend the hearings, and we are very pleased to have Senator Sparkman and Senator Watkins w i t h us this morning I think it would be difficult to overestimate the importance of these closely related policies. We have very little chance of achieving the purposes of the Employment Act, namely to achieve maximum production, maximum employment, and maximum purchasing power, if we cannot maintain an appropriate and relatively stable flow of money and credit, and if our taxing, spending, and debt-management policies do not make for stability rather than instability. 1 2 M O N E T A R Y , CREDIT, AND FISCAL POLICIES It is our duty, therefore, to find out what types of monetary, credit, and fiscal policies are capable of contributing most to the purposes of the Employment Act, to appraise their effectiveness for these purposes, to see whether or not they have in the past been appropriately coordinated with each other and with other economic policies, and to discover what changes, if any, would be both feasible and desirable. One of the major problems that we face is that of the Government's revenue, expenditure, and debt-management policies. F i f t y years ago, when the annual Federal budget was only half a billion, and the national debt was less than a billion, the Government's fiscal policy had little effect on the over-all behavior of the economy. Now, with the Federal budget at about $40,000,000,000, and the national debt at more than $250,000,000,000, our policies relative to taxes, Government spendings, and debt management are a powerful force, capable of promoting either stability or instability. It is for this reason that we are glad to receive today two reports on fiscal policy which have been drawn up and unanimously approved by a group of 14 of the Nation's leading economists. I am very happy to find such a degree of unanimity among the economic brethren, because we are all aware of the wisecrack that was once uttered, that if you laid all the economists in the country end to end they would not reach a conclusion. There is another variant of that wisecrack, that if you were to lay all the economists in the country end to end, it would be a good thing. [Laughter.] B u t we are very happy indeed to welcome this group which is presenting these reports. The conference which produced these two reports was sponsored by the National Planning Association, at the request of Senator Flanders and myself; and I understand that the reports are to be formally transmitted to the subcommittee by M r . H . Christian Sonne, chairman of the board of trustees of the National Planning Association. STATEMENT OF DR. SIMEON E. IELAND, PROFESSOR OF ECONOMICS, AND DEAN OF THE COLLEGE OF LIBERAL ARTS, NORTHWESTERN UNIVERSITY; ACCOMPANIED BY H. CHRISTIAN SONNE, CHAIRMAN OF THE BOARD OF TRUSTEES, NATIONAL PLANNING ASSOCIATION, AND DR. ARTHUR SMITHIES, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY M r . SONNE. I am H . Christian Sonne, chairman of the board of trustees of the National Planning Association, 800 Twenty-first Street N W . , Washington, D . C. Senator Douglas, and members of the committee, the National Planning Association has for several years been interested in fiscal and monetary policy, because we realize it is an important part of the problem of stabilizing our economy, and of achieving full employment. W e were, therefore, very glad to comply with the request of Senator Douglas and Senator Flanders to arrange for a meeting of prominent economists, with a view toward seeing whether there was an area of agreement on fiscal policy. 3 M O N E T A R Y , CREDIT, AND FISCAL POLICIES We made a condition that when it came to the invitations to the Conference of Economists, the responsibility should rest with the National Planning Association. We had special reasons for doing so. Just as Senator Douglas explained, citizens are a little skeptical about all these differences of opinion among economists, and sometimes they wonder whether there is really such a thing as economic science. The answer is, in part, that the economic profession has a difficulty in that it is a social science, and economists have to gage human behavior, which very often can upset the best calculations. Another difficulty is that the social sciences are faced with problems very similar to those which were faced by the medical profession some generations ago. I refer to "quack" doctors. M a n y people, today, call themselves economists who are not qualified to so so, but we know that it takes much longer for the economic health of a strong country to show visible signs of mistreatment by inexperienced doctors than it does for the human body to collapse. Consequently, I am afraid that the economic profession will still work for some time under , a handicap. This was our reason for carefully picking the participants invited to the conference. We invited economists from the point of view of their geographic distribution. W e selected economists from the point of view of their economic and human philosophy, representing all shades of economic opinion. W e invited economists who are recognized for their ability and their standing in the community. We did not succeed in getting together all the economists whom we invited. B u t we so nearly succeeded that I think it is fair to say that even if the additional three or four who were invited had been able to attend, the final result would be practically the same as that which we now present to you. We decided to confine ourselves in this conference to fiscal policy, because we felt that if we were going to take in monetary and credit policy, the problems would become too complicated for one meeting of only 3 days. Now, since I am about to transmit these statements on fiscal policy to you, I should like, without going into detail, to make it clear that the members of the conference unanimously approve of the so-called anticycle budget. That means that we recognize that there are certain phases in bad times when a deficit in the budget is not only permissible, but helpful. I think the economists would approve my saying that they do not mean that a deficit is justified at all times and in all countries. F o r instance, if the permission to have a deficit in any one year should result in reckless spending, or in squandering the Nation's fortune, i t might be a lesser evil to demand an annual yearly budget. Y o u may compare this condition to that of a doctor who knows that he can shorten the pain and the illness of his patient by giving him 3ertain drugs. But, if the patient's character is too weak, the doctor may fear that even if the patient is cured he may go on taking drugs and become a dope fiend. It may be a lesser evil for the doctor to insist on the patient's recovering in a slower and more painful way. So, an economist may well favor deficits occasionally in a wellmanaged democracy but not necessarily favor the same policy in a country that is run by an administration, let us say, of the type of a Chiang Kai-Shek-. 4 MONETARY, CREDIT, A N D FISCAL POLICIES It follows that there is no inconsistency whatsoever in citizens being in favor of an occasional unbalanced budget today in the United States, even though a decade or two ago they believed in a balanced budget. There is no change of position in agreeing today that occasionally we may have an unbalanced budget. It is a recognition of the fact that the United States has so developed in the last few decades that now occasionally an unbalanced budget is justified. Just one word, in conclusion, on fiscal policy in general: N o measures under this heading can have their full effect on the economy unless they are understood by the citizens as a whole. If leaders of agriculture, business, and labor do not understand the measures of government and do not cooperate with them, they can, through lack of confidence, undo many times what these measures try to accomplish. Hence, it is important that the country, as a whole, understand this. That is why we in the National Planning Association appreciate that the Congress, through the Joint Economic Committee, has taken up the subject of fiscal policy for very serious study. The committee will, unquestionably, as the hearings go on, apprise the country of the details of fiscal policy. We i n the National Planning Association have for years tried i n an educational way to carry such knowledge to the people, and we shall continue to do so. When requested, we are at all times ready to cooperate to the fullest extent with the Congress. D r . Simeon E . Leland was chairman of the Princeton conference when the two statements were drafted and unanimously adopted. B o t h are signed by university economists and myself. I t is my pleasure to transmit these reports to the subcommittee, and to ask D r . Leland to present them to you. Senator DOUGLAS. Thank you very much, M r . Sonne. Y o u speak of the conference being held under the auspices of the National Planning Association. I wonder if you would state briefly for the record what the National Planning Association is, who its principal officers are, and so forth. M r . SONNE. The National Planning Association is a nonprofit, nonpolitical organization, which was formed some 15 years ago-—in 1934-—for the purpose of planning for democracy. Those were the days when planning was not quite understood. Some thought it directed toward "totalitarian, planned economies." W e have tried to emphasize that American citizens must plan to avoid a planned economy. We came to the conclusion that we should always try to find the main area of agreement, and that no measures could, in the long run, be recommended unless they were approved by agriculture, business, labor, and the professions. We therefore have operated through standing committees—agriculture, business, labor, and international policy committees—on which outstanding leaders serve. Whenever the National Planning Association comes out with a joint statement, there is a guaranty to the Nation that the recommendations do not favor one selfish interest or special group, because it is underwritten and approved by agriculture, business, and labor. Senator D O U G L A S . I wonder if you would give the names of some of the principal officers and members of the board of trustees of your association. 5 MONETARY, CREDIT, A N D FISCAL POLICIES M r . SONNE. I should have given that. F r o m labor we have people like M a r i o n H . Hedges and Clinton S. Golden; from agriculture we have Donald R . Murphy, Prof. Theodore W . Schultz, and Allan B . Kline. Senator DOUGLAS. M r . Kline is president of the American F a r m Bureau Federation? M r . SONNE. That is right. Senator D O U G L A S . Y O U may continue, M r . Sonne. M r . SONNE. W e have among businessmen people like William L . Batt of S K F , Beardsley Ruml, and Fowler McCormick. Senator DOUGLAS. M r . McCormick—the president of the International Harvester? M r . SONNE. That is right. Then you have a few who represent agriculture, business, and labor. I can go over the list. There is Laird Bell of Chicago-—— Senator DOUGLAS. Member of one of the leading Chicago law firms, chairman of the board of directors of the Weyerhauser Co. M r . SONNE. A n d there is Harry Bullis, chairman of the board, of General Mills. Then, we have Robert Heller, whose report on Strengthening the Congress, you may remember, had effect on the reorganization of Congress. Then there is Luther Gulick, who is an authority on Government organization. Then, we have Philip Murray, of the CIO. Among our agricultural people is James G. Patton. Senator DOUGLAS. President of the National Farmers' Union. M r . SONNE. Then we have Clarence Pickett of the American Friends Service Committee and Wayne Taylor, who now happens to be with Paul Hoffman in E C A . I think I have given you a list representing all shades of opinion. Senator DOUGLAS. Thank you very much. Dr. Leland, we are very happy to welcome you. Y o u are going to present both of these reports? D r . LELAND. Yes. Senator D O U G L A S . I would suggest that D r . Leland be permitted to complete both reports before we start questioning him, so that we may get the recommendations as a whole into the record before we start on piecemeal questioning. Dr. LELAND. O n behalf of the group of economists who prepared these reports, I should like to say that we were greatly appreciative of the invitation that came to us from Senator Douglas and Senator Flanders. We were glad to attempt to work up statements on economic policy that would make some contribution to economic stability and that would be of service to the committee and to the Congress generally. The reports deal only with fiscal policy; they do not cover everything that Congress might do to contribute to economic stability. The reports are as follows: F E D E R A L E X P E N D I T U R E AND R E V E N U E POLICY FOR ECONOMIC STABILITY INTRODUCTION Although our economic system accords a dominant role to private enterprise, Government expenditures and receipts have now reached a scale that make them crucially important factors in our national welfare. In 1949, w i t h a gross national production of $250,000,000,000, the Federal Government is spending more than 6 M O N E T A R Y , CREDIT, AND FISCAL POLICIES $40,000,000,000, while Federal, State, and local governments together are spending around $60,000,000,000. Government programs of this size make it more than ever desirable that every dollar of Government expenditures be used as efficiently as possible. We are not rich enough to afford waste of resources by government any more than by anyone else. It is equally important that the expenditure and revenue programs of government, in their formulation and execution, be consistent with the progress and stability of the private economy. The fiscal policy of the Government must make useful positive contributions to the maintenance of high levels of employment and income—the goals declared in the Employment Act of 1946 to be a national objective. Government affects business through both sides of its budget. Payments t a Government employees, bondholders, veterans, the aged, and the needy all constitute income that can be used to buy consumption goods from business; Government procurement affords a direct market for business. On the other side of the budget, taxes capture funds that consumers might have spent or that business firms might have invested in improved facilities. Taken by themselves, tax collections tend to shrink the market of private business, contract employment,, and lower prices; just as, taken by themselves, Government expenditures tend to expand the market for business, increase employment, or raise prices. It is not only the size of revenue and expenditure that counts; their composition must also be considered in any appraisal of the effects of Government policy. The economic effects of a billion dollars collected in the form of income taxes will be different from those of a billion dollars collected in excise taxes. Spending to build roads may stimulate private investment in automobiles, trucks, and garages; there are other forms of expenditure that may have adverse effects on private investment. Rationally or irrationally, Government spending and taxing may greatly affect the climate within which families and businesses make their decisions. T H E PRINCIPLE OF A N A N N U A L L Y BALANCED BUDGET The traditional goal of fiscal policy was to secure a balanced budget in every single year. But that objective has now proved impracticable and, besides, has serious disadvantages in principle. There is not even a clear or unique concept of "budget" to which the requirement of balance could be applied. For instance^ in the regular budget, bookkeeping transfers to the social security trust account are classified as expenditures. As a result of this, that budget may show a deficit at a time when the cash budget shows an excess of receipts over outgo. But even the cash budget may not be adequate to portray the effects of fiscal policy; taxes may have their impact when tax liabilities are incurred rather than when payment is made; purchases may have their impact when contracts are entered into rather than when disbursements are made. However, where a single budget concept is used in economic analysis bearing on stabilization policy we prefer the cash budget to any available alternative. Compared to the full span of the business cycle, a year is a short period of time. T o insist upon a balance in every single year is certainly undesirable and to attain it is probably impossible. T o attempt to raise tax rates every time there is a decrease in national income will only result in discouraging private consumption and investment at a time when these are most in need of expansion; on the other hand, to try to eliminate a tax surplus by cutting tax rates or expanding Government activities would serve to increase inflationary pressures at a time when they are already acute. If the budget were balanced in good years as well as bad, there would have t a be either big fluctuations in expenditure programs or severe and perverse changes in tax rates. T o vary expenditures in this manner would disrupt the essential services provided by government. Applied to military expenditures, it would mean a large defense program in boom years and a small defense program in depression years. This is both ineffective and wasteful. Government would be increasing its employment of resources when they were scarce and cutting down on their use when they were abundant. This, of course, would aggravate the fluctuations in private business. THE P R O B L E M OF CONTROLLING GOVERNMENT EXPENDITURES Annual budget balancing is, thus, both difficult in practice and unsound i n principle. But one great merit it does have: It provides a yardstick by which legislators and the people can scrutinize each activity of government, testing i t 7 MONETARY, CREDIT, A N D FISCAL POLICIES both for efficiency of operation and for its worthwhileness in terms of cost. Every Government program undertaken has to be paid for in a clear and unequivocal sense. The legislature and the Executive are required to justify additional taxes equal to the cost of any new program. This is a principle every citizen can understand. If dropping the principle of annual budget-balancing were to mean dropping all restraints to unwise and inefficient expenditure, grave damage would be done to our economic and political system. Were expenditures divorced entirely from the need for taxation, political opposition to extension of the Government's expenditure programs would largely disappear. The scale on which the public sector absorbs resources would grow beyond what was really desired by the people as a whole; sooner or later the country would find itself in a state of chronic inflation. Such inflation is a sign of weak government and comes from eagerness to spend without a willingness to tax. Accordingly, other general principles, other habits of thought and of action must be set forward to insure the standards of judgment and the selfdiscipline of Government's activities and to do better what the principle of annual budget policy attempted—though imperfectly—to accomplish. Experience shows that business activity has its ups and downs. There is thus a strong case for countercyclical fiscal action—surpluses in good times and deficits in bad. If we do not adopt such a policy deliberately we are likely to be forced into an imperfect version of it through the pressure of events. One of the major questions for the future is how such a policy can be administered with the restraint and efficiency that is supposed to be achieved through the balanced budget rule. If a flexible policy is to win acceptance, it must not be used as an excuse to introduce expenditure or tax programs that cannot be justified on their merits. Boondoggling should have no place in a rational fiscal program. We doubt whether it would be possible, or even desirable, to rely exclusively on fiscal action to offset fluctuations in private business. That course could easily involve changes of impractical magnitudes in taxes and expenditures; it would mean placing excessive reliance on one measure for achieving economic stability and growth; it would involve problems in forecasting beyond the reach of present knowledge and techniques. We can, however, reasonably expect that the budget be formulated in the light of economic judgment available that takes full acount of the actual course of events and should contribute to economic stability rather than aggravate instability. In view of uncertainties, part of the planning process should be preparation for quick adaptation of fiscal operation to changing circumstances. Certain automatic devices for bringing remedial forces quickly into play are in a stage where they deserve consideration. GUIDES TO FISCAL POLICY I N N O R M A L TIMES When the economy is prosperous and stable and there is no clear-cut reason to expect a change in any particular direction, the objective of policy should be to adapt the budget to changes in the Government's requirements but to leave its economic impact on total employment and purchasing power unchanged. This could be approximately achieved if newly planned increases or decreases in expenditures were to be matched with corresponding changes in planned tax receipts. The net expansionary or contractionary effect of the budget would then remain roughly the same. Thus, in conditions of continued prosperity, a modified version of the balanced-budget rule could be used as a guide: Taxes should grow or shrink corresponding to desired changes in expenditures. Thus, proposed increases in expenditures would be exposed to the traditional test of whether they are worth their cost in terms of taxes. However, if recent events and the outlook for the near future pointed, on balance, toward unemployment and deflation in the private sector of the economy, then budgetary changes should be made in the direction of producing a moderately expansionary effect. New Government expenditure programs should still be considered on their merits, but the additional taxation that in prosperous times would accompany them should now be deferred. Taxes that are deferred in these circumstances should be put into effect as soon as that can be done without impeding recovery. There should be no delay in making the tax reductions warranted by any reductions in Government expenditures; and if expenditure requirements are expected to decline in the future, anticipatory tax reductions could be enacted. On the other hand, if the weight of the evidence appeared to be on the inflationary side, the opposite policy should be followed. The rule that increased 8 MONETARY, CREDIT, A N D FISCAL POLICIES expenditures should be accompanied by increased tax yields should be rigidly followed. Tax reductions that would normally be in order should be deferred; and tax increases should anticipate expected increases in expenditures. G U I D I N G PRINCIPLES I N T I M E OF ACUTE RECESSION OR BOOM Where there is a definite expectation, justified by events, of serious recession or inflation, more strenuous fiscal measures would be called for, and the policies described above should be supplemented by emergency fiscal action. In the event of severe recession, it is not only politically necessary, but economically desirable to provide additional employment projects that can be started and ended quickly. Temporary tax relief should be given in order to stimulate private spending and employment. Other incentives for private investment, such as guaranties, should be considered. There can be no social or economic justification for allowing mass unemployment to persist for extended periods at a time when there is abundant need for roads, schools, hospitals, and other useful objects of public expenditures. However, we recognize that there are difficult questions of extent and timing connected with any such program. An overambitious Government program may impede the course of recovery in the private sectors of the economy by dislocating resources and delaying needed price adjustments. On the other hand, a program that was overcautious could needlessly fail to advance recovery by not stimulating the demand for the products of private industry. M u c h skill and judgment are required to move from depression to stable prosperity. We must not rely on the private economy, unaided by Government action, to perform that task. The Government must not shirk the responsibility placed on it by the Employment Act, and fiscal policy is one of the most promising instruments it possesses. On any occasion when serious inflation is in prospect, emergency measures would be needed to curtail expenditures and increase taxation. Wartime and postwar experience provides convincing evidence that the political obstacles to a fiscal policy adequate to combat inflation are so great that there is little practical danger of going too far. The survival of a relatively free and stable price system depends heavily on our willingness to fight inflation by fiscal methods. A policy that helps to maintain stable prosperity will be no more likely in practice to result in an upward trend in the national debt than one that does not. The course of events may in fact be such that stabilization requires steady reduction in the debt. Budgeting surpluses to fight inflation will provide for the reduction of the public debt in a helpful rather than a painful fashion. Surpluses are not feasible in times of depression. They are desirable where the private economy is strong enough for the Government to tax more than it spends without causing unemployment. The private economy is not likely to possess this strength if Government policies aggravate rather than offset business fluctuations. A D D I T I O N A L POSSIBILITIES FOR A F L E X I B L E FISCAL POLICY While we consider these guides for budget policy essential to a stabilization program, the annual budget cannot, in the nature of things, be based on precise forecasts; nor can it be expected to compensate for sudden and short-run fluctuations in business that occur within the period of its operation. Even though the budget can and should be amended in the light of changing circumstances, the legislative process is necessarily too cumbersome to make delicately timed adjustments in fiscal policy. Therefore, we consider whether further flexibility can be achieved by two devices which may be called "automatic flexibility" and "formula flexibility." "Automatic flexibility" means a tax system such that revenue under a given set of tax rates will fall sharply if unemployment develops, and rise sharply in the opposite case of inflation; and expenditure programs under which increased outlays arise from increased unemployment. "Formula flexibility" means a system under which preannounced tax cuts and upward revisions of spending programs will come into force if unemployment exceeds a certain figure or production falls below a certain level, and preannounced changes in the opposite direction if price indexes rise at more than a certain speed. AUTOMATIC F L E X I B I L I T Y Automatic flexibility is exemplified by the unemployment compensation system. If unemployment increases, employers' contributions at once decline, while the unemployed begin almost immediately to draw more in benefits. Thus 9 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES the Government finds itself automatically taking less money out of the public's pockets and putting more in. There are now many such flexible elements in Federal taxes and revenues, and they have greatly increased in importance with the growth of the budget. Besides the unemployment compensation system, there is, for example, substantial automatic flexibility in personal- and corporate-income taxes. Automatic flexibility can slow down and perhaps halt a decline of activity or a rise of prices; it can give time for restorative forces to come into play, but it will not, by itself, pull activity back to a full-employment level or restore prices to a pre-inflation level. We feel strongly that the existing automatic flexibility makes an important contribution to economic stability, which should not be frittered away, as it would be, for instance, by rigid application of the annual-balanced-budget rule. But we do not believe it prudent for policy to regard automatic flexibility as more than a first line of defense; more must be done to cope with serious economic fluctuations. FORMULA FLEXIBILITY The enactment by Congress of rules under which tax rates, and perhaps of rules under which expenditure programs, will shift in certain contingencies specified in advance is a possibility that deserves further exploration. For example, the period during which unemployed workers can draw unemployment compensation might be extended according to a flexible schedule based on the volume of unemployment. The withholding rate under the personal-income tax for any calendar quarter might rise by a stated amount above a standard rate whenever, say, the index of retail prices has increased by over a certain amount in the preceding 6 months. The withholding rate might be lowered whenever standard indexes of production and employment drop below stated levels or trends. The question of formula flexibility shades off into the question of granting to the Executive wider discretionary authority than it now possesses to initiate changes in the timing or extent of the fiscal program. This raises difficult issues of political principle and administration responsibility. We can here do no more than call attention to them. CONCLUSION In this statement we have confined ourselves to fiscal policy of the Federal Government. But, while essential, that is only one element in a stabilization policy. The policies of State and local governments can make useful contributions within their more limited spheres. Monetary and credit policies including debt management must play an active role in their own right and must be properly coordinated with fiscal policy. A l l necessary measures must be taken to preserve and stimulate competition. Supported by such measures, Federal fiscal policy offers the best prospect of achieving sustained prosperity within the framework of our existing economic system. Senator DOUGLAS. M r . Leland, perhaps I should ask one question before you go on. Is this statement approved by a group of economists who represent a rather wide range of opinion? Dr. LELAND. That is correct. As a matter of fact, when the conference first started, I had no hope that the assembled group would be more likely to reach a unanimous conclusion than all the economists you mentioned in your opening wisecrack about economists. T h e shades of opinion were really quite variant. This second statement is an attempt to apply the principles which we first formulated to the economic situation now prevailing or which is on the horizon. This statement, too, was unanimously agreed upon by the entire group: FISCAL POLICY I N T H E NEAR FUTURE A t present, September 1949, the economy exhibits no clearly discernible swing—either toward a resumption of inflation or toward increasing unemployment—which would call for a major change in tax rates or expenditures. If any substantial change were made, it might accentuate an inflationary or deflationary movement in 1950 instead of countering it. 10 MONETARY, CREDIT, A N D FISCAL POLICIES Past decisions on taxes and commitments on expenditures have resulted in a current deficit in the cash budget. We regard those decisions as unfortunate, in particular the decision in 1948 to reduce taxes; it would have been the course of sound policy to have revenues exceeding or, at the least, equaling expenditures at the present level of business activity. The latter, if lower than levels of a year ago, is still high and a modest cash surplus at the present time would probably be consistent with stability. But it is one thing to deplore past mistakes and another to correct them on short notice. It would be unwise to increase taxes at this time. Such action might in itself be unduly deflationary. There is a possibility that the step might soon have to be reversed to counter a business downturn. While we do not doubt that there are expenditures that can and should be reduced—and we do not regard those of any agency or department as sacred—this reduction must be part of a constant and continuing effort. Economy efforts cannot be turned on and off at will. Although no major change in fiscal program is indicated for the immediate future, the country should have positive assurance that the Government will be prepared to act promptly either if prices should display a sharp and continuous upward swing, or if unemployment should increase substantially. Congress should plan ahead and announce the actions to be taken in either contingency. It should enact preliminary legislation to be effective when needed. Congress should act in case of a decline in activity involving a genuine increase in unemployment of more than 1,500,000 persons above present levels. This would mean total unemployment of about 5,000,000 according to present methods of computation. The extent, combination, and sequence of its actions should depend upon the severity of the recession. The appropriate steps include, first, the repeal of the special wartime excise taxes. These taxes were enacted for various special reasons during the war and are not appropriate to peacetime. A second step is the temporary abatement of the lower-bracket rates or a temporary increase in the exemptions of the personal income tax. This should be done according to prearranged legislation to become effective when economic activity declines to a specific level. The revenues from other taxes would be allowed to decline, without a change in rates, as business activity fell off. If these actions were insufficient, additional measures should be taken. The period of unemployment benefits might be temporarily lengthened, with appropriate provisions for Federal reinsurance of the emergency risks. The plan to do this should be arranged and announced in advance so that workers could count on this protection. B y this measure, the system of unemployment compensation would be made adaptable to its differing role in times of prosperity and in times of depression. Public works might be expanded. The Congress should already have arranged for a stand-by shelf of planned and ready-to-start projects, including Federal assistance for State and municipal projects. We approve the principle, expressed in pending legislation, of a shelf of public works. We recommend the prompt enactment of legislation to this end. On the shelf would be only projects that are economically desirable, and that can be started promptly when the need for additional governmental spending arises, and completed or stopped promptly when this is no longer needed. Examples of projects of this nature are: Road construction, residential housing, and construction and rehabilitation of public buildings. Should there be a resumption of inflation, marked by a persistent upward surge of prices in general, Congress should be prepared to take effective counteraction. In this case increase of lower-bracket rates or lowering of exemptions in the personal income tax would be in order. Repeal of the wartime excise taxes might appropriately be postponed. If these taxes were already repealed, or their repeal were deemed necessary for reasons of equity, they should be replaced by equivalent sources of revenue. Finally, such inflation would be an occasion for strong measures to reduce public expenditures. T o cite specific examples, the starts of civil public works of all categories should be held to the practical minimum. The test should be whether there is serious economic loss from delay. M i l i t a r y construction should also be closely measured against the urgent present needs of the armed forces. Large farm benefits, either through support prices or in the guise of soil conservation payments, should not be tolerated at a time when, in any case, farm income is likely to be high. 11 MONETARY, CREDIT, A N D FISCAL POLICIES TAX REFORM A time like the present when no emergency exists should not be allowed to go b y without consideration of fundamental tax reform. This has two sorts of relation to stabilization policy: (1) Adjustment of the tax structure so as to make private business more nearly self-stabilizing—for instance, by providing more complete averaging of losses and gains. (2) Planning tax measures whose impact w i l l be stimulating or depressing so that they can go into effect at times when short-term policy calls for additional stimulants or depressants. For example, if we are to move toward integration of corporate and individual income taxes in a way which would reduce revenue, the effective date would appropriately come in depression. It is now, and doubtless always w i l l be, impossible to forecast more than a year in advance the revenue-expenditure policies best suited to varying economic conditions. It is our final recommendation that Congress be prepared both now and in the future to make prompt alterations i n the policies adopted for any fiscal year. I t must be recognized that this w i l l involve important changes in the organization and procedures of Congress for fiscal management. 1 Senator DOUGLAS. Thank you very much, Dr. Leland. Dr. LELAND. Thank you, Senator Douglas. Senator D O U G L A S . I wonder if for the sake of completeness, you would put into the record the names of the economists who have signed these reports. Dr. LELAND. I will be glad to do that. Dr. Howard R . Bowen, dean of the college of commerce, University of Illinois. Dr. Howard S. Ellis, professor of economics of the University of California, and now president of the American Economic Association. Dr. J. Kenneth Galbraith, department of economics, Harvard University. Dr. James K . Hall, professor of economics, University of Washington, Seattle. Dr. Albert G. Hart, professor of economics, faculty of political science of Columbia University. Dr. Clarence Heer, professor of economics, University of North Carolina. Dr. E . A. Kincaid, professor of finance, University of Virginia. Dr. Simeon E . Leland, professor of economics and dean of the college of liberal arts, Northwestern University. Dr. Paul A . Samuelson, professor of economics, Massachusetts Institute of Technology. Dr. Lawrence H . Seltzer, professor of economics and sociology, Wayne University, Detroit. Dr. Arthur Smithies, professor of economics, Harvard University. Dr. Tipton R . Snavely, professor of economics, University of Virginia. M r . H . Christian Sonne, chairman of the board of trustees, National Planning Association. Dr. Jacob Viner, professor of economics, Princeton University, and the past president of the American Economic Association. Dr. Donald H . Wallace, professor of economics, school of public and international affairs, Princeton University. I might say that the document was sent to both Professor Ellis and Prof. Sumner Slichter, Thomas Lamont professor of Harvard University—the president and a past president of the American 1 Since the original release of these two reports they have been submitted to the N a t i o n a l P l a n n i n g Association labor and agriculture committees, which unanimously approved them " i n principle, but not necessarily i n detail." 12 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Economic Association. The document on policy was signed by both Ellis and Slichter. Slichter did not sign the document on advice with respect to the near future, but Ellis did. Senator DOUGLAS. M r . Leland, do you mind if I address a few questions to you and I understand Dr. Smithies is here with you, so that you can parcel out the questions between you as you wish. I wonder if you would state for the sake of the record why you approve of the deficit financing in periods of depression. D r . LELAND. We have tried to make those statements i n the document, and I think that any statement that we might make in words or phrases that are not those of the document had better be taken as our own personal opinions Senator D O U G L A S . I understand that. Dr. L E L A N D (continuing). And not standing for the opinions of our colleagues, who are not here to speak for themselves. So much of the statement is a matter of personal wording that I would hate to speak for any of them. M y own position is that whether we will it or not, every dollar of money taken in taxes, or every dollar of money spent, or dollar borrowed, has some effect upon the economy, so that irrespective of whether we intend to have a surplus or intend to have a deficit in any particular period, the action of the Government will have an important effect in determining, or helping determine, the volume of income flow and the volume of production; that unless the policies are conceived in advance, and are determined so as to direct those flows in proper directions, results which are neither desired nor anticipated may occur. If, then, you are interested in a government that has volumes of expenditures of the size that we now have, where they represent something like 20 to 25 percent of the total spending or the total of the purchasing power flows i n the economy, it is desirable that the effects of those operations be the kind that are needed to help maximize human well-being and economic welfare, so that when private business is unable to provide all the employment, or produce on its own all the goods that are desired, and there remains substantial numbers of unemployed, it is desirable to have the Government, through its taxing and spending policies, influence the total volume of production and employment. Y o u cannot let the task fall completely to the private sector of the economy at a time when unemployment is growing, and the result is that a deficit which will finance that employment is desirable in the interest of maximizing economic welfare. M r . Smithies can undoubtedly give you a shorter statement as to why we would prefer that very policy. D r . S M I T H I E S . I can give a shorter statement, but I do not think it will be a better one, M r . Chairman. I would like to say two things: First, it seems to me that experience in the past has demonstrated that it is impractical to avoid a deficit in times of depression. B o t h the Hoover administration in the 1930's, and the Roosevelt administration in its early months, made strenuous efforts to balance the budget, and found that it was quite impractical. The second point is that it is desirable not to have a balanced budget in times of depression because it is important that the Government generate more purchasing power by spending money than it contracts 13 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES purchasing power by taking money away in the form of taxes. A t a time when economic resources are unused, we do not see any justification for leaving them unused for extended periods of time when the Government could put them to work. Dr. LELAND. M r . Sonne might have a statement of his own on that. Senator DOUGLAS. M r . Sonne, would you like to comment? M r . SONNE. I would say that there is, first, the question of why this problem arises. W h y can we not have a stable economy all the time? It is interesting to contemplate that if you had a country with ideal laws, antitrust laws, stable prices, and so forth, for a certain period, it could not remain like that because of increased productivity. Man, by using his ingenuity, learns to do things better and better in a shorter time as each year goes by. So there would invariably come a period when prices would begin to fall, and then human nature would dictate that citizens abstain from buying because they think prices would fall further. Then you would find that they would save, would not spend; the result is unemployment. There would be a further drop in prices until the developments rectified themselves. Now, what should we do in such circumstances? It seems to me clear that when a large group of citizens withhold their savings for a period of years, and then suddenly, when they think it is all over and begin to buy, let us say, motorcars, that you cannot expect the motorcar factory to keep pace with this sudden demand. After 5 years of no business the manufacturer would not be able to produce suddenly all the cars the public wants. Consequently, it seems that the Government ought, during such a period, to see to it that enough purchasing power is distributed amongst those who will consume to keep the economy going—in this case a motorcar factory. There is nothing unsound in it as long as the Government pumps into the economy no more than what private individuals have saved. The Government would be able to get back its expenditures when people again were willing to spend their past savings. I can put it in another way, as a farmer—which I happen to be originally. A farmer will hire 100 men to work pretty hard when he sows and when he harvests. Then in the old days when the winter came there was a period where there was little to do. H e would not throw the workers out. H e would say, "Boys, I will feed you and will use the winter months to paint the barn and get our machinery in shape, but instead of working 50 or 60 hours a week, like we did in the summer, we can all work less." Now, he can afford to spend the money to keep the barn in shape and keep those boys employed even if, perhaps, they are not fully employed, because he knows that very soon there will be another spring and another crop. Now, this can be compared to the cycles in depressions and booms. If we have a depression, it is equivalent to the winter. W e should fix the barn, and that means we should build roads and Government buildings. T h e farmer can do this normally because he knows exactly when the crop is coming, but the unfortunate thing with private industry is that when it comes to booms and depressions, businessmen do not 99076—50 2 14 M O N E T A R Y , CREDIT, AND FISCAL POLICIES know with the same certainty when the depression will be over. Hence, the Government, in some form, must take a hand in it. Senator D O U G L A S . I noticed that in dealing with depressions, you favor a double-barreled program. On the one hand, you favor decreasing tax rates or eliminating certain taxes, and also, on the other hand, expanding governmental expenditures. D i d you reach any rough agreement as to the relative emphasis to be given to each of these? Dr. L E L A N D . I do not think we had any agreement, or even attempted to get an agreement, as to the magnitudes of one or the other. Senator DOUGLAS. There are certain groups who feel that the sole method of dealing with a depression is an expansion in governmental expenditures, while on the other hand, there are others who say that the sole way of dealing with a depression is by a curtailment of taxes. Y o u apparently advocate both, and I wonder if you could give advice to hard-pressed legislators as to the relative importance to be given to each of these. D r . Smithies, do you have anything to say on this topic? D r . S M I T H I E S . I do not think any formula would meet the needs of the case, M r . Chairman. I think decisions must rest on a broad economic judgment of what is required. Reductions of taxes will leave more money in the hands of the taxpayers, and will stimulate spending by them on the goods produced for private consumption or investment; whereas Government expenditures, for instance, on public works and projects, will benefit the community through the results of the projects. I think the correct policy depends very heavily on the economic judgment as to what the community really needs. If it needs more dams and roads, then it may be appropriate to stress expenditures. If it is the judgment, say, of your committee that we are relatively well supplied with public works, it would be more appropriate, I think, to lay stress on tax reduction, and allowing private consumers to get the benefits of the recovery policy. Senator DOUGLAS. It is sometimes said, however, that while a reduction of tax rates, particularly in the upper income brackets, would release purchasing power to potential consumers, this purchasing power would not be fully utilized because of the fact of hoarding, and that therefore reductions, let us say, of 5 billions in taxes would not reflect themselves in 5 billions of expansion in private purchasing power; whereas, in public expenditures, each dollar that is spent, in the main, going to lower-income groups, would result in a higher rate of expenditure by those receiving the amounts. D r . SMITHIES. I think this is a difficult question which must be the subject of further statistical research. I know it used to be the commonly held belief that reductions in high-bracket income taxes would not stimulate more spending; I think more recent research into consumer expenditures has thrown some doubt on that conclusion and has more or less tended toward a conclusion that reductions of all taxes might help. This, I might emphasize, certainly was not discussed in our committee, and it is a highly controversial matter. Senator DOUGLAS. A l l the budgetary studies that I have seen seem to indicate that as income increases the increase in the rate of savings is greater than the rate of increase in income; so that the income 15 M O N E T A R Y , CREDIT, AND FISCAL POLICIES elasticity of savings is greater than unity. If the savings are not translated into investments, as is frequently the case during a depression, then would not that mean that the reductions in taxes would not be as effective as an increase in expenditures? Dr. S M I T H I E S . I think you would have to draw a distinction between what people do on the average out of their incomes and what they do when their incomes increase or decrease. Undoubtedly highincome people save more than low-income people. That is an unquestioned fact, but from that it does not necessarily follow that a highincome person would spend less of an addition to his income than a low-income person. A high-income receiver might save, on the average, 50 percent of his income because of, say, life insurance commitments and other savings commitments, but if he got an additional thousand dollars, he might spend almost 100 percent of that addition. A low-income person might be spending a hundred percent of what he already had and might spend a hundred percent of any addition to his income. But, as I say, I do not want to commit myself on that point; I want to keep an open mind on it. Senator D O U G L A S . The advocates of deficit spending are sometimes accused of proposing policies that lead to a secular rise of Government taxes and spendings. It is said that they favor an increase of spendings during depression, but when prosperity and boom come around they favor a rise of taxes and no decrease of expenditures. The result is therefore said to be a continuous expansion in Federal expenditures, with the compensatory device of added expenditures being used in periods of depression, but with no tapering off of expenditures in periods of prosperity, and instead merely added taxes at that period. Then, when the next depression comes, that is sometimes used as a jumping-off place for added expenditures, so that in the long run you get a tremendously accelerated secular trend in expenditures which eats into the private economy. I wondered if any of you wanted to make statements on that question. Dr. L E L A N D . I certainly do. I want to call your attention to the fact that the entire group of economists was agreed that a cyclical fiscal policy requires attention to both sides of the Federal taxing and spending program in each phase of the cycle. B u t when it came to a depression, we not only advocated increases of expenditure where necessary to increase employment and production, but likewise decreases in tax rates. A n d conversely, in periods of prosperity, we advocated not merely increased taxation, but decreased expenditures, with some hard words in here, as hard as we could get in, to the effect that we did not think that the ideals in this respect had yet been achieved. Senator D O U G L A S . Well, I am delighted to have that statement, because I think that point has not been sufficiently stressed by the advocates of a compensatory fiscal policy in the past. Dr. L E L A N D . A n d I think one other thing ought to be added to that: If you are going to have a compensatory fiscal policy, all of the other policies of the Government should, if they are to have the greatest impact upon the economy, be consistent with it, and that means that you have a countercyclical policy not merely with respect to taxes and expenditures but also with respect to money and credit policies, with 16 M O N E T A R Y , CREDIT, AND FISCAL POLICIES respect to administration, with respect also, let us say, to regulation of certain other activities. Senator FLANDERS. M r . Chairman, may I ask a question just at this point? Senator DOUGLAS. Y e s . Senator FLANDERS. Would you say that it would be good policy for the Treasury to start or continue a heavy E bond campaign during a period of depression? Dr. L E L A N D . I do not think the E bond campaign in a period of depression makes any sense whatever. I would say likewise I am not too much sold on it in a period of prosperity. I would much prefer compulsory saving at that time to a voluntary effort—I would prefer compulsory saving to voluntary saving. B u t whatever the policy is, it ought to be consistent. T o try to increase savings in a depression when the desideratum is increased spending, is wholly inconsistent, Senator. M r . SONNE. M a y I add, Senator Flanders, that this is more in the area of monetary policy. Senator FLANDERS. That was not within the framework of reference which would M r . SONNE. I believe all economists would entirely agree with M r . Leland. Senator F L A N D E R S (continuing). Be under which you worked. I realize that. M r . SONNE. I would just like to say that although economists did not put down any particular rule about the order in which events or these measures should be taken, there was one very definite thing on which they all agreed—automatic flexibility. If you do not increase the tax rates as things get worse, you get automatically a deficit. As they say in the report, they regard that as "more than a first line of defense," meaning that knowing that this automatic thing was working, there should be a breathing spell within which Congress could decide which of all these other steps ought to be taken, with due regard, as Dr. Smithies said, to what the country needs. There was unanimous agreement on that. Senator D O U G L A S . N O W , we have briefly gone over the recommendations for cases of depression and for cases of boom. What would you advocate in the intermediate periods which can, I suppose, be designated as recessions or mild prosperity? Dr. LELAND. Well, at that point, the group tried to formulate a statement that no major changes should take place They did say two things: On the taxation side, that such a period was an ideal time in which things that ought to be done that did not have material fiscal impact ought to be undertaken. I t is an appropriate period for improving the tax system for its own sake. Similarly, it is also a period when efficiency and improvements in efficiency might well be emphasized, although the committee was agreed that any time, irrespective of the cycle, was an appropriate time for such activities. B u t when there was no perceptible trend, then the action should be such as would not make any material impact upon the economy, either in the direction of producing conditions which might tend to have an expansionary effect or, conversely, those which would tend to have a deflationary effect, 17 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. It is very difficult to pick out the dividing lines, but we have to make decisions here in the midst of circumstances, and I think what puzzles a great many of us is this: When does a recession become a depression? When does mild prosperity become a boom? It is all well and good to lay down these general rules, but are there any specific guides that you can set up as to that? Dr. SMITHIES. Could I touch on that, M r . Chairman? Senator DOUGLAS. Yes. Dr. SMITHIES. That, of course, is the essential and difficult problem from the point of view of the Congress and we struggled with that in our statement, and we have three possible cases. The first one is: When the economy is prosperous and stable and there is no clear-cut reason to expect a change i n any particular direction, the objective of policy should be to adapt the budget to changes in the Government's requirements but to leave its economic impact on total employment and purchasing power unchanged. T h i s could be approximately achieved— and we underline the word "approximately"— if newly planned increases or decreases in expenditures were to be matched w i t h corresponding changes in planned tax receipts. Our group did not go into the question of procedures in the Congress, but if I might give a personal view on that, it seems to me that the practical way in which such a rule could be implemented would be essentially through the operation of your committee. I imagine your committee, in its hearings, would make a judgment on the economic situation. If it found that there was no clear-cut reason to expect a change we would recommend that you suggest to the financial committees of the Congress that if they increase expenditures they should enact corresponding increases in taxation. Senator DOUGLAS. Well, we held such hearings i n February, and certain very reputable economists appeared before us and testified that the danger was acute inflation, and that we should take steps to reduce inflation by a high-tax policy, and various other methods. Now, within a period of 2 months, those prophecies were clearly not borne out by facts, and exactly the opposite happened. M r . SONNE. I think you will find, Senator Douglas, that in the second document we give a certain guidance there. We, first of all, say, " A t present"—which was last week end—"the economy exhibits no clearly discernible swing." A n d then we say that Congress should act in case of a declining activity involving a genuine increase in unemployment of more than a million and a half. Senator DOUGLAS. A total of 5 million. M r . SONNE. Meaning, as a guide, 5 million. Senator DOUGLAS. I was very much interested in that figure of 5 million, because it so happens that it was the rough benchmark which I have used in my mind. It comes to about 10 percent of the nonagricultural working force, or about 8 percent of the total agricultural and nonagricultural working force. M r . P A T M A N . M r . Chairman, may I ask a question here? Senator DOUGLAS. Please do, and do not let me monopolize the questioning. M r . P A T M A N . That is all right. 18 MONETARY, CREDIT, AND FISCAL POLICIES Early i n your statement on Fiscal Policy in the Near Future you say, " T h e country should have positive assurance that the Government will be prepared to act promptly either if prices should display a sharp and continuous upward swing, or if unemployment should increase substantially." Now, you place No. 1 there, the upward swing, and the No. 2, unemployment. D o you consider that there is danger of inflation at this time more than unemployment? Dr. L E L A N D . Y O U are asking me my personal opinion? M r . PATMAN. Well, you explained a moment ago that any opinion you expressed would be a personal opinion. Dr. LELAND. Yes. Well, I do not see any marked signs that prices are likely to move sharply upward or that we are in danger of much in the way of inflation at this juncture, or that it is to be a likely event in the months immediately ahead of us. Y o u understand that is my own personal opinion. M r . PATMAN. But, do you believe that there is more danger of an inflationary condition than there is a deflationary condition? D r . LELAND. Well, that depends, I think, in part upon the general effect of the demands for increased wages, and the continued high cost, high unit cost levels, with respect to labor. M y own general feeling is that if conditions are not much different than they are now, the general drift is down, with some pick-up in the volume of business activity this fall. M r . PATMAN. I would like to know if these other two gentlemen would like to express their views on that subject, too. M r . SONNE. I would like to just answer your question here. Y o u mentioned that we said first, upswing, and then, unemployment. M r . PATMAN. Yes. M r . PATMAN. Yes. M r . SONNE. I would like to confine myself to the document. Where we stated that there was no clearly discernible swing I think we felt that Congress should be ready to act, in the case of either alternative, either an upward swing or downward swing. W e suggested that a downward swing be judged by the number of unemployed people, whereas with regard to the upward swing, we suggested using price indices as a guide for. M r . P A T M A N . N O W , the second question, would you mind commenting on it? Are we more in danger of deflation or inflation? M r . SONNE. There you ask for a personal opinion, and I may say that we were careful to put in the statement, "September 1949." I would have preferred having the date fixed as that of the last week end, because no sooner was this statement made, than sterling went down to $2.80, and it is difficult to know what the repercussion would be. M r . P A T M A N . Y O U are not expecting any repercussions in this country to amount to that, bad repercussions? M r . SONNE. Repercussions about sterling? M r . SONNE. That remains to be seen. Y o u see, the answer is that when it comes to prices we, in this country, may well know that this had to be, but the people who determine the price of a number of commodities, such as burlap, coffee, cocoa, are not the Americans, but the people who sit in Africa, India, and South America. The 19 M O N E T A R Y , CREDIT, AND FISCAL POLICIES question is, W h a t repercussions will the drop of the pound sterling have on these business decisions and outlook? Whether we wanted it or not, commodity prices in certain instances have dropped materially. I t is very likely that there will be only a short period until we will know the outcome, but I would have said, with more confidence last week than this week, that there is no discernible trend. M r . P A T M A N . N O discernible trend? M r . SONNE. Either up or down, we said last week. M r . PATMAN. Either way? M r . SONNE. E i t h e r w a y . Today, if I sat in Congress, I would say " L e t us be a little more prepared on the downward side than the upward side because the chances are that if there is a change, it will be downward." M r . P A T M A N . Y O U think that is more likely than upward? M r . SONNE. Yes; but I say both are within the realm of possibility. M r . P A T M A N . I would like to have this gentleman's opinion with respect to that. Dr. SMITHIES. I would agree with that possibility. I agree there is a possibility of further inflation, and there are further possibilities of recession. I believe that the possibilities of recession rather outweigh the possibilities of further inflation. Incidentally, I do not happen to agree with M r . Sonne on the effects of the depreciation of the pound, but to go into that would lead us too far afield today. However, I do feel that the possibilities of depression do not sufficiently outweigh the possibilities of expansion and prosperity to warrant any emergency action or any change in policy at the present time. B u t I fully agree with this report that advance preparation should be made. Could I just revert for a moment to your initial question, because I think this illustrates the basic difficulty? We have gone at great pains in this document to stress the inability of people to forecast, and we know that some of us, as economists, have frequently been wrong. Nevertheless, someone has the task of preparing a budget at this time of the year to take effect over the following fiscal year. A l l we can say here is that it has to be prepared on the basis of the best economic judgment available, and I imagine it is one of the functions of your committee to take what economists say to you with the necessary grains of salt. Something has to be done, and we cannot hope that those forecasts or that judgment will always be correct. That is why we say that the judgment that is applied to the annual budget this time of the year to take effect the following fiscal year has to be supplemented by preparations for these emergency and extraordinary measures that may have to be taken during the year. M r . PATMAN. Just one other suggestion that I want to make here, to be more practical and to be more specific: D o you not think this $2,800,000,000 paid to veterans the early part of the year, commencing in December, will have a tremendous effect on our economy? Dr. SMITHIES. I believe it will have a strong stimulating effect. M r . PATMAN. Concerning the payments being made to World War I veterans, I have not seen any mention of it in the newspapers. Dr. SMITHIES. The veterans' bonus in 1936 did have a powerful stimulus. 20 MONETARY, CREDIT, AND FISCAL POLICIES M r . PATMAN. A n d that was only less than one-half, about 40 percent. Dr. SMITHIES. Payment of the dividend enters into our judgment on this matter. That is one of the expansionary factors that offset the possible deflationary factors. M r . PATMAN. There is another factor that I have never seen discussed i n the newspapers or the radio. There are between four and five hundred thousand veterans of World War I who kept their policies, and who have been receiving an enormous increase i n their spending power. One veteran had two $5,000 policies, and he received $225 on one and $120 on the other, $345 on those two policies, and that has gone on all over the country recently. I have not seen that in the newspapers. That is bound to be an enormous amount of money, and the $2,800,000,000 is bound to have an influence on our economy. I believe you agree with that? D r . SMITHIES. Yes. M r . BUCHANAN. M r . Chairman, relative to military expenditures in the budget for fiscal '50, was there any agreement or climate of opinion so far as that subject is concerned as to present Government policy? Dr. LELAND. We did not discuss what you do with the present military budget or what you should do with it, but everyone was certainly agreed that military expenditures are no more sacred than any other expenditures, and one of the places to look for economy at all times is in the military budget. There is an adage, you know, that if you want either to cut expenditures or to operate upon revenues, you have to look where the money is. Y o u do not find money either where it is not possessed or it is not being spent, and there was agreement that those budgets and those requests should be looked at in the light of the policies indicated with the necessary qualification, of course, that the defense and the international position of the country has to be considered. Senator FLANDERS. M r . Chairman, I would like to ask D r . Leland whether the net result of this document would indicate, perhaps, a long-term reduction in the national debt rather than a long-term increase in it or a long-term balance. D r . LELAND. Well, I think—and this is purely a personal opinion— that the document itself would indicate over the long run some decrease in the public debt. It implies, of course, that there will be expansion in the public debt during periods of depression, and at times when there are budgetary deficits. But, conversely, it implies although it does not say so definitely and specifically, that this is a part of the field of fiscal policy that needs to be more comprehensively covered by a specific inquiry into the money and credit policy, but I think that the implication of the recommendation for a surplus is to the effect that those surpluses would in the end be used to finance reductions in the national debt. Senator FLANDERS. Perhaps, it is outside the task to which you set yourself to answer this question, but I will ask this also: D o you feel that there is anything in the secular decrease in the debt that is a worthy objective in itself? Dr. L E L A N D . T O state now whether or not I think that debt payment, irrespective of the cycle is worth doing? 21 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator F L A N D E R S . N O ; I am talking about a secular decrease. Is that a worthy objective, and does it have a determining effect on these policies? Dr. LELAND. If that means a reduction of the debt in good times, and its expansion in poor times, I think you will find that there is some disagreement of opinion among the economists as to the way it ought to be handled. The general statement is to the effect that you run deficits in depressions, and you retire the deficits during booms. M y private opinion is that if you take that as the policy, the payment of the debt in the boom contributes to the boom, and adds to the inflation. M y feeling is that prosperous periods are the times to impose taxes for the purpose of debt retirement, and that the money collected for that purpose should be sterilized and kept out of the monetary system, and that during the depression and the beginning of the depression, is the time to pay the debt, and that this policy will lessen the total amount that necessarily must be borrowed. So that it really means the imposition of high taxes in boom times, the sterilization of the funds collected during the boom, and then the initial repayment of the funds, and the payment of the debts to the holders of the debt during the depression. Senator F L A N D E R S . I S this sterilization which }rou are talking about to be accomplished by preference retiring of bank indebtedness rather than privately held indebtedness, or are there other means? Dr. LELAND. That is one way. The other way, of course, would simply be to sterilize the fund and put it in an independent treasury, which is not connected with the banking system. Y o u could ship that down to Fort Knox, along with the gold. Senator F L A N D E R S . Y O U could ship paper as well as gold. Dr. L E L A N D . Y O U might, yes, that is right. [Laughter.] Y o u asked for another possibility—understand, I am not recommending that; I just added that to the sum total of things that might be done—but the action on the bank-held debt is the most hopeful way of meeting that situation. Senator F L A N D E R S . Y O U regard the principles of your report as following the Keynesian theory of economics? Dr. SMITHIES. I would like to add a word about what Dr. Leland has said about the national debt. I think there we are entirely in the field of personal opinion. Our group certainly did not consider what the course of the national debt would be in the future, and I would not like to give the impression that we are trying to provide anyone with an easy way to reduce the national debt. It seems to me that the future course of the national debt will be determined by events. I t will not be determined by the budgetary policies followed by the Government. If we have more depressions in the future than we have booms, I think we will inevitably have an increase in the national debt. If we have more periods of inflation in the private economy than periods of depression, we shall have retirement of the national debt. B u t it seems to me it is quite impossible to forecast what the course of the national debt will be in the future. We do feel, as we say i n this document, that we feel reasonably confident that the policy we recommend here will not result in any 22 MONETARY, CREDIT, AND FISCAL POLICIES reater increase in the national debt than any other policy that might e adopted. We believe that if you adopt a prosperity policy, you may in fact have periods of prosperity in which you can retire the debt, whereas, if you do not do it, you may have periods of chronic depression where you will inevitably have large deficits. Senator FLANDERS. What you are saying is if the purposes set up in the statute by which the joint committee was set up are successfully effected, then the national debt will be reduced. Dr. LELAND. Over a period of time. Senator FLANDERS. Over the long time. I n other words, if we are successful, on the whole, in maintaining high employment and production, then probably the national debt might conceivably diminish cyclically—not cyclically, I mean secularly. D r . SMITHIES. I think it has to be put rather carefully. It seems to me that you can say that, if the inherent strength of the private part of the economy is sufficiently great, the Government may be able to afford to tax more than it spends without impeding prosperity. B u t that is a different thing from saying that the policies of the Employment Act, if they are carried out, will result in debt retirement, because you may, in fact, need deficits to attain the objectives of the act. Senator FLANDERS. Yes. Dr. LELAND. I want to add to that point. I want it to be perfectly clear to all those present that in replying to that question I was replying for myself alone, and, secondly, I would reply to part of the question that was asked with respect to the cyclical aspect and not to the secular aspect that you put to M r . Smithies, because there I happen to believe in the necessity for the secular long-term reduction in debt, and M r . Sonne Senator FLANDERS. I was going to say that M r . Sonne looks to me, M r . Chairman, as if he might have an idea in his mind, and I would like to ask him to make an observation. M r . SONNE. I felt that I would like to report what I think was the consensus—although not necessarily a hundred percent. I think it is fair to say that the majority of economists at the meeting do not like debt for debt's sake. Dr. SMITHIES. I do not think any economist likes it for its own sake. M r . SONNE. If for no other reason than that interest charges would come back in taxes. Now, they say it is impossible, as D r . Smithies says, to engage over the years in a discussion as to whether there are going to be long periods of recession or good times, but it is conceivable that at the end of, let us say, a 30-year period, under this policy our debt will be reduced. It is also conceivable that it will be larger. If it is enlarged, it will be regarded as a lesser evil than to have unemployment and bad times. They also go so far as to say that if it is enlarged through the exercise of this policy, it would also have been enlarged as a result of the old-fashioned idea of balancing the budget, because we simply would not be able to do it. I think that is a pretty fair statement, as I say, but I think most of them expressed the hope that over the years it will be reduced, although they do not necessarily think that it will happen. 23 M O N E T A R Y , D r . SMITHIES. CREDIT, AND FISCAL POLICIES Yes. Senator F L A N D E R S . I started to ask another question, and that was as to whether the ideas in the report followed the, what we have come to consider as, Keynesian philosophy in economics. D r . L E L A N D . I would like to say on that score that I do not think that M r . Keynes is entitled to credit for the belief that the budgets of governments ought to be cyclically unbalanced. I think he is entitled to considerable credit, along with other people, for having argued that way, and seen the consequences of it, but most of M r . Keynes' contributions to economics fall in the field of monetary, banking, and employment policy rather than particularly with respect to the fiscal operations of the Government. It happens that in this particular case they coincide, and the reasons are harmonious, but the general belief in unbalancing budgets, I think, was prevalent before M r . Keynes wrote his first book upon this topic, and many others have pointed to the intimate connection between the public and the private economy and the role that the Government plays in.influencing the effect of business activity. So, it is both in the tradition of the Keynes' doctrine, and it is completely apart and outside of it. Senator FLANDERS. Dr. Smithies, I have had the general impression that Keynesian ideas were rampant in the institution of which you are a part. D o you want to give your comments on that? [Laughter.] Dr. SMITHIES. W e are inhabited by all shades of opinion. I would like to say that I deplore the practice of labeling people as Keynesians or anti-Keynesians. However, certain fiscal ideas have been labeled "Keynesian," and I think this document is undoubtedly indebted to those ideas, but it does stress an aspect of the matter that has been insufficiently stressed in the literature—the necessity of keeping adequate control over the size of Government expenditures. That leads me back to one of the questions that Senator Douglas put before, whether the kind of a policy we suggest leads to high expenditures in depression times and high taxes in boom times. For all that has been said in this so-called Keynesian literature, that problem, so far as I know, has never been adequately dealt with. We believe the essential budgetary principles must be maintained if we are ever going to get rational consideration of fiscal policy. I think, therefore, our report differs from what is usually labeled— perhaps wrongly, as M r . Leland says—as Keynesian, by stressing that point. Senator FLANDERS. Of course, that leads up to the practical question of how we are going to put the principles mentioned into operation here in a politically minded Congress. Have you any suggestions to make on that? Dr. SMITHIES. It seems to me, as I said earlier, that it depends very heavily on the success of your committee. I do not think there is any magic, from what I know of the Congress, in reorganizing the Congress because, whatever the organization adopted, most Members of Congress are chiefly concerned with particular programs of government. I n my opinion, it is necessary to get an economic point of view superimposed on the consideration of the particular programs, and I think every economist who feels the way we do welcomes very heartily the Employment Act, the establishment of 24 M O N E T A R Y , CREDIT, AND FISCAL POLICIES this committee and the establishment of the legislative budget under the Legislative Reorganization Act. I feel that the ideas we express here can only be brought into play by a sort of educational process which, I am very happy to see, your committee is making strenuous efforts to carry out. Senator F L A N D E R S . Y O U also spoke of examples of projects which could be started and stopped, increased or diminished, and you mentioned residential housing. I think one of our achievements has been in introducing the idea of flexibility into the public housing plan. D r . LELAND. T h a t is right. Senator FLANDERS. A n d that is a definite step in the direction of your report. I note in the report, before the subheading of " T a x reform," your statement with regard to large farm benefits. There, of course, you strike a field in which there is intense political thinking at the present time, and it is an example of the difficulty that Congress has i n coming to an economic conclusion in the face of strong political forces. I do not think it would be proper for me to ask you how we are going to handle that political problem, but I think we will have to recognize that it is there. Dr. LELAND. I think it would be equally inappropriate, Senator, if we gave you advice. We faced that problem squarely. W e recognize that this is a document on economic policy, prepared for a branch of the Government that is our most important political instrumentality. W e are familiar with the difficulties that face Congress at any phase of the cycle. For instance, in the depression, I think there is ample evidence to indicate that during the last depression Congress did not spend enough; just as during the period of prosperity recently passed, they did not tax sufficiently, and we are familiar with the difficulties which face the Congressmen in increasing taxes, which are notoriously unpopular at any time; and similarly decreasing a spending program which may equally be unpopular at another time, so there is no counsel of perfection to be given here at all. We are mindful of the problem, but unless the consequences are clearly realized, we will never get to a point where we can get movements, at least in the right direction. Senator FLANDERS. M r . Chairman, I have finished the questions I wanted to ask. I just want to comment that it seems to me that these two documents are extremely valuable. I do not know when we have had anything since the committee has been in active service that is more simple or more clear or more useful than these documents that have been presented to us this morning. Senator DOUGLAS. Congressman Buchanan? M r . BUCHANAN. M r . Chairman, I believe that since the document is so warm at the present time, it should be brought to the attention of the entire membership of the Congress, and I would like to request that you, as the chairman of the subcommittee, see to it that it is incorporated in the record, if you will, and if it meets with the wishes and comments of the other members of the subcommittee. Senator D O U G L A S . D O you have questions? M r . B U C H A N A N . N O questions. 25 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . I must apologize to both Congressmen Buchanan and Patman for taking up so much of the time. M r . PATMAN. That is expected of the chairman. Y o u mentioned blocking off of a part of the national debt a while ago and you suggested that we could just put it down in Kentucky where we have gold, and it might be a good thing and get it out of the way. Could you not do the same thing by having the Federal Reserve banks buy up a part of the national debt, especially that which is owned by the different local banks, that is so inflationary, and freeze it, not put it in circulation? Dr. LELAND. Certainly, if other measures were taken to prevent the Federal Reserve funds from adding to excess bank reserves. M r . PATMAN. That would be the same thing. Dr. LELAND. Yes. M r . SONNE. A n d save some interest, by the way. Dr. LELAND. Oh, yes. Those are possibilities that a group considering money and credit policies ought to consider. M r . PATMAN. This gentleman here, being a farmer himself and having given a great deal of thought and study to the different farm plans, I wonder if he has come to any conclusion on the Brannan plan? M r . S O N N E . I would be happy to discuss that question with you unofficially, because it is slightly outside the sphere of this hearing. M r . P A T M A N . I will not insist on it. That is all, M r . Chairman. M r . SONNE. I am very much interested. Senator D O U G L A S . I was puzzled by Congressman Patman's question and your reply. Suppose the Federal Reserve, with a surplus, were to buy Government bonds held by member banks i n the open market. Would that not give to the member banks a credit deposit with the Federal Reserve System which could also operate as an inflationary device, and that, therefore, it would not be deflationary? M r . PATMAN. Which could be easily corrected b y raising the reserve of the banks. Senator DOUGLAS. D r . Leland, do you want to make any comments? Dr. L E L A N D . I think the question of whether it is deflationary or inflationary is determined by the sources of funds that are used to retire the debts. It is the taxes that are imposed that get the money that are deflationary, whereas, the very fact of retirement, as you point out, may put money into the hands of the banking system unless accompanied by changes i n the reserve ratio and voluntary abstinence i n the use of those funds. Y o u cannot get a complete answer without tracing through all of the effects, first, from where the money comes; then, second, the effects of what it is used for, and how the purchasing power either is withheld or goes back into the total economy. The mere payment may simply restore the purchasing power at a different spot and may offset all the good that is accomplished by the taxes imposed. Senator DOUGLAS. Well, as we move on into money and credit policy, I see that we will have some ticklish problems there. Congressman Patman, do you have any questions? M r . P A T M A N . N O questions. 26 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Congressman Buchanan? M r . B U C H A N A N . N O questions. M r . PATMAN. Remember, I am not criticizing you for taking the time that you did. Y o u r questions were very constructive. Senator D O U G L A S . I have a guilty feeling of taking more time than I should have, and I want to apologize M r . P A T M A N . N O apology is needed. Senator DOUGLAS. A l l right, gentlemen. Thank you very much. (Whereupon, at 12:30 p. m., the subcommittee adjourned, subject to the call of the Chair.) MONETABY, CREDIT, AND FISCAL POLICIES WEDNESDAY, NOVEMBER 16, CONGRESS OF T H E U N I T E D 1949 STATES, SUBCOMMITTEE ON M O N E T A R Y , CREDIT, AND F I S C A L POLICIES, JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to notice, at 10 a. m., i n the caucus room, Senate Office Building, Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senators Douglas (chairman of the subcommittee) and Flanders; Representatives Buchanan and Wolcott. Also present: Dr. Grover W . Ensley, acting staff director, and Dr. Lester V . Chandler, economist to the subcommittee. Senator D O U G L A S . Ladies and gentlemen, as the Subcommittee on Monetary, Credit, and Fiscal Policies reopens its hearings, we are happy to have as our first witness, M r . A l f r e d H . Williams, president of the Federal Reserve Bank, Philadelphia. M r . Williams, I believe you have brought along an associate, who may assist you with certain technical questions. I wonder i f you want to identify him at this time for the record. M r . W I L L I A M S . H e is M r . K a r l R . Bopp, vice president, Federal Reserve Bank, Philadelphia. Senator D O U G L A S . I assume you will, yourself, want to answer questions relating to the fiscal policies of your bank and the Federal Reserve System as a whole, but I hope you w i l l not hesitate to refer any questions to M r . Bopp i f you care to do so. Senate Concurrent Resolution No. 26, which authorized the establishment of this subcommittee, directed us to make "a thorough and complete study and investigation of the effectiveness and the coordination of the monetary, credit, and fiscal policies i n dealing with general economic policy." This is obviously a very broad subject, and i n your written statement to the subcommittee, which I have here, you have already dealt with many aspects of it. I think perhaps it would be best this morning i f we started off with having your own judgment as to what are the most important and urgent problems i n the field, so that we may narrow the range of consideration at the beginning of our hearings. STATEMENT OF ALFRED H. WILLIAMS, PRESIDENT, ACCOMPANIED BY KARL R. BOPP, VICE PRESIDENT, FEDERAL RESERVE BANK, PHILADELPHIA, PA. M r . W I L L I A M S . M r . Chairman, perhaps I should at the outset make the point that I am speaking as president of the Federal Reserve Bank of Philadelphia and not as a representative of the President's Con- 27 28 MONETARY, CREDIT, AND FISCAL POLICIES ference of the System or of the Board of Governors. Y o u have the record of replies to your questionnaire which indicates the general point of view. That record was created by appointing a committee of economists from the 12 banks, who met and discussed the questions and formulated replies. Individual deviations from those replies, either i n the way of supplement or disagreement, are i n the record. I think it might be helpful i n this initial hearing to discuss the broad aspects of the problem of coordination and effectiveness of monetary and fiscal debt-management policies. I am glad to do this, because it seems to me that the area under consideration by the subcommittee is an extremely vital area, a very important one. I t is especially important to the System, because we are under a legislative mandate to use the techniques attached to monetary policy to bring about improved economic stability i n the public interest. I would like to make the general point that i n my judgment the problems of economic instability are becoming increasingly difficult, and that the basic ground swells may well be inflationary. A s I reflect and digest developments, it seems to me that in considerable measure these stem from a zeal for social justice. There are many observers who think of this as arising only i n the United States. I n my judgment, it is world-wide. Roughly, there are 65 sovereign powers on the planet, and I think a survey of these would indicate that the zeal is at work i n almost every one of these groups. I suspect that at some future time, when a historian sits down to record the developments, he w i l l think of this as the period i n which the Zeitgeist, the spirit of the age, is one of getting a greater amount of what we may term social justice. I n the United States, that is taking the form of conscious efforts on the part of the state to achieve a larger measure of equity i n every specific situation where trouble appears. I t would be presumptuous for me to go into this i n any detail. I take it that the experience of the members of the committee i n specific provinces that f a l l within their assignments would furnish us all the material we need. Senator DOUGLAS. M a y I interject for a moment? M r . WILLIAMS. Surely. Senator D O U G L A S . D O I take it that you are somewhat afraid that the expenditures on so-called welfare purposes w i l l result i n unbalancing the budget and, therefore, exert a steady inflationary pressure on the economy % M r . W I L L I A M S . I think that is a fair statement of my feeling. Senator DOUGLAS. O f course, about 78 percent of the Federal budget goes for either preparation against a future war or payments incurred as a result of past wars or nearly 33 to 34 billion dollars of the total of 43 to 44 billion dollars that w i l l be spent for the current fiscal year; and I wondered i f you would not add to this feature that you have mentioned the fact that the world is i n a state of uncertainty and that h i g h military preparations are being made, and that these exert an even greater inflationary pressure than the so-called welfare measures. The specific welfare measure appropriations by the Federal Government amount to only about 2.2 billion dollars out of the total of 44 to 45 billion dollars i n the budget. M r . WILLIAMS. I quite agree, and these expenditures are highly inflationary because they are i n essence wasteful, except as they produce real or fancied security. 29 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. W i l l you proceed? I merely wanted to correct the record a bit so that the so-called welfare state would not be charged with responsibility for unbalancing the budget. M r . WILLIAMS. There are other aspects that w i l l tend to produce economic instability, and I think, as I proceed, they w i l l be brought out and result finally in a more balanced picture than I give when developing this first point, Chairman Douglas. What we have is an attempt to give to each aggrieved part of the economy, to each claimant, a cure. W e look at agriculture, at veterans' affairs, at housing, at local depressed areas. M y native birthplace, a town i n Pennsylvania, is added to the list as of this past week. The danger is that we give to each and assume there shall be no losers. This, of course, is impossible unless we can expand output with each gift, and this i n turn soon comes to an end because of the impossibility of indefinite expansion. The Germans have an adage that trees do not grow to the sky. W e tend to shore up the weak points as they appear rather than view the development of weakness as a process by which resources are redistributed. I turn for a moment and contemplate the small-business scene. Without taking the position that more of these claimants deserve all possible aid, I think of the philosophizing of a Danish economist, who says, "Thank God for the bankruptcies." B y that he was thinking of the bankruptcy as a process by which individual enterprises are sloughed off and resources are redistributed. This is not to say that we should not make every effort to see that, for example, a depressed area is given some aid; but we should raise the question as to whether we ought not to make an orderly transition from the type of economy that exists there to something that is more balanced and w i l l not continue the difficulties that are occupying our current interest. This zeal for social justice reflects itself also i n the form of our efforts to obtain f u l l employment with ever-rising wage rates. The postwar record is one of successive demands and pretty much of successive acquiescence. A second force that is likely to make our economy more unstable is the changed character of economic action. It seems to me that economic movements are more pronounced; they are more powerful; they are more unpredictable. Decisions are no longer made by large numbers of participants in the economic process where you get the operation of the law of large numbers. I referred a moment ago to the 65 sovereign powers. A l l of them are now entering into the actions of the market place. One gets by reason of state action—and for other reasons, too, of course—gyrations in all forms of economic activity. F o r example, before us at the moment is the price of coffee. Now, these are in some cases unpredictable because they grow out of political influences and not the give-and-take of the buyer and seller i n an open market place. I am not saying we ought to return to the days of so-called free competition. I am discussing what seem to me to be realities at the moment in the light of achieving economic stability. This w i l l bring us ultimately to the question of what we can do via fiscal policy, in the management of the public debt, and through the operations of the Federal Reserve System. 99076—50 3 30 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I would cite as a second illustration of the changed character o f economic action what is happening in the field of collective bargaining. A t the outset I would make the point that I am not against collective bargaining and that what I am about to say ought not to be construed as antiunion. W e have had a development i n the labor movement which is of the utmost significance from the standpoint of wage rates, pensions, et cetera. I enter this field, M r . Chairman, with some diffidence because of your own professional interest and competence i n the area; but, as I read it, we had up to 1934 a relatively slow growth of tradeunions. A t that time there were 3,000,000 members. I f one looks at the composition of the unions, we find for the most part they were the elite of the labor movement. The A . F . of L . and the brotherhoods dominated the situation. The general public was not conscious of the results of their collective-bargaining efforts. B u t suddenly there came forth i n 1934 and continued to grow a democratization of the labor movement. W e brought i n not only the craftsmen, the men with technical skills, but went down into the ranks of labor and organized those. Today we have not 3,000,000 members of trade-unions but 16,200,000. Now, these new members differ from those that peopled these smaller unions. They have zeal for social justice. They set up demands; and, because they are unskilled for the most part, or have highly specialized skills, and for other reasons, we have the development of industry-wide bargaining. So, as a result of contractual negotiations, we have wage rates that cut right across an industry. If, as a result of strong bargaining, a leader in one industry achieves a wage increase^ perforce the leader in every other industry must get it, too. H e must bring the bacon home to his men. Y o u have here a force that is very pervasive. One contract permeates until it soon influences an entire industry, and that industry influences the others. I f a mistake is made i n the initial contract, it is transmitted to others and becomes a major mistake for the whole economy. There is a witticism concerning Nazi Germany to the effect that it was so well organized that it could make only major mistakes. I n a sense, that conveys something of the thing I am trying to put across at the moment. Another aspect of these major factors making for economic instability is the fact that this country has been catapulted into a position of world leadership by virtue of a long chain of events that need not be analyzed here. I t seems to me that this position of world leadership and responsibilities which are attached to it reinforce the drive to see that we shall not fail, because of the consequences of any untoward domestic action on us in the international scene. This tends to make us less flexible, less willing to suffer defeat on one front because we fear it may go to others. I am leading to the conclusion, M r . Chairman, that we must redouble our efforts to achieve stability and to achieve it under conditions of high levels of employment and production and at reasonably stable prices. This i n the minds of able students is the only way i n which i n the long run, you are going to be able to achieve social justice. The problems are not only complex; they are on the increase. The stakes are larger. 31 M O N E T A R Y , CREDIT, AND FISCAL POLICIES The question is, H o w do you achieve this stability ? Broadly speaking, there are two ways in which it can be achieved. One is by a series of specific controls, and the other is by attempting to get some general influences that w i l l be impartial, that w i l l be impersonal, that w i l l be pervasive. T o select the former route is to begin to go down a road where one control leads to another. I suspect that the British Labor Government finds itself i n a position where it cannot very well go back and, therefore, is going on, perhaps very reluctantly. I think we have to be very careful about that. I think the period that we are now i n is one in which we are going to make some basic choices. I shall attempt to tie this in to the attitudes that exist now within the field of banking and within the field of bank administration. I refer again to the fact that the area you are exploring here is i n my judgment a very important one. I take it you are interested i n our judgment as to the inherent effectiveness of work i n this area of general controls. What is our judgment as to the way we are organized and some of the results that we are failing to achieve because of lack of organization ? A r e the tools that are at our disposal ones that needed to be added to or resharpened ? I stop to say at this point that my own choice is for general instruments of control and influence. They can be few i n number i f they are well chosen. Senator DOUGLAS. M a y I interject a question there ? M r . W I L L I A M S . Y e s , o f course. Senator D O U G L A S . I take it what you are saying that i f we could have a sound monetary, credit, and fiscal policy, reasonable stability of prices, but with prevention of depressions, then i f that can be effected through monetary, credit, and fiscal policies, you would prefer to use that; and that specific controls over given areas, such as an industry, and so forth, should be discarded or abated and that you would trust instead to the forces of competition i n fixing individual prices within the framework of the general stabilized price system; is that right ? M r . WILLIAMS. The question is an extremely difficult one to answer, M r . Chairman. I n agriculture the Government has a bull by the tail. I n agriculture we have 6y2 million business enterprises—I call the modern farm a business enterprise—subject to unusually unstabilizing factors. I would not go so far as to say we ought to begin now and by a process of orderly liquidation over a period of years get out of agriculture completely, but I think we ought to ask ourselves the questions: T o what extent can we get out of agriculture ? H o w rapidly can we accomplish this reduction i n commitment ? W h a t are the ways in which we can bring this about? I t ought not to be a separate approach to a problem which ramifies out i n all directions and which has essential unity. Senator DOUGLAS. The presumption, however, should be i n favor of a general solution rather than a series of specific measures ? M r . WILLIAMS. Quite so, and the presumption should be that everyone who is affected by a general policy ought to be informed about that policy. Senator FLANDERS. M a y I ask a question ? S e n a t o r DOUGLAS. Yes. 32 MONETARY, CREDIT, AND FISCAL POLICIES Senator FLANDERS. M r . Williams, does what you are saying also apply to credit control itself ? D o you feel that credit control by the Government through the Federal Reserve System or by any other means should be general rather than applied to specific areas of business operation ? M r . WILLIAMS. I would go into specific credit areas with the greatest reluctance. W e w i l l come to that question later. S e n a t o r FLANDERS. T h a n k you. M r . WILLIAMS. This background focuses attention upon the role of the Congress, of the Treasury, and of the Federal Reserve System i n this drama, i f I may use the term, the social drama that I am attempting here to sketch. I consider first the role of the Congress i n the fiscal policy. Here again I may be presumptuous in bringing up the question. I do so only because it is such an essential part of it. The role of fiscal policy i n economic stability is one that i n broad outline is easily handled by students of the subject under the general term of compensatory fiscal policy. The Government achieves economic balance by putting funds i n and taking them out of the spending stream. Question is raised as to how frequently you must be i n balance. There are several schools of thought with respect to it. Do you attempt to achieve it annually? D o you attempt to achieve it over a longer period of time? Theoretically, the scholars say you achieve it over a longer period than a year. These economic recessions and swells do not occur according to the calendar. When you turn to compensatory fiscal policy, i n practice, you step out of the closet into the world of men who are sensitive to political values—and I do not use that invidiously. I mean Congressmen are locally elected, and I may say reelected or rejected; and that influences their actions. I n 1948 we had tax cuts, which increased the money available for spending by $5,000,000,000. There were probably many considerations which led to the action, but the chances are that not many of them centered around—let me put it this way: there were some that d i d not center around the question of achieving economic balance. I am not saying this critically, because there are a great many limitations to the effectiveness of the role that Congress can play i n this question of achieving economic balance, and I hope i f I am i n error here that you w i l l set me right. T o be successful, there must be some fairly accurate predictions, sometimes far i n advance, because the economic effects of congressional action may be delayed for a considerable time. Fiscal policy as carried out by Congress is not a flexible tool. Y o u cannot change tax and expenditure policies quickly. Also, as important as anything, when the decisions are made, frequently the aggregates are not in view. B y focusing attention on one aspect, particularly i f a person is politically motivated, you get a total result which you would not accept i f you knew i n advance that it was coming. Y o u do not get the discipline that frequently arises i n other fields of action, notably business, where the penalties are pretty direct and pretty immediate and pretty close at hand. 33 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES I think that the most we can hope for in the consideration of what Congress can do in this whole area—that is, fiscal policy—is that it w i l l not seriously aggravate the problem. That is a pretty mild statement. A t the same time, the effects of fiscal policies are large and growing. F o r example, during the twenties Federal and governmental expenditures were in the magnitude of $5,000,000,000, compared to a gross national product of $90,000,000,000. Today we have $40,000,000,000 of governmental expenditures and gross national product of $250,000,000,000. Now, the Government can waste resources just as readily as can the individual citizen or the business enterprise. I think it would be helpf u l if we were constantly reminding ourselves that the responsibilities that are set forth broadly in the Employment Act of 1946 contain implied responsibilities for Congress as well as for the Treasury Department or the Federal Reserve System. It involves the art as well as the economics of government and, I think, deserves the fullest possible attention. That brings me to a consideration of Treasury and the Federal Reserve System responsibilities and relations. The Treasury, of course, aside from advising the Congress in tax matters, has certain operating responsibilities that we can pass by—collecting tax revenues, making Government disbursements, managing the operating balance. The last of these, that is to say, building up or drawing down the operating balance for regular payments to meet maturing issues, and so forth, does gear in pretty closely to the work that we do. The major field, however, is management of the public debt. This involves Treasury decisions as to refunding, as to maturities, as to marketable and nonmarketable issues, and importantly as to price. These operations are closely geared into the Federal Reserve's responsibilities and opportunities. We turn to the Federal Reserve System for a moment. Here the basic responsibility is one of adjusting the money supply to the flow of goods and services. The most important manner in which we influence this situation is the way we work in changing the amount, availability, and cost of actual reserves, and the level of reserve requirements. We have three tools in our kit. The first is discount rates. Initially, it was the most important instrument when banks were acquiring reserves by discounting. It is now less important because reserves are influenced through open-market operations, although I think we can underestimate the influence of the discount rate because of the psychological aspects of this tool. Open-market operations are a tool of major importance at the present time in the matter under consideration, because through our purchases of securities we supply additional reserves, and by our sale of securities we reduce reserves. Senator DOUGLAS. M r . Williams, I wonder i f you would state for the record of what open-market operations consist. Mr. W I L L I A M S . I w i l l ask M r . Bopp to answer that question. Mr. BOPP. They consist, Chairman Douglas, of the purchase by the Open-Market Committee of the Federal Reserve System for the account of the Federal Reserve banks' Government securities of such maturities and at such prices, and so on, as may be determined by the Open-Market Committee; and, correspondingly, sales of securities in 34 MONETARY, CREDIT, A N D FISCAL POLICIES the open market. A n adjunct to sales involves the redemption of securities as they mature on the part of the Treasury. Senator DOUGLAS. When the Federal Reserve System purchases the Government securities from banks, what are the banks given i n return ? M r . BOPP. The Open-Market Committee deals with a list of Government security dealers, so that typically a bank would operate through a dealer. The purchase would be made by payment of a check drawn on the Federal Reserve bank itself, which would be given to the seller of the Government securities. This seller in turn would deposit that check i n his bank, and his bank would send it up to the Federal Reserve bank and get credit for it on the books of the Federal Reserve bank i n the form of an increase i n its deposit account. The deposit account of a member bank is also its reserve account. The result of the purchase of the security by the Open-Market Committee is an increase i n the private deposit account of the seller of the security at his local bank; and that bank i n turn would have an increase not only in its deposits but a corresponding increase i n its reserve account at the Federal Reserve bank. A sale would have the opposite effect. Senator DOUGLAS. A Federal Reserve bank creates a credit w i t h which it purchases Government bonds ? M r . BOPP. That is correct, and that credit initially is i n the form of a deposit i n the Federal Reserve bank. Senator DOUGLAS. What proportion of the earnings of the Federal Reserve System come from this type of credit operation ? M r . BOPP. Virtually all. There are a few small types of other earnings, but virtually all come from ownership of Government securities. Senator DOUGLAS. Is this a type of transaction which was not originally contemplated when the Federal Reserve System was set up ? M r . BOPP. I think that is probably a fair statement of it, Chairman Douglas. Initially the Federal Reserve System was considered rather a more passive institution. I t was assumed that with an increase i n the general level of economic activity there would be an increase i n what at the time was called and still is called eligible commercial paper arising out of the increased activity. I f a businessman needed additional credit, he would take that paper to his bank for discount to secure a deposit for it. I f the bank i n turn needed funds, it would take that paper to the Federal Reserve bank for discount. The Federal Reserve would pay for that paper by an increase i n the deposit account of the bank. However, at the time it was also f e l t — and this is trying to recollect the history of the time or the reading of the history—that there might be times when the Federal Reserve System would have inadequate earnings, and when business might be depressed, and, therefore, the System should have some authority to put funds into the market of its own violition. Therefore, it was given authority to deal i n the open market i n Government securities and certain specified other securities, but initiallv it was not considered a basic instrument of policy. I t became so i n the 1920's. I think it is, therefore, a correct statement to say that the ultimate development of open-market policy was not contemplated by the framers of the Federal Reserve Act. 35 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WILLIAMS. W o u l d you comment on the matter of initiative on the part of the bank, on the one hand, and of the System on the other ? M r . BOPP. I n the case of open-market operations the System is enabled to take the intiative to put funds into the market or to take them out. I n the case of discounting, the initiative is on the part of the prospective borrower. If, however, the System, as during the war and postwar periods, establishes a price i n the market at which it w i l l deal i n Government securities, then the initiative may be taken by the market rather than by the Federal Reserve System so far as amount is concerned. Senator FLANDERS. M a y I ask a question ? S e n a t o r DOUGLAS. Yes. Senator FLANDERS. M r . Bopp spoke of the open-market operations as affecting the available bank reserves. I would like to inquire whether in its actual operation the purpose of open-market operations is directed toward increasing or decreasing bank reserves, or is it directed toward maintaining the price level of the bonds themselves ? M r . BOPP. D u r i n g the war period and for a considerable period after the war, as I mentioned, the Federal Reserve System established the yield structure on Government securities and bought or sold securities so as to maintain that yield structure. The effect on reserves was incidental to that. However, with the announcement by the Open Market Committee i n June of this year, it was stated that i n the future the Open Market Committee w i l l be concerned with the general level of economic activity, which I would interpret to mean that it would be more concerned with the level of reserves than it had been hitherto. Senator FLANDERS. Does that mean that as a result it w i l l be paying less attention to the maintenance of an interest rate, which I presume means the maintenance of price because the earning rate is dependent on the price—that it would be less concerned with that i n the future than it has been i n the past ? M r . BOPP. The exact interpretation is one I cannot personally give. I t is a matter of the individuals who have prepared the statement. However, I think one can get some impression as to the meaning of it by following the Federal Reserve holdings of Government securities. I f one looks at the holdings of the United States Government bonds, for example—these are the long-term securities held by the Federal Reserve System—the volume remains unchanged week after week. There were a few very small changes and one large change which happened to come at the time of the maturity of a bond issue. T h a t would mean, it seems to me, that the Federal Reserve open market committee was not i n the market i n the long-term issues. That is evidenced also by significant changes in the prices of long-term issues since the statement was issued. Senator FLANDERS. Has the history of yields of Government securities and the market prices on which those yields are based actually shown more flexibility since that decision was arrived at than was the case before ? M r . BOPP. W i t h respect to long terms, I am quite sure that is the case. I w i l l have to check with the chart book. Senator FLANDERS. Specifically, are there any issues which have been allowed to go below par ? 36 MONETARY, CREDIT, AND FISCAL POLICIES M r . B O P P . N O ; with the release of reserves and this policy statement, the pressures all were i n the other direction, and prices have gone up very significantly, which means that yields have gone down. When I express the judgment that the variations i n yield on long terms have been significant since that time, I meant not an increase i n yields, but a decrease i n yields of a significant amount. M y hunch would be a quarter of a percent i n yields. Senator FLANDERS. The effect of that policy has not been detrimental so far to the policy, i f you want to call it policy, of maintaining the price of Government securities, but has been the reverse so far ? M r . BOPP. Well, I should say that it is evidence that there is no ceiling at the present time. Senator FLANDERS. B u t the floor is still there ? M r . B O P P . A S I say, that is a question that M r . WILLIAMS. W e are floating i n the air and have not explored the floor yet. Senator FLANDERS. W h a t w i l l happen when you hit the floor i f reserve requirements should indicate that prices should go below the floor ? M r . WILLIAMS. I think that question w i l l come up again later, M r . Flanders. S e n a t o r FLANDERS. A l l right. Senator D O U G L A S . N O W , you have mentioned two weapons that the System has—the rediscount rate and the open market operations. M r . WILLIAMS. Reserve requirements being the third. S e n a t o r DOUGLAS. Yes. M r . WILLIAMS. Just one more point to supplement what M r . B o p p has said about the operations of the Open Market Committee. T h i s is a force in the money market that has great leverage. B y that I l^iean that i f used with deftness, with psychological astuteness, it can work results that are far beyond the magnitudes here involved. One i n effect sits there shooting with a rifle and not with a shotgun, and you have the entire market revealed before you. Y o u come to know it, and the task of managing the account, which is one of great importance, is in my judgment one that has been superbly carried out, i f one goes back especially to the postwar period. Senator D O U G L A S . I wonder i f either of you would briefly sketch for the record the effect upon the general supply of credit when the System sells securities i n the open market, M r . WILLIAMS. I think you have traced i n more detail the effect of the System buying, M r . Bopp. M r . BOPP. The sale of securities would require payment by the purchaser of the security to the Federal Reserve bank for that security. I n making this payment, the Federal Reserve bank i n turn would collect the check for payment from the bank whose customer had purchased the security, and that would result i n a reduction i n this bank's deposit account, which is its reserve account at the Federal Reserve bank, and also a reduction in this bank's deposit account with its customer; so that you would have initially a reduction i n both reserves of all member banks of the Federal Reserve System and a corresponding reduction of the accounts of private customers i n their commercial banks. 37 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. A n d hence a reduction i n the potential lending capacity of member banks ? M r . BOPP. Yes, sir; unless offset by excess reserves. I f it d i d not have excess reserves, it would be short of reserves and could force a retraction through the banking System. M r . WILLIAMS. This brings me back to the topic of relations between the Treasury and the Federal Reserve System. I think M r . Bopp's explanation and the connotations of it indicate that the task of the Treasury i n managing the public debt and its working balance and the task of the Federal Reserve System in using its monetary authority to achieve stability are very closely meshed. M r . WOLCOTT. M a y I ask a q u e s t i o n ? S e n a t o r DOUGLAS. Y e s , o f course. M r . WOLCOTT. What M r . Bopp said a moment ago just registered with me. Y o u made a statement that i f the bank sells out its reserves, in answer to a question asked by Senator Douglas, that it decreased the amount of money which was available for loaning by the bank. Is it the practice to reduce reserves sometimes to make available more money for loaning—private loaning ? M r . BOPP. T o reduce reserve requirements ? M r . WOLCOTT. Reserves. I f thev are above the requirements, there is a tendency to liquidate their reserves? M r . BOPP. Provided they have excess reserves, they w i l l use that for lending purposes. If, however, the Federal Reserve System has sold securities, that w i l l initially reduce the reserves of the bank whose customer bought the securities. That bank w i l l then have less reserves available for lending, purchasing securities, or whatever purpose it has. Not only that, i f it began the process without excess reserves it would then be short of reserves because the reduction i n reserves is as great as the reduction in deposits. I t is required by law to keep only a percentage of reserves against deposits, and it would then have to restore the deficiency of reserves by the sale of some assets. M r . WOLCOTT. When there is a movement on the part of a great many banks to liquidate a great many excess reserves, then is it the function of the Federal Reserve, i f they have flexibility enough i n their reserve requirements, to increase the reserve requirements to stop that practice? M r . BOPP. I should say it is contingent on whether, i n the judgment of the Reserve authorities, an expansion should take place. I f so, they would encourage it. I am thinking of the thirties, when banks had large volumes of excess reserves and when the Federal Reserve System was interested i n having expansion. I f banks had expanded, that would have been to the good. On the other hand, i f this process is going on at a time of inflationary pressure when the desire is to restrict, then you would have the question of whether to restrict by sales of securities or by changing requirements. M r . WOLCOTT. Previous to the Banking A c t of 1935 the Open Market Committee functioned i n more or less an advisory capacity. They were given power i n the Banking A c t of 1935; they did not have the power to initiate purchases and sales previous to that. M r . BOPP. I should say it was a voluntary arrangement prior to that, and any individual Reserve bank could refuse to participate i n 38 MONETARY, CREDIT, A N D F I S C A L POLICIES the open-market operations which the committee itself had recommended for the System as a whole. I f , however, the committee felt that a specified volume of securities should be bought or sold and a particular Reserve bank should have refused to participate, they might have distributed that amount among the other banks. However, so far as I know, no bank refused, i n fact, to participate i n them. B u t your question concerned the power of the System itself. I t had the power. However, by law it was lodged in the individual banks who collectively had an open market committee to advise with respect to and to engage i n open-market operations subject to the rules and regulations of the Board of Governors, but the individual bank had the power not to go along i f it desired. Senator DOUGLAS. A n d now ? M r . B O P P . A n d now it is a System operation and no individual Federal Reserve bank may refuse to go along. Senator DOUGLAS. A n d the amounts which each bank must take or must sell are specified by the Open Market Committee ? M r . B O P P . Actually it is a single account for the entire System, and the actual ownership of the securities by the individual Reserve bank is distributed from time to time. A s to the exact formula, I confess you have every right to expect me to know that. I have known it for as long as a half hour after reading it, but for the long run I have considered the burden on my memory to be greater than the value of the information. I can, however, supply you with it. Senator DOUGLAS. W e w i l l ask someone to make it a matter of record. (The formula referred to above is as follows:) F O R M U L A FOR ALLOCATION OF SECURITIES I N THE SYSTEM O P E N M A R K E T ACCOUNT Securities i n the System open market account are allocated by the F e d e r a l Open M a r k e t Committee among the individual Federal Reserve banks on the basis of their expense and dividend requirements. The formula is based on estimates for the year of each Federal Reserve bank's expenses, dividends, and earnings f r o m sources other than securities i n the System open market account. R a t i o s of the estimates for each Federal Reserve bank to those for the 12 F e d e r a l Reserve banks combined are then computed and securities i n the System open market accounts are allocated on the basis of these ratios. Adjustments may be made in the allocations f r o m time to time i f the reserve position of a particular Federal Reserve bank indicates that an adjustment is desirable or i f the allocations on the basis of the original estimates are no longer appropriate. M r . W O L C O T T . I n that connection, perhaps affiliated with the subject with respect to rediscount rates, previous to the Banking A c t of 1935 Federal Reserve banks could initiate increases i n rediscount rates, but they would not become effective without approval of the Federal Reserve Board, and now the Federal Reserve Board may initiate increases or decreases in rediscount rates. M r . B O P P . That particular provision, Congressman Wolcott, has had an interesting history. A s I gather it, the provisions i n the initial draft of the Federal Reserve A c t contained a provision that the Federal Reserve banks shall establish from time to time rates of rediscount, subject to review by the Federal Reserve Board. 39 M O N E T A R Y , CREDIT, AND FISCAL POLICIES A t some time during the process of hearings and subsequent reports this wording was changed to read, "Subject to the review and determination by the Federal Reserve Board." Now, it is a question as to what those words mean. I n my own judgment, and I can be i n error, I think the Congress intended to be somewhat vague, and time would tell. Y o u would see how the thing worked out. The Attorney General was asked, and it is my recollection it was i n 1919, as to a judicial interpretation of these words. H e said that going through the legislative history it is clear that the words "and determine" were added, and since they were added, attention was specifically called to them and they meant something. I f they meant something, they meant something other than "review" and, therefore, it meant that the Board had the power to determine rates. H e interpreted the words to mean that, i f necessary, the Board could initiate a change i n the rate, and it did prior to the Banking A c t of 1935 i n the case of the Federal Reserve Bank of Chicago. I think the year was 1927. So the Board did, as a matter of fact, prior to the Banking A c t of 1935 initiate and require the Federal Reserve bank to change a rate which the bank did not want to change. Senator Douglas may remember that Chicago incident. M r . WILLIAMS. I return now to the question of relationships between the Treasury and the System, starting with the war period. The prime consideration from the standpoint of the Treasury and the System was to w i n the war; and management of the debt and the changing policies with respect to reserve requirements and open market operations were in the light of this prime consideration of achieving military victory. Looking at the economy as a whole, I take it that to the extent we were interested i n stability we relied pretty much on direct controls. The system's task during the war was to facilitate the operations of the Treasury. The Treasury had a number of important decisions to make. One of them had to do with the interest rate pattern, and there I would rather rely on M r . Bopp's memory than my own as to what happened during the thirties to bring us up to the point of entrance into the war with a plethora of funds and low interest rates. The general point is that we froze the interest rate structure into a pattern beginning at three-eighths of 1 percent and ending at 2% percent. I think it may be interesting for the record to outline what had transpired during the thirties which had resulted i n this situation. M r . BOPP. Although this is not the ultimate beginning of it, one may begin with the change i n the price of gold on the part of the United States from $20.67 to $35 an ounce. A t any rate, following that we had very large importations of gold into the United States, and a very great plethora of funds and the absence of a demand for funds to any considerable extent. Banks having these large excess funds and no very great demand for credit desired to keep their funds i n short-term assets; and as a consequence, one had a superabundance of funds, particularly shortterm funds. A t one time the United States Treasury was able to borrow 90-day money at a zero rate of interest, and for some peculiar 40 MONETARY, CREDIT, A N D FISCAL POLICIES tax provisions i n the city of Chicago, on rare occasions, at a negative rate of interest. However, i n part because bankers, and others felt that these rates were excessively low and that it was merely a matter of time until they would rise, investors were unwilling to commit themselves at the long-term rate then prevailing. I n a period i n which anticipations are for a rise in interest rates, one gets a rate structure with short-term rates below long-term rates. Incidentally, we have had other periods i n which people have anticipated declines i n interest rates and when the short-term rate has been above the long-term rate. Because of the plethora of funds and institutional habits w i t h respect to investments and anticipation of ultimate increases i n rates, we had a rate structure and a period of depression and lack of demand i n which the short-term rates were very low relative to the longterm rates, with all rates being low relatively on a historical basis. Those circumstances, however, are quite different from the circumstances into which we were going once the war broke out. M r . WILLIAMS. I n an attempt to avoid the mistakes of W o r l d W a r I, when there was a reluctance on the part of some to participate i n war loans i n view of the fact that the next loan might carry a more favorable rate, we froze the structure, and it became known that we had frozen the structure. There were, I think, relatively good results from the operation of the Treasury and Federal Reserve System during the war period. Roughly, we raised 40 percent of the needed funds by taxation. T h i s could have been higher, but I think Canada's record was 43 percent or thereabouts. I t was slightly above. Great Britain, where the capacity to endure taxes, is, I think, pretty highly developed, d i d not do a much better job. W e got good results from our distribution of the 60 percent we borrowed; the distribution of that among the nonbank market was 35 percent of the total, roughly. The position of the banks—I think they all understood it—was they were to be the residual buyers of anything and they were to provide the funds we could not obtain by taxation and borrowing from the rest of the economy. They came forward and took 25 percent, and it would be my judgment that that is a pretty good result. K a r l , is that your opinion? M r . BOPP. Y e s . Senator DOUGLAS. I wonder i f you would describe the process by which the individual banks subscribed to this 25 percent, or I believe somewhere around $70,000,000,000. M r . WILLIAMS. Karl, w i l l you do that ? M r . BOPP. I n order to facilitate the sale of securities banks were permitted to open what is technically called a war-loan account, which is a deposit account i n the bank to the credit of the Treasury. There were some changes during the period, but the general process was that a bank could pay for its securities to the Treasury by simply giving it credit i n the war-loan account, which meant that initially the bank picture would be an increase i n its holdings of the Government securities and an increase i n the Treasury's deposit at that bank. 41 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Then it was a private creation of purchasing power made available to the Government through the creation of deposits, and the Government drew checks upon these accounts ? M r . BOPP. That is correct. Senator DOUGLAS. And, therefore, the money supply, i f you include checks as a portion of money, was inflated ? M r . BOPP. Yes. Senator DOUGLAS. This portion was not financed out of the current savings or current taxes. M r . BOPP. That is correct. Senator DOUGLAS. B u t through a creation of monetary purchasing power, which had an inflationary effect. M r . BOPP. Yes. Senator DOUGLAS. A n d which i n turn you tried to restrain by specific controls. M r . BOPP. That is correct. M r . WILLIAMS. The next period was the postwar period. M r . WOLCOTT. Just a minute. I n connection with those accounts, purchases by the banks—or sales, rather, by the banks—which the money got into that account, were deflationary. Is that right, and would that offset the inflationary tendencies incident to the creation of this account ? I mean by that that when a bond was sold by a bank, sold to an individual, that came out of that individual's earnings or savings, it was a bond which could not be monetized—payment of that bond into this account—and the Treasury would draft on that account for what the individual had put into the account. W e were told when the drives were on that to avoid inflation we should get as many as possible of the E bonds and other savings bonds out to the people and encourage them to hold them as an influence against inflation. M r . BOPP. T h a t is quite correct. A s individuals bought Government securities, they would pay for them with a draft on their own deposit accounts; and you then would have a shift from that purchaser's account to the war loan account of the Treasury. T h a t resulted i n neither an increase nor a decrease in the total money supply. The banks in these war loan drives were selling Government securities out of their own holdings, but they were selling fresh issues which the Treasury brought out. M r . WOLCOTT. W o u l d it reduce the pressures which would otherwise be on prices? M r . BOPP. Quite right. M r . WOLCOTT. W h i c h is a reflection of the depression of the value of the dollar by making that much less money available, creating a demand for consumer goods. M r . BOPP. Roughly 60 percent of the total cost of the war was met by borrowing. O f that 60 percent, roughly 60 percent again or 35 or 36 percent of the total was purchases of securities by nonbank investors, but the other 25 percent was purchases by banks, so that you had the two processes going on at the same time; and yet over the war period banks expanded their Government security holdings by the 25 percent of the total volume issued. Senator DOUGLAS. Their deposits went up correspondingly, too. M r . BOPP. That is correct. 42 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator F L A N D E R S . W h e n you say individual purchasers, you include also corporate purchasers ? M r . B O P P . A l l nonbank purchasers. Senator F L A N D E R S . Insurance companies, business firms, and so on? M r . B O P P . Yes; all nonbank purchasers. M r . WILLIAMS. Every effort was made to induce nonbank buyers to acquire i n order to thus channel off the purchasing power that otherwise would be reflected on a diminished supply of goods. W e were seeking to curb these inflationary pressures i n this manner and relying also on direct controls to help take the pressure off by means of allocation and rationing. W e had a period here of 4 or 5 years when monetary and debt management considerations were focused on a military objective. Now, since then we have had a period of 4 years, and the question comes up as to what our objectives have been during this period. I f I were asked to describe this i n one phrase, I would say i t was to make an orderly transition from w^ar to peace. Now, I call your attention to the fact that at the height of the war the* Government was spending a billion dollars every 4 days, and for the most part was spending it for destruction. I f we may revert to the war period—as an incident to war finance, a great deal of purchasing power was built up. B u t the psychology of the situation after the war was such that we forgot about that purchasi n g power and focused our attention on what would happen when the Government ceased to spend $90,000,000,000 a year. T h i s was the underlying psychology of it. People said that the Federal Government, the principal buyer of the goods of manufacturing and mining, is going to step out of the market and we w i l l get a collapse of Government spending to $30,000,000,000 a year, and that is going to bring on depression. There was a surprising amount of agreement among professional students of the situation that we were not going to be able to get through this transition without severe depression, and estimates of unemployment went from 8 to 10 to 12 million—I do not know i f any got above that, Senator Douglas. Senator D O U G L A S . I believe there was only one man who made a forecast that there would not be a depression. Senator F L A N D E R S . W h o was he ? Senator D O U G L A S . M r . Woytinsky i n the Social Security Board. Senator FLANDERS. Also a group that goes under the name of the Committee for Economic Development. Senator DOUGLAS. A l l right, there were two. M r . W I L L I A M S . There certainly was the possibility of depression. It was i n the picture. Senator F L A N D E R S . I t was entirely possible. M r . W I L L I A M S . Yes, Well, it didn't materialize. Senator F L A N D E R S . W i l l you tell us why it didn't? M r . W I L L I A M S . Well, I w i l l make an effort, Senator Flanders. I t didn't materialize primarily for two reasons, in my judgment. One was that we had, beginning with the home, empty linen closets, empty pantry shelves—someone said that we got guns and butter both during the war, but there wasn't much butter. There was a lot of soft goods which make it appear that total personal consumption didn't greatly diminish. B u t this is one of these deceptive totals. T o make i t significant you have to take it apart and see what composes it. W h e n 43 M O N E T A R Y , CREDIT, AND FISCAL POLICIES you take it apart you see there an unsatisfying craving for a lot of goods, durable consumer goods. A n d when you go back beyond that, to the department store, the storerooms had to be filled. When you go beyond that, back to the wholesaler, the storerooms had to be filled. A n d , beyond these, to the manufacturer, warehouses and storage yards had to be filled. Throughout the 4-year period as a whole, Senator Flanders, there were some unusual demands set up for filling the pipe lines and refurbishing the plant of our economic system. Shortly after the cessation of hostilities we set about preparing for war. W e were not only preparing but assisting some of our allies. I n referring to preparing for war, I include all of the economic efforts of maintaining a front against the Russians i n western Europe. Senator D O U G L A S . It is an exercise in semantics but I would prefer to say that we were preparing against war rather than preparing for war. M r . W I L L I A M S . Yes; I accept the amendment. Senator FLANDERS. Didn't you also have a good money supply ? M r . W I L L I A M S . Well, yes. There existed the capacity to take the goods and the desire to take them. Senator DOUGLAS. There was a tremendous accumulation of purchasing power, built up in the form of these bank reserves, credits, savings accounts of individuals, Government bonds, and so forth, so that there was a tremendous latent purchasing power, there; isn't that true ? M r . W I L L I A M S . That is right. Senator D O U G L A S . A n d that, combined with the desire, created an effective demand? M r . W I L L I A M S . Yes; I think your thumbnail description there contains the broad details. I n addition, there was a psychological element that I think needs to be taken into consideration. I w i l l refer to this later in a discussion of our policy with respect to use of the open-market instrument as a mechanism. I f you look back at the period, this expected depression—if I can use a John L . Lewis phrase—reared its ugly head every spring, almost. K a r l , your memory is better than mine. Sketch this potential setback, the series of set-backs that appear in this period. M r . BOPP. W e had one in 1946, just after the war. W e had another in the spring of 1947, in the spring of 1948, and in the spring of 1949. I t seems to be an annual affair. It is a matter that I think merits some study. I must confess that I haven't studied it. It happens also that the Federal budget, even though balanced over a given calendar year, w i l l have a very large surplus of cash receipts i n the first half and then a deficit i n the second half of the year. Whether this periodic spring recession which we have had is related to that or not I am not altogether sure. I t merits inquiry, I should think. I must confess I felt the inflationary forces would be much stronger. Unless, however, one is awfully dogmatic, and is sure he is right with respect to the future, he is influenced by such periodic recessions. Every spring there would be a gradual decline and one would say, perhaps we had better take another look. W e did have this little uncertainty throughout. M r . W I L L I A M S . That result, as you look back over the period, worked i n our favor. What was potentially a situation which could have developed into runaway inflation, just as it could have developed a 44 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES depression, turned out to be a period of action, where, by fits and starts, we have come through, i n my judgment, with remarkably good results. There are others who disagree. But, M r . Bopp and I would have you look at the chart on commodity prices. I t would be unfortunate i f there would be lack of confidence because of a lack of understanding of what transpired during this period. M r . BOPP. D u r i n g the war period, as President Williams has mentioned, we had inflation which was, i n a sense, suppressed via direct controls. These controls were removed i n the summer of 1946. Immediately you had a very strong upsurge i n prices. 45 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES I t seems to me that much, i f not indeed all of that was merely bringing to the surface what had hitherto been held under the blanket of direct controls. M u c h of that initial post war rise i n prices was, i n a sense, bringing to the surface what you really had. I f one takes that initial upsurge i n prices to the spring of 1947 as merely bringing out the hidden inflation, we find the wholesale price level, relative to 1926, at roughly 150. Subsequent to that the highest point reached was, roughly, 170. So you have 20 points, or 12 to 15 percent, which, it seems to me, is the general order of magnitude we are talking about at being subject to more restrictive credit action. Since then we have had the subsequent decline to roughly 154 at the present time. M r . W I L L I A M S . I would say then, Senator Flanders, that we came through this period in a manner such as to avoid depression, avoid runaway inflation, avoid undue harm to international relations, and without undue disturbance to the internal economy, and with a public debt that was not dislodged, although it had the possibilities of dislodgment. Now, there is a result, I think, to which the system contributed by means of its powers, and they were modest powers; remarkably good over-all results have been achieved. W e did it by a close intermeshing of the Treasury and the System. Some students w i l l raise the question as to why the support, to the extent that it was given to the Government bond market, was not withdrawn and why we did not allow these forces to have free reign so as to determine, i n the market, what the price of money should be. Now, my friends ask me that question. Well, I serve only intermittently, as do the other presidents under the plan of rotation on the Open Market Committee. I say that as I look back at it, and realize what the responsibilities were, that I think if I were to relive that period, I wouldn't do anything substantially different, especially now that I have knowledge of what the results have been. There were a great many debates on the part of all of us who were i n the System as to what we should do and what we should not do; debates between each other and internal personal debates. I was conscious of the fact that we had a volume of public debt that had increased very greatly, that we had a tense international situation, that we had difficulties of labor adjustment in bringing into a wage structure the realities of power. Someone said that a labor arbitrator is one who unctuously gives to the lion the lion's share. Well, the lion here was demanding a lot. There is no question that we were closely intermeshed. I wouldn't w^nt to debate the question as to who led the parade, but we were going down the road together here. Let us now turn our backs on this wartime period and the four postwar years, and ask the $64 question: Where do we go from here ? That is the question. M r . WOLCOTT. M r . Williams, how much of the thinking, or has the thinking of the men in your position, been influenced by the fact that we are i n a de facto war, and possibly because of our defense efforts—our economy being affected by it as much as it would be during a war—we must approach our problems with about the same spirit as we approached them during the war. H o w much has that influenced your thinking? 99076—50 4 46 MONETARY, CREDIT, AND FISCAL POLICIES Have I made myself clear ? I n other words, we are spending a good many billions of dollars for defense, as we were spending a good many billions of dollars during the war for defense. H o w much has your thinking on economic matters been influenced by the fact that* the Government has got to make these continuing expenditures over a period of years—to make these tremendously large expenditures for the defense effort ? M r . WILLIAMS. I might answer the question in this manner, Congressman Wolcott, that two considerations weigh heavily i n my own personal thinking. One is that this is a period of potential war, as you have just said. The other is that, undoubtedly, it is a period of great social struggle. There are at work within the American social f abric forces that w i l l produce results that I think we are not in a position to predict. There is going on here a social struggle which can take a variety of forms. I think that is all right. That is what life is. W e get about what we want. W e are trying to work out what we want. I t doesn't do to rail against the New Deal or the square deal. Our task is to find out what the problems are and to take an intelligent position and try to use our personal influence there. Now, it is those two forces that are influencing my judgment w i t h respect to what we ought to be doing. I am trying not to use any of my personal predilections in the decisions that I make with respect to the operation of the Federal Reserve System. Have I answered you? What you have said is a very important factor. M r . WOLCOTT. I t does have influence on your thinking ? M r . WILLIAMS. V e r y definitely. M r . WOLCOTT. Apparently we are going to have the problems w i t h us for some time to come. M r . WILLIAMS. Yes, M r . WOLCOTT. W o u l d it be possible to divorce that from our money ? F o r instance, previous to some date i n the thirties, you had a certain amount of commercial paper. W e amended the law to make that no longer necessary. So at the present time, with the exception of 25 percent of the gold which is put up, all of the rest of it can be put up i n debt, Government bonds. That seems, to many people, to so wed debt to our money as to create instability in the value of the American dollar. Unfortunately as the debt increases and decreases there is such an affiliation between the national debt and the money that fluctuations i n debt cause fluctuations in the value of the currency. Is there some way to offset that by, perhaps, segregating—or what term do you use—quarantining—a certain amount of debt, so that it could not be monetized, and by that remove the threat of these constant fluctuations, incident to fluctuations i n debt? M r . WILLIAMS. Well, Congressman, there are many rational plans that can be devised and have been devised. The difficulty with them is that they are designed to affect adversely our private banking system, our commercial banking system, on the score that the banks reap where they haven't sown. I have a great reluctance here to give any aid or comfort to consideration of these plans because of my conviction that American free enterprise owes a great deal of its strength to the presence i n the structure of 14,000 banks; and, when I look at the return on invested capital i n banking and compare it with the returns from other fields, I say 47 M O N E T A R Y , CREDIT, AND FISCAL POLICIES the evidence that banks are reaping where they haven't sown doesn't appear in what is either distributed as dividends or added to capital accounts. Now, i f I may stop and digress for a moment. W h a t I say later may be interpreted—improperly interpreted—as being critical of commercial banking. I want here to put in a plug for commercial banking because of the service that it renders. W e have i n American business a condition whereby there wells up from underneath every year a lot of Joe Dokeses who have unusual capacities to go into business and rub one dollar against another and produce a third. Now, we have got to preserve that. W e all benefit by the presence of these people. A great many of them go by the boards. I don't know how many cousins have been put in the grocery business and their failure accepted philosophically by the family providing the funds. The family relatives say: "Well, we guess Joe isn't a good groceryman." But a lot of these fellows are good grocerymen and we need them. H o w does banking fit into this picture? I t works i n this way. We have i n these 14,000 institutions a group of loan officers who every day are making thousands of judgments as to whether they ought to put the bank's credit into business ventures. T o the extent that these banks are close to the local scene and flexible i n their policies, they are picking the people who have managerial talent and are backing them. So you have a screening process at work which brings to the fore these people with talent. There is a social service which banking contributes. I think it ought to be recognized. I mention it to get it i n the record. Senator DOUGLAS. M i g h t I return to a line of questioning which Congressman Wolcott started. I t is this: The banks have enormous quantities of Government bonds i n their portfolios; and, as I understand it, i f the banks present these bonds to the Federal Reserve System, the System must accept them and give them credit i n the form of reserves? M r . WILLIAMS. T h a t is right. Senator DOUGLAS. N O W , i n view of these enormous amounts of bonds held by the banks, doesn't that take away from the Federal Reserve System the power of controlling inflation, because banks can present the bonds, have the accounts credited as reserves, and then can expand their loans to other sectors of business correspondingly; so that doesn't this weaken the amount of control which the System can exercise over the total loan funds of the country ? M r . WILLIAMS. That is true. The extent or the effect w i l l turn entirely on the price at which we are w i l l i n g to accept the bonds, Senator Douglas, which is leading directly into the question of the support of the Government bond market, I take it. I can answer it in this way—and this brings me, incidentally, to the next fundamental point that I want to present: I think that from here out, or at some reasonably near time, we, as a system, ought to be i n a position to use fully any of the tools that are necessary on our part to stem the inflationary forces i f they develop, and I said at the outset I expect them to develop. Therefore, I think that we are right up against the alternative of whether we are going to regain the use, the flexible use, of the tools at our disposal, which means essentially open-market operation in both directions, buying and selling, as con- 48 MONETARY, CREDIT, AND FISCAL POLICIES trasted with a policy of fixed interest rates, where we supply funds i n boom times and withdraw them i n depression times. Now, I have indicated before the advantage of use of a general tool. I think that the sharpening of our tools, the regaining of their use, is important. I don't mean to imply that they haven't been used. Perhaps my phrasing is in error. The fuller use of the tools than we have made is entirely compatible with freedom, with the attainment of freedom. One of the great instruments among the general instruments to which I refer is this device of open-market operations. That has implications for the commercial banks, implications for the Treasury, and implications for the System. I f circumstances call for the use of reserve requirements, there must not be a feeling on the part of any bank that this is an improper control. W e have weathered the four difficult years. I f the circumstances call for a flexible interest-rate structure, there ought not to be any grave doubts about the stability of the credit of the United States Government. This calls for an understanding of monetary policy on the part of commercial banks and a willingness to accept changes i n policy. I think, i f we are to obtain that willingness, it calls for a degree of skill i n maintaining and creating good banking relations that w i l l bring that acceptance. Senator DOUGLAS. M i g h t I ask, M r . Williams, what relationship these statements that you began with would have to the support program of the Reserve System and of the Treasury ? M r . WILLIAMS. I think they are directly related, M r . Chairman. Senator D O U G L A S . I wondered i f you would itemize them and i f you would state specifically what they are. M r . WILLIAMS. Well, for the Treasury the implications are that we ought to continue to work together closely. Here are two agencies that had a close degree of cooperation during the war period and the postwar period. I think relations were never more satisfactory than they are at the moment, but the mere size of the debt and the mere size of the fiscal operations of the Government are such as to call at all times for study of their implications for general economic stability. A n overriding consideration ought not to be low cost of servicing the debt. Uncle Sam is spending $40,000,000,000 and the cost of servicing is about $6,000,000,000, roughly. I n other words, we have $34,000,000,000 which is being paid for other things. Both of these agencies, as indicated at the outset and i n our reply to questionnaire, are really under the mandate of the Employment Act, and I think it would not be out of order to get specific reference to that fact i n legislation. Senator FLANDERS. M a y I inquire i f what you are saying is that you can conceive of conditions i n the not distant future in which you think the desirable action would be one which would raise the interest rate to the Government ? M r . WILLIAMS. Yes. Senator D O U G L A S . H O W would you do that ? M r . WILLIAMS. Well, one way would be via open-market operations. I am assuming now that conditions would arise which would indicate that we ought not to be supplying funds to the market at the initiative of the market so as to build up already developed inflationary tendencies. 49 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. W o u l d you describe i n some detail the changes i n open-market procedures which would be necessary i f this policy were to be carried out ? M r . WILLIAMS. That would depend entirely on the circumstances that arose. I take it that it would not be a step from support to nonsupport. I indicated at the outset that open-market operations are very subtle; they have to be handled very deftly. Y o u use your leverage i n ways that vary greatly according to specific circumstances. W e have a large number of onlookers and participants i n the Governmentbond market who are seeking to understand. Senator DOUGLAS. Suppose we were to get out of the recession and move into a period of f u l l employment, and then prices started to move upward, so that we would be i n danger of inflation. Have you thought about what changes, i f any, you believe should be made i n the openmarket operation ? M r . WILLIAMS. Well, I think we ought to be siphoning funds out of the market. Senator DOUGLAS. A n d how would you do that, by selling Governments ? M r . WILLIAMS. By selling. Senator FLANDERS. That might reduce the price of Governments and thereby increase the yield and also increase the interest which the Treasury w i l l be forced to pay on any new issues. M r . WILLIAMS. That is right. A n d I realize, of course, we are entering a period of refundings, in which the volume of refundings are very large, but it is a question of relative costs. Discuss the matter of relative costs for a moment, Karl. M r . B O P P . Y O U have the present interest charge on the Government debt Senator DOUGLAS. M a y I follow up this point ? M r . BOPP. Yes. Senator DOUGLAS. Suppose you do sell Governments to the banks and the banks have more Governments. Under your present provisions the banks can then come back and voluntarily present the Government bonds and you have to accept them. A r e you proposing now that the Reserve System should not have to accept them ? M r . WILLIAMS. F r o m the standpoint of the commercial bank, it has a choice as to where it employs its funds. Is it going to invest its funds i n Governments, or is it going to employ its funds i n the extension of credit. ? D u r i n g the postwar period we exerted a considerable snubbing influence by .the management of the short end of the maturity structure; namely, bills and certificates. I t may well be that we can operate this account i n such a way as to lure banks away from the extension of credit during the inflationary trends i n business. W e have, also, of course, the tool of reserve requirements. Senator D O U G L A S . I know. That is always in the background. M r . WILLIAMS. Yes. Senator DOUGLAS. But I was primarily interested i n the movement i n the open-market operations. M r . WILLIAMS. I t is a case of alternative choices on the part of the banks. Senator D O U G L A S . I want to follow up this line of questioning that Congressman Wolcott started some minutes ago, as to whether you 50 MONETARY, CREDIT, AND FISCAL POLICIES think it should continue to be an obligation of the System upon the request of the banks to accept Government bonds and credit that to the reserve accounts of the member banks, thus creating a much greater potential loan capacity, and whether you can have an effective system of control, i n your judgment a total system of control, i f these powers still remain for the member banks ? M r . WILLIAMS. Well, it is a question, of course, of using your tools i n combination, and it is a question of the price you set on the Governments that are outstanding. W e have been pegging the price thus far. A departure from a policy of a fixed price structure is going to bring about an adjustment of market values, and it may well be that banks would prefer to remain i n Governments rather than to enter into the field of commercial credit extension. Senator FLANDERS. M a y I ask a question ? Supposing that it seemed desirable some time before long to allow bond prices to go down and interest rates to go up. That affects our responsibilities here i n Congress i n the way of searching for a balanced budget. I don't want to say that we are searching with f u l l earnestness and determination. But it is always an ideal that is fluttering around us. D o you see anything in its effect on general business conditions, i n which such a policy, appropriately applied at an appropriate time, might have the effect of increasing national income so that it wouldn't have a harmful effect i n the long run on the Government income ? I n other words, that the increased cost of servicing the debt would, by any means, be counterbalanced by the increased return from taxation, or would it be a net loss ? M r . BOPP. There is another aspect to the problem, because the Government is interested, so far as its budget is concerned, in total expenditures, one item of which is the interest cost on the debt. Suppose we take $5,000,000,000 as the interest cost at present. A n increase of 20 percent in that is $1,000,000,000. If, through that increase i n the interest charge of $1,000,000,000 you prevent prices from rising, the Government may profit because it is buying 35 or 40 billion dollars' worth of goods and services. A 3-percent increase i n prices of the goods and services purchased by the Government would cost the Government as much as a 25-percent increase i n the total interest cost to the Government. So far as the Government budget is concerned, it is the total that really interests Congress. Senator F L A N D E R S . I am glad that point has been brought out. I would like to follow that up with one further question. H o w direct is the influence of the money supply on prices? I raise that question because, as I remember, during the thirties, we increased the debt to some extent, the free money supply along toward $15,000,000,000, and its effect on prices was not very great. I wondered i f you feel that there is a direct and usable relationship between the money supply and the prices. M r . WILLIAMS. M r . Bopp has handed me a page that I had copied out of D r . Goldenweiser's book on Monetary Management Senator FLANDERS. M a y I just make an inquiry of the staff? I was told that when he was furnished with this questionnaire he sent i n his book. I don't know whether that is significant or not. 51 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WILLIAMS. I t is a book that has some delicious gems i n it, Senator Flanders. Here is one which M r . Bopp, with a twinkle i n his eye, passed along. H e is discussing money. [Reading:] I n certain respects money, one of the most concrete of economic entities, is nothing but a state of mind. I t means something entirely different to different people, depending on their state of mind. T o the miser it is an end i n itself. T o the spendthrift i t is a means of enjoying the process of spending, and to the thrifty, industrious citizen, it is a means of obtaining the necessaries of l i f e and of providing for emergencies and old age. T h e same amount of money represents plenty f o r some and penury f o r others, peace of m i n d for one group and worry f o r others. N o r is this entirely a matter of l i v i n g standards. I t differs i n its significance for persons w i t h roughly identical standards and economic responsibilities. There are people who always have enough money and some to spare, almost independently of the size of their income, provided it is not below an irreducible minimum necessary for the maintenance of decent standards. There are others who are always short of money regardless of the size of their income. T h e difference between the two is not entirely i n the magnitude of their wants nor i n the degree of their competitive vanity or of appreciation of finer and more costly things, It is i n the whole gamut of almost imperceptible minutiae, i n habits about gratuities, i n preferences about diet, i n responsiveness to others' needs, i n sensitiveness about criticism, i n aptitude for arithmetic, i n willingness to take pains, i n relative appraisals of the cost of effort, i n relative knack for knowing the ropes, i n relative degrees of affection for money i t s e l f — i n a word, i n differences more closely associated w i t h the mind than w i t h the pocketbook. In discussing the economic role of money, the cardinal fact that the forces w h i c h affect its functions are not a l l concrete or easily definable, but are to a considerable degree intangible and psychological, needs to be recognized. It is a negation of the economic man and a recognition of men w i t h different natures, habits, and states of mind. It is a caution signal for the rash generalizer. Senator F L A N D E R S . I S there a general average statistical economic man? M r . WILLIAMS. Well, we find, Senator Flanders, that bankers who are professionals i n the field of money, are motivated i n many of the ways that are mentioned here, and that they are psychologically affected. I t is difficult, Chairman Douglas, to point out the extent to which uncertainty with respect to the maintenance of par on Government bonds would influence the actions of commercial bankers i n the extension of credit. W e stand ready takers and sellers, and it may well be that a continuance of this—whereby in periods of business upsurges we are providing funds, and i n periods of business recessions we are acting in an opposite way—will render ineffective this important tool that has been placed at the disposal of the System to use i n this field to help to reduce economic instability. So that my general philosophy here is that we are i n this period of the rise of governmental action and we have to be careful because ambition w i l l overleap itself and f a l l on the other side. Senator D O U G L A S . I don't want to push you too far, but I just want to follow out these questions that I have been attempting to ask. T o what degree are the open-market powers of the System i n the period of inflation really effective as long as the banks can then take back to the System the bonds which the System has sold to them and get reserves ? M r . WILLIAMS. That is a matter of their attitude toward disposing or holding the bonds and that in turn is geared into the price. Senator FLANDERS. I f you sold them to them low enough they might keep them ? 52 MONETARY, CREDIT, A N D F I S C A L POLICIES M r . BOPP. Yes. That is, I think the banks and others could be discouraged from selling by the price they w i l l receive when they do sell. Hence they prefer to hold on rather than sell at the lower price; and hence the System is not asked to buy because of the low price which it offers for those securities. ( W i t h the permission of the committee, M r . Williams subsequently inserted the following amplification of the discussion of a flexible open-market policy:) T h e purpose of a flexible open-market policy involving flexible, but not erratic, interest rates would be to promote economic stability by influencing the flow of expenditures through adjustments i n the volume, availability, and cost of reserves. T h e relationship between reserves and the flow of expenditures is not r i g i d or invariable. F o r this reason it is not possible to give a precise blueprint f o r the day-to-day administration of a flexible open-market policy. I t is possible, however, to give some implications of such a policy. Fundamentally, i t implies the possibility of movement of both directions—that is, more restrictive as w e l l as less restrictive—as circumstances warrant. T h i s means that there would not be inflexible support at any specified level of prices. It does not, however, mean that the Government securities market w o u l d be abandoned to its own fate. Indeed, unanimity does not exist as to the meaning of a "free" market i n such securities under existing conditions. Of the $17,000,000,000 of Government securities owned by the Federal Reserve banks, $10,000,000,000 mature w i t h i n a year; some mature every week. Does a free market mean that maturing issues w i l l be replaced w i t h other issues or that they w i l l be redeemed? I f they are to be replaced, w i t h what other issues? I f they are to be redeemed, what w i l l happen to the money market f r o m which $10,000,000,000 is w i t h d r a w n by the central bank i n a year? A n d what is "natural" about having the rate of w i t h d r a w a l determined by the particular maturities of issues acquired previously? Consideration of the maturities of issues i n the System account reveals also t h a t the System need not, as is sometimes supposed, sell long-term bonds to w i t h d r a w funds f r o m the market. It can do so by not replacing some of its maturing issues. It can reduce reserves also by sales of short-term issues. T h e day-to-day operations of the open-market account are influenced not only by the securities i n the portfolio but also by market forces whose strength varies a great deal. F o r example, if investors sell securities because of panic or fear, the appropriate action may be for the System to purchase i n order to allay that fear. On the other hand, i f owners are selling i n order to invest or lend elsewhere, the appropriate action may be to permit yields—long, term, short term, or both—to rise and correspondingly to allow prices of securities to fall. T h e System is interested i n the volume of reserves not as an end i n itself but as a means of influencing the flow of expenditures to promote economic stability. I n my judgment, the most important w a y i n w h i c h the System can make its contribution to stability is through operations i n an orderly and flexible tout neither a rigid nor a completely free market f o r Government securities. M r . WOLCOTT. M a y I ask what might be a foolish question. When a member bank puts up its bonds as collateral for a Federal Reserve note, the title of the bond is not transferred to the Federal Reserve bank, is it? M r . BOPP. I am sorry. The Federal Reserve banks put up the collateral for Federal Reserve notes which are issued to them by the Federal Reserve agents. The bonds that are put up by the Federal Reserve banks may have been bought from banks or from individuals through open-market operations, namely, through Government securities dealers i n the first instance. M r . WOLCOTT. W h o gets the interest on the bonds which are pledged ? M r . BOPP. They are owned by the Federal Reserve bank and the Federal Reserve bank gets the interest. 53 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . W O L C O T T . S O the interest is theirs. I was wondering what influence a higher yield on Government bonds would have on their pledging the bonds for currency issues. M r . B O P P . I think the way the matter operates, Congressman Wolcott, is that the Federal Reserve bank takes its own Government securities, and i f the commercial banks need Federal Reserve notes, they draw down part of their deposit account at the Federal Reserve bank, but they do not specifically send up Government securities to pay for the Federal Reserve notes which they want. M r . W O L C O T T . I t is taken out of the reserves deposited with the Federal Reserve ? M r . B O P P . That is correct. The commercial banks have nothing to do with this collateral reserve requirement. O n the general relationship between debt and money, first, it has been historically true, ever since the goldsmiths became bankers, that debt has been related to money, although for a long period of time it was primarily private debt. W h a t has happened is that now it is primarily public debt, but the intimate relationship between the debt and money is the essence of all banking. M r . W O L C O T T . That is the point I bring out. The old goldsmiths determined that there was a certain safe margin, the issuance of certificates against the gold which was in their keeping, and it kept increasing and increasing until the time that the Government came i n and took over. W e are confronted, apparently, with the same situation today, with respect to Government debt. I t seems to me that we have got, somewhere along the line, to get better control, better control of the volume of public debt which can be monetized. Now, as I understand it, the objective of this committee is to find out the causes of our dips and booms, and then recommend to the legislative committees ways and means of preventing them. A s I get it you have three weapons, which we w i l l consider orthodox weapons: the manipulation of the rediscount rates, manipulation of reserve requirements, and the open-market operations. Now, am I correct in the statement that when you increase the rediscount rate, and when the interest rate, or the yield rate on Government bonds is increased, there is a tendency on the part of the banks to pass that on to the commercial borrowers, and does not that influence the demand by commercial borrowers for credit ? M r . B O P P . Yes, as well as M r . W O L C O T T . Isn't that the orthodox way of controlling volume and velocity of credit? Senator D O U G L A S . I don't want to answer the question of my colleague, but is it not true that rediscounting has virtually ceased, and that the amount of paper which the member banks present to the Reserve banks and the System, is infinitesimal ? M r . BOPP. Yes. M r . W I L L I A M S . That is the psychological tool which I referred to before. M r . B O P P . O n September 2 8 of this year the total amount of discounts and advances of all Federal Reserve banks combined was $ 3 0 0 , 000,000; at the same time the total United States Government securities held by the Federal Reserve System was $ 1 7 , 8 5 2 , 0 0 0 , 0 0 0 . So that the order of magnitude is 3 out of 178. M O N E T A R Y , CREDIT, AND FISCAL POLICIES 54 M r . WILLIAMS. I think, Congressman Wolcott, i t is also difficult to generalize as to the effect of interest costs on the actions of businessmen, because a prospective profit may mean that the difference i n the cost, with a rise of the interest rate, would not deter them f r o m going ahead with their ventures. M r . WOLCOTT. Last spring we were told, when we had hearings on corporate profits and earnings, that there were very few stock and bond issues by corporations. H o w are the people getting their credit i f they don't get it from banks ? M r . WILLIAMS. I think the amount put out varies from time to time M r . WOLCOTT. P u t out by whom ? T h e banks ? M r . W I L L I A M S . N O , no; I am thinking of the amount of funds f r o m the sale of stocks and bonds, that are issued, by investment bankers' fields, i n anticipation M r . WOLCOTT. L e t me clarify my own thinking on this. I don't think I am clear on this matter now. The banks, i f they are not rediscounting, where are they getting the money to make the commercial loans, and other loans, anything that they are loaning on ? A r e they getting it out of earnings ? M r . W I L L I A M S . Y O U have the figures there, K a r l , of the increase. M r . BOPP. The loans of commercial banks, as a whole—just one moment, t i l l I find the figures. I have a chart of commercial loans at member banks i n leading cities. I shall give you just three dates. Interpolating from the data here—at the beginning of 1948, they were of the general order of magnitude of $15,000,000,000. They fell bv the middle of the year to, roughly, $14,000,000,000; and then rose to just under $16,000,000,000; and at the present time are about $13,500,000,000. So you have had a reduction of something like 2% or 3 billion dollars i n the total loans extended by member banks i n leading cities, which roughly reflects what has been going on. So there has not been an increase i n bank loans i n the last year. M r . WOLCOTT. The peak was $17,000,000,000? M r . BOPP. F o r member banks, i n the leading cities, roughly $16,000,000,000. M r . WOLCOTT. That was due to industrial expansion, perhaps, which has leveled off somewhat? M r . BOPP. Yes. Senator DOUGLAS. M r . Bopp, the real answer that the banks such large reserves i n the Reserve banks is that they do not to resort to the System for rediscounting of commercial paper, they have built up these reserves by gold imports, which have through their hands into the System, and into the Treasury. that the answer ? M r . BOPP. have need that gone Isn't Yes. Senator DOUGLAS. A n d also by the sale of securities ? M r . BOPP. Yes. Senator D O U G L A S . T O the banks ? M r . BOPP. Yes; quite right. M r . WOLCOTT. I t is to be noted that I coupled the manipulation of Tediseount notes w i t h the increases i n yields on Government bonds. Now, I assume that, because of the large holdings of Government bonds by the banks, i f the new issues provided for a larger or higher interest rate, and we do not make provisions for retroactively taking 55 M O N E T A R Y , CREDIT, AND FISCAL POLICIES care of the present holdings, that there would be a tendency on the part of the banks to liquidate their present holdings i n favor of new issues ? M r . BOPP. Yes. M r . WOLCOTT. W h i c h brings me down to this point, the point which I started out to put forward: What is going to happen to all of this when we have to retire the savings bonds, the E bonds, and so forth, when we have to refund those, what is going to happen then to our bond market, and this situation generally, when we have to pay off? M r . BOPP. The first part, Congressman Wolcott, is technical, and I w i l l take that, i f you don't mind, and then the other is more a policy matter. W i t h respect to the willingness of anyone to hold onto currently outstanding issues, I think you are quite correct i n saying they would like to dispose of them, except that for someone to dispose, someone else must acquire,, and the other person w i l l not offer a price on the old outstanding issue except one that is commensurate with the yield on the new issue. M r . WOLCOTT. B u t the Open Market Committee w i l l peg it. Won't they maintain them in some manner ? M r . BOPP. I misinterpreted the question. I thought you started out by saying, what i f the Federal Reserve System, the Open Market Committee, permits an increase in yield on Government securities, which means they do not buy them at the former existing prices, but at lower prices. M r . WOLCOTT. That would be the way you would take care of the outstanding issues, by pegging at a price comparable to the price of the new bonds. M r . BOPP. I f prices on outstanding issues were pegged at the old level, you would not have the increase in the interest rate or yield that you have mentioned. M r . W O L C O T T . Y O U can increase the yield rate by pegging them at a lower price. M r . BOPP. B u y i n g at a lower price, not necessarily pegging. M r . WILLIAMS. Increase the yield to the extent that it would be i n line with the new issue. M r . WOLCOTT. T h a t is r i g h t . M r . WILLIAMS. O f course we have a structure here that is M r . WOLCOTT. A l l of which brings me to this point, that, apparently, where we are increasing constantly the reserves of the banks, so that the banks don't even have to rediscount to the Federal Reserve, to get enough credit with which to make their commercial loans, that being the case, as the banks increase the size of their Government portfolios, don't we increase the threat to the stability of our money proportionately as those bonds which are held by the banks might be monetized? W h a t can we do to remove that influence, which I might say w i l l be aggravated when we have to refund the E bonds that are outstanding? M r . WILLIAMS. W e have a price mechanism here that has been i n existence, and what I am inferring is that we now ought to get it out and use it. Senator DOUGLAS. A r e you proposing that you would successively lower the support price on bonds, thus increasing the yields, and therefore making it more palatable for the banks to hold the Government bonds which w i l l be sold to them? 56 MONETARY, CREDIT, AND FISCAL POLICIES M r . W I L L I A M S . N O . I am proposing that we inject an element of uncertainty into the structure here, i n such a way as to give rise to decisions, alternative choices. M r . W O L C O T T . Y O U don't need any new congressional authority to manipulate rediscount rates, do you? M r . WILLIAMS. NO. M r . W O L C O T T . Y O U don't need any new authority i n the Open M a r ket Committee to peg the price of Governments. That is a practice among the System ? M r . WILLIAMS. T h a t is correct. Senator FLANDERS. O r to unpeg them ? M r . WILLIAMS. NO. M r . WOLCOTT. N o r to u n p e g them. Now, we had some discussion this last year i n respect to whether you had sufficient authority to manipulate reserve requirements i n such manner as to reduce the demand for money or prevent the monetization. Have you any recommendations to make i n that respect ? I might say that it has been the practice before congressional committees to make the first witness the "goat," so i f you don't care to answer now, you don't have to. M r . WILLIAMS. Well, of course, I said at the outset that I do not speak for the System. I take it we w i l l have no hesitancy i n coming back i f we think that additional authority is needed. The discussions which ensued last M a y when we asked for renewal of the supplemental grant of 4 percent are clearly i n mind. Subsequent developments were such as to indicate they were not needed. I t is a matter of judgment as to what is i n prospect, and developments have been such as to bring about a decrease, a cession of upward pressures. M r . W O L C O T T . D O you think it would be helpful to the stability of our economy to give the Federal Reserve the authority to raise reserve requirements, we w i l l say up to 10 percent, making them so flexible that the Federal Reserve Board could, within its discretion, use them up to that limit? W h a t I have in mind is this: Wouldn't the fact that the Federal Reserve has the authority to go up to 10 percent cause a great deal of uncertainty which would or might offset all stabilizing influences? M r . WILLIAMS. T h a t raises the question of our relationships with the banks and the banking system, which is the last topic that I have to present, and which is an important one, and stems right back to this matter of understanding. Senator DOUGLAS. Before you proceed to that—Mr. Buchanan. M r . BUCHANAN. W o u l d you care to itemize the specific congressional directives to those responsible for policy i n the coordination of fiscal-debt management and monetary policy ? M r . WILLIAMS. I think it ought not to be i n terms of specific directives. W h a t I was proposing was a recognition on the part of Congress that management of the public debt is meshed into the operation of the Federal Reserve System, having to do with general credit and monetary policy, so that the two i n combination might work with a view to achieving stability. I think it would be regrettable i f we get into an attitude that we have a mechanical mechanism that can accomplish results, and then say, thank God, we are organized and can dismiss that question from mind. The situation would be even 57 M O N E T A R Y , CREDIT, AND FISCAL POLICIES more regrettable i f we have that feeling on the part of one group and a feeling on the part of another group—such as I fear is growing among bankers—that here is just another governmental regulatory body, and a plague on their house. When you get into that position you find too much being expected of the System on the one hand and a resentment for whatever is being done by the System on the other hand. I t places you i n an impossible position. We have a thoroughgoing job of public relations on our hands with respect to the whole commercial banking structure. That is what I was referring to a while ago when I gave a plug for commercial banking, when I said that my later testimony might be construed as critical. Senator FLANDERS, I don't know whether this is what M r . Buchanan had i n mind, but do you have any legislative, any restrictions of law on your rates of rediscount ? Y o u can set them what you please, can you? M r . WILLIAMS. Yes. Senator F L A N D E R S . D O you have any legal restrictions on your openmarket operations? M r . BOPP. There is one technical qualification with respect to rediscount rates. Section 10 (b) of the Federal Reserve Act, which authorizes the Reserve banks to extend credit to member banks on noneligible assets, does require that the rate charged by the Federal Reserve bank for such advances be a half a percent higher than the highest discount rate. I t is a curious circumstance i n which the System has complete discretion with respect to the general level of rates, and with respect to the interrelations of rates, except for this particular rate which must be related to one other particular rate. Senator DOUGLAS. But that is a minor thing ? M r . BOPP. Yes. Senator FLANDERS. So you have no legislative restrictions, practically speaking, on the rediscount rates, you have no legislative restrictions, practically speaking, on the open-market operation, but you do have legislative restrictions on the reserve? M r . BOPP. Yes. M r . WOLCOTT. M a y I ask one other question. I was leading up to this. I am trying to find out how much of the debt could be monetized under present authority. I guess perhaps the best way of determining that is to determine how much of the Government debt holdings by Federal Reserve banks is i n a position where it could be pledged and that would be approximately three-quarters of the potential, of the possible volume, would it not? M r . BOPP. The restriction on Federal Reserve bank acquisition of assets is written i n reverse, namely, it is a requirement that the liability on note and deposit accounts be backed by a minimum of 25 percent of gold holdings. So the total liability on these accounts may be equal to four times the gold holdings. Since the liabilities are offset by corresponding earning assets they could be roughly four times our gold holdings. I f I remember correctly, our present gold holdings are about $25,000,000,000 which means we could have liabilities i n the order of $100,000,000,000 and earning assets of $75,000,000,000. M r . WOLCOTT. That would be Federal Reserve notes. That is for the Federal Reserve banks. M r . BOPP. That is the Federal Reserve alone. However, i f the commercial banks and the public, i n their discretion as to the kind of 58 M O N E T A R Y , CREDIT, AND FISCAL POLICIES liabilities they wanted, chose to have all of this increase i n the f o r m of deposits of Federal Reserve banks, the total for the entire banking system would be much larger. Deposits at the Federal Reserve banks are the reserves of member banks, which i n turn enable them to increase their purchases of Government securities. T h e order of magnitude of the additional reserves would be: $ 7 5 , 0 0 0 , 0 0 0 , 0 0 0 of earning assets minus $ 1 7 , 0 0 0 , 0 0 0 , 0 0 0 , which we now have, or $ 5 8 , 0 0 0 , 0 0 0 , 0 0 0 . I f the average member bank reserve requirement is 20 percent, we m u l t i p l y that by five and get 240 to 250 billion dollars. So the total for the banking system, including the Federal Reserve, is about $300,000,0 0 0 , 0 0 0 . I n terms of legislative power it is, I should say, well adequate. M r . W O L C O T T . M a y we sum it up this way, and would this be a f a i r statement, that under existing authority it is theoretically possible to raise the volume of our money to—what would you say ? M r . B O P P . 4 0 0 or 5 0 0 billion dollars. Senator F L A N D E R S . M a y I ask a frivolous question at this point, and when I say "frivolous" I mean "frivolous": W h a t would happen i f every debt i n the U n i t e d States, private business and Government, were by some magic p a i d up, what would happen to money ? M r . W I L L I A M S . W e would begin to acquire additional debt. T h e sharp pencil boys would get it f r o m the rest of us. I have discussed the relationship of the System, oil the one hand, w i t h the Treasury. I would like to t u r n now and consider relationships w i t h the banking system as a whole. Senator D O U G L A S . W i l l you discuss their reserve requirements, M r . W i l l i a m s , i n this connection ? M r . WILLIAMS. Yes. Senator D O U G L A S . I t is now 12:20 p. m. I wonder i f you w o u l d return at 2 o'clock, and we w i l l ask the witness who was to appear at 2 o'clock to postpone his appearance u n t i l later i n the afternoon. M r . WILLIAMS. Yes. Senator D O U G L A S . T h a n k you very much. (Whereupon, at 12:20 p. m., a recess was taken u n t i l 2 p. m., of the same day.) A F T E R N O O N SESSION Senator D O U G L A S . M r . W i l l i a m s , you had not completed your statement this morning, and I take i t you had about come to some definite recommendations. W e would be very happy to have you proceed now, i f you would. STATEMENT OF ALFRED WILLIAMS, PRESIDENT, AND KARL BOPP, VICE PRESIDENT, FEDERAL RESERVE BANK, PHILADELPHIA— Resumed M r . W I L L I A M S . I want to talk, i f I may, about System relationships w i t h banks. I include this i n the presentation because i t seems to me to be a problem of first-rate magnitude and affects the atmosphere i n w h i c h we work. I find—and I think some of the other Federal Reserve B a n k presidents do—that bankers are restive; they are skeptical; they are querulous; their morale is low. Some feel aggrieved; feel that they are singled out unduly for attention i n this matter of regulation and control. W h e n one explores the question as to why this should be, the answer divides itself into the attitudes of member banks and of nonmember 59 M O N E T A R Y , CREDIT, AND FISCAL POLICIES banks. I think to the extent that it exists among member banks it arises from the upping of reserve requirements last year under inflationary conditions. Senator DOUGLAS. W o u l d you state for the record the increase i n the reserves which w^as put into eff ect last year and during this year % M r . BOPP. T h i s is the record for 1948 and 1949: O n February 27, 1948, reserve requirements of central reserve city banks were increased from 20 to 22 percent; on June 11 they were increased to 24 percent; then on September 16 the reserve requirements for county banks against net demand deposits were increased from 14 to 16 percent, and on time deposits for the same group of banks from 6 to 7% percent. Effective September 24, the reserve requirements against demand deposits were increased from 24 to 26 percent for central reserve city banks and from 20 to 22 percent on reserve city banks, and at the same time the requirements against time deposits for both groups were increased from 6 to 7y2 percent. On M a y 3, 1949, the reserve requirements for country banks were reduced by 1 percent on demand deposits and by % percent on time deposits. On M a y 5 there was a reduction from 26 to 24 percent against demand deposits for central reserve city banks and from 22 to 21 percent on reserve city banks, and a reduction of l/2 percent against time deposits at those two classes of banks. On June 30 there was a further reduction at reserve city banks from 21 to 20 percent against demand deposits and from 7 to 6 percent on time deposits. O n J u l y 1 there was a reduction of 1 percent against both time and demand deposits of country banks; on August 1, a further decrease of 1 percent on country banks against net demand deposits only. Then a series of changes, a half percent at a time, followed through i n August at these various banks. We could insert the f u l l table i n the record, i f you want. Senator DOUGLAS. W e would appreciate it i f you would. (The table referred to above is as follows:) M E M B E R I B A N K RESERVE REQUIREMENTS [Percent of deposits] Net demand deposits 1 Effective date of change 1948—Feb. 27 June 11 Sept. 16 . . Sept. 24.. 1949—May 1... -May 5 June 30.. _ July 1 _ Aug. 1 Aug. 11. _ Aug. 16.. __ Aue. 18 Aug. 25 Sept. 1 . _ In effect Oct. 1, 1949 ... .. Central reReserve serve city city banks banks 22 24 20 26 22 24 21 20 23 K 23 22K 22 22 19K 19 ISM 18 18 Country banks Time deposits (all member banks) 14 6 16 2m 15 27 14 13 3 7 36 26 12 35 25 12 5 1 Demand deposits subject to reserve requirements, i. e., total demand deposits minus cash items in process of collection and demand balances due from domestic banks (also minus war loan and series E bond accounts during the period Apr. 13, 1943-June 30, 1947, and all U. S. Government demand accounts Apr. 24,1917-Aug. 13, 1935). 2 Requirement became effective at country banks. 3 Requirement became effective at central reserve and reserve city banks. 60 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . D O I understand, M r . Williams, that member banks feel these reserve requirements are too high ? M r . WILLIAMS. Resistance to the increase, I think, grew out of two reactions on the part of the member banks. (1) A feeling that the timing was not good and not completely understanding what the conditions of business were that brought about the increases; and (2) The problem of competitive relationship. Frequently we think of this in terms of the low percentage of deposits i n nonmember banks and say that this is a relatively minor matter, and is a low price for the freedom that State banks enjoy for having the right to come i n the System or stay out of the System and, therefore, we ought not to disturb it. Senator DOUGLAS. I had some figures prepared on this by the members of the staff. They show that, as of June of this year, of the 14,149 commercial banks, 4,987 were national banks and a little less than 2,000 were State banks inside the System, or a total of around 6,900 banks inside the System, or about 49 percent. But the deposits which these banks held amounted to 85 percent of the total deposits i n the country. I wondered i f there is not a sufficient body to the dog to be able to wag the tail. M r . WILLIAMS. Competitively, the placement of a nonmember bank in a local situation can be such as to work a disproportionate influence. Furthermore, quite apart from whatever advantages, real and fancied, there are to nonmembership, you have a psychological factor. I f , when he is restive, the question of increase i n requirements comes up, the member bank begins to raise Senator DOUGLAS. A r e you saying this: That among the 2,000 State banks, which, by their own choice are members of the Federal Reserve System, but which may have the power, as I understand it, to withdraw from the System at any moment, that there are rumblings that some of them may get out of the System, at least ? M r . WILLIAMS. There is talk. I think there is more talk than actual intention. I n our own district two banks have raised the question, two banks of considerable size. I n one instance the banker came down and went over i n some detail the advantages i n dollars and cents of getting out, and talked with us at some length about that. Senator D O U G L A S . I wonder i f you would be willing to make a considered statement on the relative advantages and disadvantages to a State bank as to whether or not it w i l l voluntarily join or stay i n the System. M r . WILLIAMS. M a y I have the privilege of working that out and inserting it i n the record ? Senator D O U G L A S . I wonder i f we could develop some of it by questions. W h a t is the situation on clearance? D o nonmember banks have their checks cleared through the Federal Reserve System? M r . WILLIAMS. Generally speaking, the nonmember bank is operating via a correspondent city bank; there are some exceptions. Senator D O U G L A S . Their checks are cleared through their correspondent, which is a member of the System, you mean, rather than directly ? 61 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WILLIAMS. That is right; and the correspondent i n turn may be using our facilities, doing some of the work himself and not doing other portions of it. Senator DOUGLAS. W i l l the State banks have the privilege of clearing directly through the System ? M r . WILLIAMS. Only to a very limited extent. Senator DOUGLAS. But, when they operate through a corresponding bank, is any service charge made to the State bank not a member of the System for having its checks cleared by the System ? M r . WILLIAMS. NO. Senator D O U G L A S . S O that service is given to them free, although it costs the Government naturally something to provide it. That is not an advantage, then, for their joining the System, since they can get the service without cost through a correspondent bank which is a member. M r . WILLIAMS. That is right. There is also a question as to relative efficiency of the two systems. Always we are attempting to improve our service and speed up delivery, but I would not want to imply that we always do a better job than correspondent banks, because that does not necessarily follow. Senator DOUGLAS. But, i f correspondent banks clear through the System, then they extend those privileges by that fact. M r . WILLIAMS. The clearances are direct on the part of the correspondent bank, where they have relationships with other correspondent banks, and one cannot generalize about that situation. Senator DOUGLAS. Have you ever tabulated the laws and regulations which apply to national banks and to State banks that are members of the Federal Reserve System but which do not apply to State banks not members of the System ? M r . WILLIAMS. Our vice president i n charge of bank examinations has. I would not feel competent to testify offhand. Senator DOUGLAS. I have had a list prepared, which comes to 30 items, which are restrictions upon members of the System which are not restrictions upon nonmembers of the System. M r . WILLIAMS. They exist; there is no question. Senator DOUGLAS. They are limitations on total loans to one borrower, regulations governing purchase of investment securities, prohibition against purchasing stocks, prohibition against engaging i n underwriting of investment securities and stocks, restrictions on loans to executive officers, restrictions on dealings with directors, restrictions on interlocking directorates or other interlocking relations with other banks and with securities companies, prohibition against banks having less than 5 or more than 25 directors, provision authorizing supervisory authority to remove officers and directors for continued violations of law or continued unsafe and unsound practices, prohibition against affiliation with securities companies, restriction on holding-company affiliates, restriction on bank stock representing stocks of other corporations, limitations on loans to affiliates, requirements of reports of affiliates and publication thereof, requirements for examination of affiliates, limitations on investment i n bank premises, minimum capital requirements, minimum capital requirements for 99076—50 5 62 MONETARY, CREDIT, AND FISCAL POLICIES branches, prohibitions against loaning on or purchasing own stocky restrictions on withdrawal of capital and payment of unearned dividends. I f this list is correct, there are a large number of restrictions which are imposed upon members designed to safeguard the integrity of the deposits which are not imposed on nonmembers. M r . WILLIAMS. Yes. Senator DOUGLAS. A n d , therefore, nonmembers i n the absence o f stringent State regulations are i n general able to get many of the advantages of the Federal Reserve System but without subjecting themselves to these limitations; is that correct ? M r . WILLIAMS. Yes. Senator DOUGLAS. A n d would you develop the question of reserves, namely, comparative reserves ? M r . WILLIAMS. These vary widely from State to State, but I think it undoubtedly is an accurate generalization to say that our requirements are higher than the State requirements. One can illustrate that i n the statements that nonmember banks make to our field men when we approach them. I could have M r . Bopp give you a few of those. Senator DOUGLAS. I wish you would. M r . BOPP. These relate primarily, M r . Chairman, to the objections which nonmembers had to the question of the increase in reserve requirements i n the year 1948. Senator DOUGLAS. W h i c h nonmembers had ? M r . BOPP. Excuse me—which members had because the higher requirements were not applicable to nonmembers. First, "opposed to any increase unless applicable to all banks"; second, "feels the increase i n reserves very unfair to member banks"; third, " i f a member bank's reserves are increased further, this State bank member's board of directors w i l l undoubtedly consider withdrawing from the System." Those are comments which our field men get; whether the bank would actually withdraw, of course, is not demonstrated. Continuing, "administration was wrong i n not subjecting nonmembers to the same reserve requirements as members"; "unfair, should apply to nonmembers"; "opposed to giving Board more power i n this direction"; "officer agrees with Federal Reserve policy curtailing credit but recommended withdrawal of their State bank from the Federal Reserve System because of the increased reserve requirements." These are illustrative comments which we have received, which our field men have received from member banks with respect to the difference i n requirements. Senator DOUGLAS- I n connection with another matter, Senator F l a n ders and I had a comparative study made on State reserve requirements, and I should like to have that put i n the record at this time* 63 M O N E T A R Y , CREDIT, AND FISCAL POLICIES (The study referred to above is as follows:) State reserve requirements for commercial 1, 1949* banks and trust companies, July S E C T I O N A — R E Q U I R E M E N T S F O R S O - C A L L E D " C O U N T R Y B A N K S , " I. E., B A N K S N O T D E S I G N A T E D OR A P P R O V E D AS R E S E R V E D E P O S I T A R I E S , N O T L O C A T E D I N C E N T R A L R E S E R V E OR R E S E R V E CITIES, E T C . Composition of reserve required on demand deposits Required reserves State Uniform Different reEither require- quirements on— balances ments with deon deVault positary mand cash banks Time and Demand or vault detime deposits cash posits 1 deposits Percent of deposits specified Alabama Arizona Arkansas California Colorado Comiecticut Delaware District of Columbia Florida Georgia Idaho ... Illinois (no statutory reserve requirements) Indiana Iowa Kansas 6 Kentucky _ Louisiana Maine __ Maryland Massachusetts Michigan Minnesota Mississippi _ Missouri.... ___ Montana _ Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma. 315.0 15.0 20.0 15.0 12.0 10.0 15.0 12.0 15.0 15.0 12.0 5 15.0 14.0 20.0 0 6 6 15.0 5 12.5 7.0 12.5 7.0 20.0 14.0 15.0 15.0 3 3 5 3 0 6 6 0 12.0 15.0 15.0 5 7 3 15.0 5 15.0 15.0 5 3 14.0 15.0 10.0 15.0 15.0 SecuriEither ties, balbalances ances with dewith de- Vault positary cash positary banks banks, or vault or vault cash cash 2 Percent of demand deposits 4 10 6 5 5 10 5 7 0 5.0 0 4.0 ^ 3.0 4.0 0 0 0 0 0 0 1.05 0 2.33 0 4. 67 0 3.0 0 0 0 3.0 0 0 0 0 3.0 0 0 0 0 0 0 15.0 10.0 15.0 8.0 12.0 9.0 14.0 5 20.0 0 15.0 10.0 12.5 5.95 12.5 4. 67 20.0 9.33 15.0 6.0 12.0 12.0 15.0 12.0 10.0 12.0 15.0 15.0 12.0 12.0 14.0 15.0 10.0 15.0 15.0 Composition of reserve required on time deposits Securities, balances with depositary banks, or vault cash 2 Percent of time deposits 0 0 0 0 (4) 2.0 0 0 20.0 0 5.0 0 2.5 0 1.0 4 3.0 0 0 0 0 0 0 0 0 0 0 0 0 0 6.0 0 0 0 0 0 3.0 0 0 0 0 0 0 0 0 0 0 .45 0 1.0 0 2.0 0 0 0 0 0 3.0 0 0 0 0 .6 0 0 0 0 0 0 4.0 7.5 15.0 0 12.0 0 6.0 5 6.0 0 0 10.0 3.0 2. 55 5.0 2.0 0 4.0 0 0 0 5.0 7.0 0 10.0 4.0 15.0 0 2.4 12.0 6.0 5.0 5.0 4.0 5.0 (4) 0 0 0 4.0 0 0 0 20.0 5.0 5.0 0 0 0 0 0 0 6.0 0 12.0 0 0 0 0 1 0 5.0 0 0 0 0 0 6.0 0 *In most cases the percentage requirements shown are prescribed in the State law itself. Where the law empowers banking authorities to change reserve requirements, the percentages shown are those which were actually in effect on July 1, 1949. The data in this table are based on Provisions of State Laws Relating to Bank Reserves as of December 31,1944, published by the Board of Governors of the Federal Reserve System, and on changes in State reserve requirements reported to the Board since that time; the data have not been checked with the State banking authorities. 1 The reserve requirements shown in the "Time deposits" column for Arizona, California, Connecticut, Massachusetts, Nebraska, Rhode Island, Utah and Wyoming apply only to deposits in the savings departments of commercial banks and trust companies. Other time deposits are subject to higher requirements, but inspection of State banking department annual reports indicates that such deposits in California4 Connecticut, Massachusetts, and Rhode Island State commercial banks and trust companies are relatively small in comparison with deposits in their savings departments. 2 Securities eligible as reserves are United States Government obligations and, in some instances, State and municipal obligations. 3 There is a 50-percent requirement for banks in places with less than 1,500 population, with capital of $10,000 or more but less than $25,000. 4 The required 3 percent vault cash reserve may be held "in cash and/or obligations of the United States." 5 Vault cash may not be counted as part of the required reserve. 6 For trust companies the reserve requirements are 25 percent of demand and 10 percent of time deposits, but there are only four trust companies (with little or no deposits) in the State. * There is a 10-percent requirement on "secured savings deposits." 64 State MONETARY, CREDIT, AND FISCAL POLICIES reserve requirement for commercial banks and trust companies, July 1, 19J$ (Section A)—Continued Composition of reserve required on demand deposits Required reserves State Uniform Different rerequire- quirements on— ments on deVault mand cash Demand Time and dedeposits time posits 1 deposits Percent of deposits specified Oregon P ennsyl vania Rhode Island South Carolina South Dakota Tennessee Texas Utah.. Vermont Virginia. . __ Washington West Virginia Wisconsin. Wyoming 17.5 15.0 12.0 15.0 14.0 15.0 7.0 10.0 »15.0 15.0 20.0 10.0 Either balances with depositary banks or vault cash Securities, balances with de- Vault positary cash banks, or vault cash 2 Percent of demand deposits 8 5 6 0 3 3 5 5 7 3 10.0 5 20.0 10 0 0 6.0 0 0 0 0 1.88 0 0 0 2.0 0 0 15.0 8.4 9.0 7.0 7.0 10.0 15.0 13.12 8.0 10.0 15.0 8.0 8.0 20.0 Composition of reserve required on time deposits 0 5.6 0 0 10.5 0 0 0 12.0 0 0 0 4.0 0 Either balances with depositary banks or vault cash Securities, balances with depositary banks, or vault cash 2 Percent of time deposits 0 0 0 0 0 0 0 1.25 0 0 0 1.0 0 0 5.0 3.6 0 3.0 7.0 3.0 5.0 3.75 2.8 3.0 15.0 4.0 8.0 10.0 0 2.4 0 0 10.5 0 0 0 4.2 0 0 0 4.0 0 1 T h e reserve requirements s h o w n i n the " T i m e deposits" c o l u m n f o r A r i z o n a , C a l i f o r n i a , Connecticut, Massachusetts, Nebraska, Rhode Island, U t a h , a n d W y o m i n g a p p l y o n l y to deposits i n the savings departments of commercial banks a n d t r u s t companies. O t h e r t i m e deposits are subject to higher requirements, but inspection of State b a n k i n g d e p a r t m e n t a n n u a l reports indicates t h a t such deposits i n C a l i f o r n i a , Connecticut, Massachusetts, a n d R h o d e I s l a n d State commercial banks a n d t r u s t companies are r e l a t i v e l y s m a l l i n comp a r i s o n w i t h deposits i n their savings departments. 2 Securities eligible as reserves are U n i t e d States G o v e r n m e n t obligations and, i n some instanues, State a n d m u n i c i p a l obligations. 8 There is a 10-percent requirement on time deposits i n noninsured banks, but there was only one such bank on July 1,1949, and it had no deposits. » There is a 20-percent requirement for banks with capital stock of less than $25,000. 65 M O N E T A R Y , CREDIT, AND FISCAL POLICIES State reserve requirement for commercial banks and trust 1, 1949 (Section A)—Continued companies, July S E C T I O N B — R E Q U I R E M E N T S FOR BANKS D E S I G N A T E D OR A P P R O V E D AS R E S E R V E DEPOSITARIES, ETC.** Composition of reserve required ou demand deposits Required reserves State Differ*3nt reUniform Either require- quireme nts o n balances ments with deon deVault positary mand cash banks Time and Demand or vault detime deposits cash posits 1 deposits Percent of deposits specified Arizona .. Arkansas California, banks in places with population of— 100,000 or more 50,000 to 100,000 Colorado . Iowa Kansas Kentucky Massachusetts - Minnesota _ Mississippi Missouri Montana Nebraska Nevada New York: Manhattan Borough Brooklyn, Bronx, and Buffalo.. Oklahoma .. Utah Wisconsin 20 15 15 20 10 6.67 8.0 13.33 12.0 18.0 15.0 20.0 10.0 12.5 10.0 20.0 15.0 25.0 18.0 5 3 9.0 5 3 7.5 6 <4.0 1.5 3 5 0 3 3. 33 0 4.0 5 0 10 0 3 7.0 0 5 0 0 9.0 7.5 16.0 8.5 12.5 6.67 8. 0 15.0 25.0 11.0 15.0 16.0 15.0 20.0 SecuriEither ties, balbalances ances with dewith de- Vault positary cash positary banks banks, or vault or vault cash cash 2 Percent of demand deposits 20.0 Composition of reserve required on time deposits 0 0 0 0 (4) 0 0 0 8.0 0 0 0 0 4.0 0 Securities, balances with depositary banks, or vault cash 2 Percent of time deposits 2.5 8.0 7.5 12.0 1.0 1.0 2 .45 0 1.0 0 0 0 3.0 0 0 0 0 0 4.8 2. 55 5.0 2.0 0 5.0 10.0 0 15.0 4.0 15.0 41. 24.0 7 0 24.0 0 0 20.0 18. 0 20.0 7 5 5 0 0 2.5 0 20.0 18.0 17.5 13.33 0 0 0 6.67 0 0 1. 25 0 0 0 4.0 4.0 (<) 0 0 0 0 0 0 0 0 1.0 0 7.0 0 7.0 5.0 3. 75 13.33 0 0 0 6.67 *In most cases the percentage requirements shown are prescribed in the State law itself. Where the law empowers banking authorities to change reserve requirements, the percentages shown are those which were actually in effect on July 1,1949. The data in this table are based on Provisions of State Laws Relating to Bank Reserves as of December 31,1944, published by the Board of Governors of the Federal Reserve System and on changes in State reserve requirements reported to the Board since that time; the data have not been checked with the State banking authorities. **In States not listed in this section or in this footnote, the reserve requirements shown in section A are applicable to all State commercial banks and trust companies. The requirements shown in this section apply to banks designated or approved as Reserve depositaries, banks in central Reserve or Reserve cities, banks in specified cities, and banks in cities with specified population, as follows: Arizona—the requirement applies to banks in places with population of 50,000 or more. Arkansas—the 20-percent requirement applies to banks designated as Reserve agents. California—the requirements for banks in places with population of 50,000 to 100,000 apply also to Reserve depositaries in places with population under 50,000. Colorado— the requirements apply to banks designated as Reserve agents. Iowa—the requirements apply to banks in Reserve cities (designated as such under the Federal Reserve Act). Kansas—a 20-percent Reserve is required against demand deposits due to banks; the 12.5-percent requirement applies to other demand deposits. Kentucky—the 10-percent requirement on demand deposits applies to banks in Reserve cities. There is a 13-percent requirement against demand deposits for central Reserve city banks, but there is no central Reserve city in the State. Massachusetts—the requirement applies to trust companies doing business in Boston and less than 3 miles from the State House. Minnesota—the requirements apply to banks in Reserve cities (designated as such under the Federal Reserve Act). Mississippi—the requirements apply to banks in places with population over 50,000. Missouri—the requirements apply to banks in places with population of 200,000 or more. Montana—the requirement applies to banks approved as Reserve depositaries. Nebraska—the requirements apply to banks in cities with population of 25,000 or more. Nevada— a 25-percent Reserve is required against deposits due to banks: the 15-percent requirement applies to other demand deposits. Oklahoma—the requirements apply to approved depositaries. Utah—the requirements apply to banks in places with population of ^0,000 or more. Wisconsin—the requirement applies to banks designated as Reserve depositaries. 1 The reserve requirements shown in the "Time deposits" column for Arizona, California, Massachusetts, Nebraska, and Utah apply only to deposits in the savings departments of commercial banks and trust companies. Other time deposits are subject to higher requirements, but inspection of State banking department annual reports indicates that such deposits in California and Massachusetts State commercial banks and trust companies are relatively small in comparison with deposits in their savings departments. 2 Securities eligible as reserves are United States Government obligations and, in some instances, State and municipal obligations. 3 The" vault cash" requirements (9 percent for cities with population over 100,000 and 7.5 percent for cities with population of 50,000 to 100,000) apply only to reserve depositaries in such cities; for other banks in such cities the vault cash requirement is 6 percent, and the balance of the required reserve may be held with depositary banks. 4 The required vault cash reserve may be held "in cash and/or obligations of the United States." 66 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES Basic statutory requirements, actual requirements on July i, 1949, and minimum and maximum reserve requirements for State commercial banks and trust companies in States in which banking authorities are empowered to change reserve requirements Percent of demand deposits State Alabama i Arkansas 23 __ Connecticut4 Delaware... __ District of Columbia Kentucky: Reserve cities 6 . Elsewhere« Maine ... Maryland.. Massachusetts:4 Boston 7 Elsewhere Michigan2 New Hampshire New Jersey New Mexico 2 New York: Manhattan Borough Brooklyn, Bronx, and Buffalo... Elsewhere North Dakota Ohio Oregon 9 Pennsylvania^ Utah: Large cities Elsewhere Vermont. Basic Actual Minimum 15 12 7 FR 15 15 14 20 15 12 FR FR 10 7 15 15 10 7 14 15 (5)15 20 15 12 15 15 12 20 15 12 15 15 12 13 10 7 10 15 15 15 24 20 14 10 15 15 14 20 15 15 20 15 20 Percent of time deposits Maximum Basic FR 5 FR FR 1 15 0 3 FR 4 15 0 6 6 1 15 0 FR FR 3 3 0 3 3 3 6 6 3 3 0 3 6 6 FR FR 6 0 0 12 5 3 12 0 0 12 5 3 12 0 0 12 85 3 12 0 0 24 85 6 15 0 0 0 5 10 5 7.5 6 6 6 5 10 5 6 0 0 0 5 (5) 4 (5) (55) () 10 (5) 10 5 5 3 5 5 7 5 5 2 10 10 8 () 10 7 20 14 FR FR 30 (55) () 12 (5)15 (55) ( )24 12 FR 30 15 13 FR 26 10 FR 20 7 FR 14 20 10 5 5 12 30 5 30 () () 20 15 9 () 40 30 30 Actual Minimum Maximum FR FR FR 5 0 (5) 15 FR—This sumbol standing alone signifies that the State law provides that the basic, maximum, and/or minimum shall be the same as prescribed by Federal authorities for member banks; where the symbol appears with a percentage, the requirement prescribed by State authorities may not exceed either that percentage or the corresponding requirement applicable to member banks. 1 The provision for changes in reserve requirements by the State banking board applies only to time deposits. 2 In Arkansas, Michigan, and New Mexico, identical requirements apply to demand and time deposits. However, in Michigan the entire reserve on time deposits may consist of United States Government securities. 3 Neither these percentages nor the authority to change requirements extends to banks designated as reserve agents. 4 In Connecticut a 7 percent requirement is applicable to time deposits in the commercial department, •and in Massachusetts the demand deposit requirement applies to certain time deposits in the commercial •department. This table, however, shows zero requirements against time deposits, because the deposits in savings departments (of departmental banks) comprise all but a relatively small portion of their time deposits. 6 None specified. 6 The State law prescribes higher requirements for banks in central reserve cities, but there are no such cities in the State. 7 Applies to banks in Boston and within 3 miles of the State House. 8 The range of reserve requirements on time deposits in the commercial department is from zero (apparently) to the Federal Reserve maximum, but the reserve requirement on deposits in savings departments of commercial banks is the same asfixedfor savings banks, namely, 5 percent. 6 Neither these percentages nor the authority to change requirements extends to noninsured banks, but there was only 1 such bank on July 1,1949, and it had no deposits. Banks in cities with a population of 50,000 or more. Senator DOUGLAS. I n brief these tables show a general requirement somewhere around 15 percent, although i n most cases this could be i n the form of deposits i n correspondent banks as well as vault cash, but there were certain States which fell even markedly below this standard. M y own State of Illinois has no statutory reserve requirements. Kansas has 123/2 percent, Kentucky has 7 percent, California has 12 percent, Minnesota has 12 percent, South Carolina has 7 percent, Tennessee has 10 percent, Washington has 10 percent, West V i r g i n i a has 10 percent. 67 M O N E T A R Y , CREDIT, AND FISCAL POLICIES So that you think the conclusion is that in general the reserve requirements are lower under the State system for State banks not members of the System than in banks which are members of the System? M r . WILLIAMS. T h a t is right. Senator DOUGLAS. A n d that a considerable portion of this can be i n the form of mutual deposits—A in B and B in A ? M r . WILLIAMS. I think it is fair to say that there are competitive disadvantages from the standpoint of reserve requirements i n membership in the System. These are offset in other ways. Senator D O U G L A S . N O W , has this fact that the State banks can always get out of the Federal Reserve System ever operated to deter the System from raising reserve requirements? Is it a factor which is present in your considerations ? M r . WILLIAMS. I confess the statement i n the report submitted for the record, which said that the Board might be reluctant to take action because of the effect of the action on membership, escaped me. Personally, I doubt very much whether that is a factor i n the determination of Board policy. I think that is an overstatement. That would be my judgment. We are living with the problem in other ways than attempting to solve it by not acting. Do I make myself clear ? S e n a t o r DOUGLAS. Yes. M r . WILLIAMS. I would doubt whether that was an important factor in the determination of Reserve policy, hesitancy to act because of the fear of withdrawals. W e have had one withdrawal—that is, not associated with consolidation or merger—in 10 years. I checked on the matter for the third district just before I left. But that does not indicate that it does not have its effect through the generation of a state of mind, because there is undoubtedly a spirit of restiveness. I think it is apparent. I think you would share that feeling, M r . Bopp. M r . BOPP. Y e s , sir. M r . WILLIAMS. Both of us get into the field very frequently because of the policy of the bank of going out some 30 times a year to meet with bankers in our district i n small groups. E a c h of these bankers brings a director with him. W e have a round-table discussion for a period of 2 hours before dinner and a period of an hour after dinner i n an attempt to bring to the bankers and their directors— and, incidentally, we bring nonmembers i n on this discussion—in line with our general approach that one way to solve the problem is through education and the increase of understanding. I n the course of those discussions we get the feeling that the Federal Reserve is constantly i n their minds. W e get the feeling that there is activity on the part of State organizations. I think there is undoubtedly a wish to build a defense or to stem a tide that may at any time start legislation. F r o m the standpoint of public relations, it is an unhealthy situation. I t raises a question as to how you solve it. I have pondered the question of legislation. Y o u have before you a proposal from the chairman. I admire the chairman's efforts i n attempting to divorce this problem of monetary policy operating through reserve requirements from the question of the dual banking system, which always serves as a battle cry. H e attempts to do that by stating that we are interested i n having some 68 MONETARY, CREDIT, AND FISCAL POLICIES influence on bank policy and on national policy via your bank through your reserve requirements, and he puts 'forward a plan which, as you know, would compel all to come in, but I am firmly Senator DOUGLAS. Just a minute. I do not think M r . McCabe's proposal is to have all banks come into the Federal Reserve System, but to rather require a uniform reserve requirement, M r . WILLIAMS. I was using the term "banking system" i n a different sense; and, of course, he gives an alternative. Senator DOUGLAS. H i s proposal is for uniform reserve requirements for commercial banks the country over, whether or not members of the System. M r . WILLIAMS. That is right; I did not make my statement clear. I do not think that an approach of that sort would be an acceptable one to the nonmember banks. F r o m my contact with bankers, I conclude that they are thoroughly aroused, M r . Chairman, on this question of the long arm of the Central Government reaching out and coming i n to the State banking system; and I think there is little likelihood that one would be able to get M r . McCabe's proposal into action. I took the same position before the Senate Banking and Currency Committee last May, where, as you w i l l recall, there was attached to the application for renewal of the supplementary reserve requirement this condition of applying it to nonmember banks. The president of a State bankers association told me within 3 months that i n his judgment the dual banking system i n the United States was not a classification which separated national banks from banks that received their charters from States, but it was a classification of banks into member banks and nonmember banks. Senator DOUGLAS. B u t the State banks always have the option of withdrawing. M r . WILLIAMS. Surely. Senator D O U G L A S . S O that makes the differentiation applicable, and also the rules concerning the types of loans which can be made are different, so that there are very real differences on those points. M r . WILLIAMS. T h a t is right, but I am citing this to indicate his attitude of mind as to what the crucial problems were. T h e crucial problem i n his mind was one of avoiding compulsion to get into the Federal Reserve System. Now, from our standpoint that poses a major problem of bank relations. I f a large number of banks out i n the country feel that way about us, then we have an important problem on our hands as to how to dissipate that attitude of mind, because i n my 10 years experience with the Federal Reserve System, I have no inclination to work i n any other way than in behalf of banking, both State and national. T o have others judge your actions as being something inimical to their interests is disturbing. So that I assume you cannot approach the problem via coercive means because you w i l l not get the bill, i f you attempt to approach it that way. I t has been suggested that we approach it via the route of self-discipline. I f I recall correctly, the retiring president of the American Bankers' Association i n San Francisco has raised the question of State banks and their forcible inclusion i n the system. H e takes the position that although they are 50 percent in number of all banks i n the United States, they have only 15 percent of the deposits and, therefore, they 69 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES are unimportant. H e would rely on self-discipline. I reject the selfdiscipline approach just as I reject compulsory legislation. I reject self-discipline, because it does not work because of competitive forces. It cannot very well w^ork because of competitive forces. I turn then to still another approach, and that is one of increasing an understanding of the function of the System, and the way it operates—and not only increasing the understanding but increasing the participation of the bankers i n making decisions through the process of consultation and explanation in why we are doing what we are doing. I n that way w i l l be stepped up the voluntary entrance into the System. Now, that may be a long procedure but I prefer to follow it. Should it fail, then I am for the use of compulsory methods, maybe along the lines that the chairman devised. I t is an important problem and ought to be thoroughly studied and a plan worked out only after study by both private banks and the central bank together. A thorough explanation of the problem is needed; because we are now suspect. W e hear in the field directly and indirectly that the System wants "Power for the sake of power." W e get evidence on every hand of a lack of understanding as to what the function of reserves is and as to how they operate. Senator DOUGLAS. I n your educational conference do you ever quote from article 1, section 8, of the Federal Constitution, which gives to Congress the power "to coin money, regulate the value thereof"—and the verb "coin" has long since been broadened to include not merely metallic coins and also printing paper money, but the general regulation of the money supply, and i f there is anything clearer than that power I do not know what it is, do you ? M r . W I L L I A M S . NO. I state the matter a little differently. I say to bankers we have 3 y 2 million business enterprises i n the United States. Only 14,000 are banks. Now, banks are peculiar in this capacity to create and extinguish credit. F r o m the days of the founding of government, you have been subject to controls. Do not assume at a time when the whole drift is toward totalitarianism that you are going to swim in the opposite direction. Y o u r important problem is: i f you do not like the system, devise a better one. I f you think we ought to change it, come in and help us change it. B u t i f you do not understand the way i n which reserve requirements operate, it is high time you begin to understand this function, because you have a very valuable task to perform in the operation of the economy and you cannot perform it by assuming that you are just like the fellow making sealing wax or shoes. Y o u are a different breed of cat. I would add that i n addition to understanding it is a matter of confidence. That may give you, Senator Douglas, something of the spirit of the way in which I am approaching the problem. A t the same time, I repeat with equal vigor what I said earlier i n the testimony here today. I say, let banking live. W e need it for the reasons that I outlined earlier in my testimony. I assume that the task of achieving understanding and confidence is one not only on the part of the Federal Reserve Governors and the 12 Reserve banks, but of banking leadership throughout the commercial banks. I had the same feeling when I listened to M r . Sproui make his speech in San Francisco and heard M r . Woollen's reply, which, of course, 70 MONETARY, CREDIT, AND FISCAL POLICIES was a very brief one, and listened to the conversations afterward i n the lobbies of the hotels. It is d i s t u r b i n g * to one who is a well-wisher of banking and who believes in general controls rather than a series of specific controls. Senator DOUGLAS. A r e you saying this: that you are somewhat afraid that i f an inflationary movement should start or i n the opinion of the Federal Reserve System it should start and that the Federal Reserve System in order to check this increased its reserve requirements, that it would meet with terrific opposition or with great opposition from the banks inside the System and would be subject to competition from the banks that are outside the System ? M r . WILLIAMS. A n d could result in withdrawals from the System. Senator DOUGLAS. A n d you know, of course, that the b i l l which passed the House of Representatives and was reported out by the Senate committee—namely, making possible conversions of National banks into State banks—has not yet been passed ? M r . WILLIAMS. I think i t is highly unfortunate for the State banking departments and State banking commissioners to view with alarm any change from State banks to National banks, any change from nonmembership to membership. I do not think they should look at this i n terms of proprietary interest. M r . WOLCOTT. T h i s is opposite. Senator DOUGLAS. This is from National to State. M r . WILLIAMS. Yes. Senator DOUGLAS. W h i c h was fostered by the State banking commissioners. M r . WILLIAMS. Perhaps I ought to amplify my statement and say some look with satisfaction upon a transfer from the National system to the State system. Senator DOUGLAS. I do not want to involve you i n an argument, but the head of the State banking commission i n Pennsylvania has been most active i n spearheading this drive of conversion from National banks to State banks on the same basis that State banks can now convert to national banks and in trying to repeal the section of the McFadden A c t which prohibits such conversions. M r . WILLIAMS. M y problem has been made more difficult by what is going on i n the States. There are complexities from a State standpoint because of the acquisition of branches by some of the larger banks; so the problem is tied i n to the unit banking system. There is, however, no doubt that my problems have been made more difficult as a result of the development to which you just referred. Senator DOUGLAS. Then you see dangers i n the so-called dual banki n g system or 49 systems of banking? M r . W I L L I A M S . N O , I would not want to disturb the right of a State to charter banks. I would not want to disturb the right of a State banking department to set up standards, even though those standards would be competitively lower. I do look with alarm on any attempt to prevent banks from getting into the System on a voluntary basis and voluntarily subjecting themselves. The problem also has geographic aspects. I n one district 70 percent of the banks are nonmembers. Y o u get a segregation because of that geographical distribution, and i n a time of crisis that might have effect. 71 M O N E T A R Y , CREDIT, AND FISCAL POLICIES W e ought not to be impeded i n our attempt to influence monetary policy by lack of understanding or unwillingness to submit themselves to the discipline of it. I assume some of the responsibilities myself. A s an operator of the Philadelphia bank I indicate to banks why they ought to subject themselves to the discipline of Reserve requirements. I n the course of a discussion i n one of these field meetings at which the Secretary of Banking was present, I said to him that the best way that I know for State banks to retain the privilege of staying out of the System is for them to make it clear by their actions that they are not profiting by being out of the System and not subjecting themselves to our restraints because the more people who are subjected to restraints the more might be the advantages of persons who are not subjected to it. But I would explore and live with the problem i n a sincere effort to solve it by other than coercive means before I went to coercive means; but, f a i l i n g to solve it, I certainly would stand firmly for compulsory Reserve requirements. Senator D O U G L A S . H O W long wmild you carry on this educational process ? M r . WILLIAMS. I cannot answer that. W e have not made within the System, it seems to me, a sufficiently vigorous, intelligent, and concerted effort to go after the problem. Senator DOUGLAS. Have you put up to the nonmember banks the fact that the System indirectly gives them greater stability because i n a period of crisis though you do not have to take their bonds or commercial paper, they can go to a correspondent bank which is a member, and i f the correspondent bank accepts, then the correspondent bank can present the bonds or paper to you and that, therefore, indirectly you add a great element of stability to the nonmember banks; is that true? M r . WILLIAMS. Yes. W e have pounded on the subject and w i l l continue to do so; I have heard M r . Bopp, whose skilled exposition you heard this morning, explain that all very clearly. Senator DOUGLAS. Have you had any success to date? M r . WILLIAMS. There is no doubt that we are making progress. Senator DOUGLAS. A r e there a number of nonmember banks i n your district who have become member banks ? M r . W I L L I A M S . W e h a v e accessions. M r . BOPP. State banks that have come into membership: I n 1942, one; 1943, three; 1944, three; 1945, two; 1946, four. M r . WILLIAMS. W e already have A pretty high proportion. M r . B O P P . N O accessions in either 1 9 4 7 or 1948. M r . WILLIAMS. There are cases we are now working oft, but it is a case by case approach. I t is slow work. M r . WOLCOTT. W o u l d it be objectionable at this point i f I were to reminisce a little bit with respect to history of this question as I remember it? Senator D O U G L A S . G O ahead. M r . WOLCOTT. I n 1935 a b i l l was introduced, which later became the Banking A c t of 1935, which provided that all banks must become members of the Federal Reserve System i n order to participate in the Federal Deposit Insurance Corporation. I t would have resulted i n the creation of a highly centralized banki n g system. There would have been no dual banking system. There 72 MONETARY, CREDIT, AND FISCAL POLICIES would have been no State banks as such, because, of course, no State bank, which was not a member, not having its deposits insured, could prevail against a competing bank which d i d have its deposits insured. The same bill, as it was originally introduced, provided that the President would be empowered to remove all members of the Federal Reserve Board at will. About that time the N R A was crumbling, the Supreme Court later found it unconstitutional, and the charge was made that i f the original bill was passed, that the Federal Government through the Federal Reserve Board, which was to be politicalized under the bill, could write into the loan agreements all of the provisions of any of the codes, which had been in existence or might be entered into, which were formerly known as N R A codes. O f course, that contemplated that no bank would withdraw from the Federal Reserve System when once it got in. Well, we succeeded and, of course, it also follows that i f the Federal Government got control over the lifeblood of the American economy, which is credit, that they could successfully manage the entire economy. American agriculture and industry and labor and business cannot function without credit. W e compromised on this b i l l by providing that the President could remove the chairman of the Board of Governors of the Federal Reserve Board but not the other members. W e provided also, as I recall it, a 2-year period in which the banks would come into the Federal Reserve System. Otherwise, they would not have their deposits insured. A t that time, as I recall it, we did give the Open Market Committee these initiatory powers we have discussed here. Now, at about that time the Federal Government, I assume through the Comptroller's Office or the Federal Reserve, went to some, and perhaps most, of the State banking commissioners and told them that i f their legislatures would provide for a conversion from State banks to Federal banks, they would recommend to the Federal Congress that it do likewise i n respect to authorizing conversion from national banks to State banks. The Federal Congress would provide for the reconversion or the conversion, rather, of national banks to State banks. Now, this question that we are discussing here today is to me as old as that. I t goes back to 1935. The b i l l which was passed i n 1948 authorizing the conversion of national banks to State banks, passed almost unanimously by the House, died i n the Senate, and the one passed this year similarly was i n consequence of the implied promises made by the Federal Government to the States i n respect to the conversion of national banks into State banks. I thought it might be interesting at this point to review some of the history of this question, and it is from memory only. I may not be correct i n all my details, but i n principle and substance the statement is correct. So we apparently have with us then the only question remaining as to whether you think there can be any greater degree of economic stability i f all of the banks become through force or otherwise members of the Federal Reserve System. M r . WILLIAMS. I think our effectiveness would be increased. M r . WOLCOTT. Y o u r control would be increased. M r . W I L L I A M S . A n d , t h e r e f o r e , effectiveness. M r . WOLCOTT. Whether your effectiveness would be increased would have to be proven i n practice. I t has not been proved yet. 73 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WILLIAMS. That is right, and I merely expressed a judgment, and I quite agree that you could not debate that very profitably. M r . WOLCOTT. I f I may follow up with one other question. Chairman Douglas read from the Constitution with respect to the power of Congress to coin money and regulate the value thereof, concerning which we get letters almost daily, and they provoke a discussion of a very interesting question. The contention has been made that the Congress, notwithstanding general thinking that it does not coin money and regulate the value thereof, does by the delegation of authority to the Federal Reserve. Now, the Constitution also provides that the Congress shall provide for the national welfare, and we are constantly enacting legislation i n that respect. The Congress is not an administrative body. I t can delegate the administration of its functions to departments of the Government or independent departments which it sets up. I may be wrong i n this, but it always seemed to me that i n keeping w i t h the practice and the authority which the Congress has to delegate the administration of its functions, the Congress has delegated to the Federal Reserve System the authority within certain fairly well-defined limitations and i n accordance with certain well-defined standards to coin money and regulate the value of it. Senator DOUGLAS. I am glad to have this statement by my very able colleague, but I think the question is whether Congress has also provided the Federal Reserve System with powers adequate to carry out this purpose. M r . WOLCOTT. I was going to suggest that it seems to me to be perhaps the only question before us, as to whether we have set up sufficient standards or created such definite limitations that they can execute the function of Congress i n that respect. M r . WILLIAMS. I was attempting, M r . C h a i r m a n M r . WOLCOTT. I t would be interesting i f you have suggestions as to what the Congress should do in carrying out that function by way of legislation to more clearly define the Federal Reserve Board's authority, delegated to it from the Congress, to coin money and regulate the value thereof. M r . WILLIAMS. Well, it is something to which we should give consideration. There are other ways of influencing the behavior of both member banks and nonmember banks by the conference methods of the sort we are experimenting with. I hesitate to build up psychological bars. I am trying to tear them down rather than constantly erect new ones and have the charge hurled at us, "Power for the sake of power." Senator DOUGLAS. I n good Philadelphia fashion, you are attempting to follow the methods of peaceful persuasion. M r . WOLCOTT. I forgot an important chapter i n this history of this subject. I n 1939 a b i l l — I think the number was H . R . 6940—was reported out of the House Banking and Currency Committee which, i n effect, would have compelled all savings banks to convert to Federal savings and loan associations or go out of business. That b i l l was passed by the House in a modified form with all of these objectionable features taken out of it the latter part, as I recall it, of that year, or possibly the following year, and never was considered by the Senate. 74 MONETARY, CREDIT, AND FISCAL POLICIES B u t at least two attempts have been made to centralize the control of banking and the credit which emanates from banking i n the Federal Government without any restrictions whatsoever. M r . WILLIAMS. M r . Chairman, that concludes my presentation. Senator DOUGLAS. I would like to ask another question, i f I may. I n your written statement to our subcommittee and also in the statements which were made by most of the other presidents of the Reserve banks you proposed that control, as I remember it, of member-bank reserve requirements and also approval of rediscount rates should be shifted from the Board of Governors to the Federal Open Market Committee. M r . WILLIAMS. Yes. Senator D O U G L A S . I can see why you would feel that all these powers should be i n the same hands i n order to get concentrated and unified policy, but why do you favor concentrating them i n the hands of the Open Market Committee rather than i n the Board of Governors of the Reserve System ? M r . WILLIAMS. Well, concentration, of course, i n the Board of Governors would call for a transfer of the open-market operation from the committee to the Board; but we have a Federal system. W e are attempting i n all possible ways to bring about a representation from the field, and I know it is a subject that is close to the heart of Chairman McCabe. The representation of the Board on the committee which would handle these three instruments of banking would still not disturb the locus of control, but would give to the committee the firsthand experience of all of us in operating our institutions; we are out i n the field constantly. Senator D O U G L A S . A S I understand it, the Open Market Committee is also composed of seven members of the Board of Governors plus five chosen from the presidents of the Federal Reserve banks, and these are generally, as I infer from your statement this morning, elected in some degree of rotation. M r . WILLIAMS. Except one; he is the president of the New Y o r k bank, where the presence of the bank in the principal money market of the country gives him permanent representation. The manager of the account is located i n his bank, and there is a close liaison. B u t we undoubtedly can and do bring to the deliberations of the Board here i n Washington a knowledge of the attitudes and values and of problems. Senator D O U G L A S . S O this proposal of yours would further federalize the System by giving the member banks a larger share i n these larger policy determinations. M r . WILLIAMS. That is right, and I think ought not to be construed as a move that would result i n greatly increased influence by commercial banks because of the presence of Reserve bank presidents on that committee. Senator DOUGLAS. One further question. This morning you spoke r>f the need for very close coordination between policies of the Federal Reserve Board and policies of the Treasury. D o you consider the present methods of coordination satisfactory or would you suggest changes for this purpose? M r . WILLIAMS. Chairman Douglas, my experience as an administrator causes me to rely increasingly on my capacity to work with my fellow men rather than on administrative set-ups. 75 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I w i l l go along 100 percent with the dictum of some wise man who said, " Y o u have power with people, not power over them." W e function with a minimum of administrative procedure i n my institution. I think it would be unfortunate if we had an arrangement which would call the Secretary of the Treasury over to the Federal Reserve Board for a meeting where there was a lot of administrative minutiae passing through the mill. I think there is an opportunity for close liaison. They are both i n the same city, the buildings are near to each other, they have the telephone at their elbows, they are meeting i n other organizational meetings. Senator D O U G L A S . I may remind you, but you are of course aware that the A r m y and Navy are together in close physical proximity to each other, and the immediate effect did not seem to be such as to make them dwell together in complete peace and concord. M r . W I L L I A M S . What I meant when I said we have power with people is that power is derived through understanding. I take it that the great gap that exists between the A r m y and the Navy is due to a failure to solve what are essentially technical problems as to which arm of the service should be dominant and the relative importance of the two. When we concern ourselves with questions of status, with who are the chief fiscal monetary officers of the Federal Government, we are getting away from the realities of life. We ought to demean ourselves before problems and say, "What must we do to solve them?" Senator D O U G L A S . N O W , i f all men were as self-abdicating as you seem to be, there would probably be no problem, but we are dealing with imperfect human nature—all too imperfect. M r . W I L L I A M S . I did not say that unctuously. Senator D O U G L A S . I did not regard your statement that way. M r . W I L L I A M S . I do not believe a change is necessary. I think the problem can be solved in other ways. Y o u could bring them together, and the problem would not be solved. Y o u could keep them apart and it would be solved. There are other approaches to the problem. I am giving you, of course, a strictly personal attitude toward it. Those are the questions in the questionnaire that did not interest me a great deal, Chairman Douglas. Senator D O U G L A S . Congressman Buchanan? M r . B U C H A N A N . N O questions. Senator D O U G L A S . Thank you very much, M r . Williams and M r . Bopp. M r . W I L L I A M S . Thank you very much, indeed. W E were very glad to be here. Senator D O U G L A S . I S M r . Robertson here? W e are glad to welcome you. STATEMENT OF J. L. ROBERTSON, DEPUTY COMPTROLLER OF THE CURRENCY M r . Robertson, we understand you are the First Deputy Comptroller of the Currency. M r . ROBERTSON. Yes. Senator D O U G L A S . Y O U seem to have a good Scotch name and are, therefore, presumably competent to handle our public moneys. D o you want to make a prepared statement ? 76 MONETARY, CREDIT, AND FISCAL POLICIES M r . ROBERTSON. Just a very short one. Senator D O U G L A S . Y O U may proceed. M r . R O B E R T S O N . I would merely like to say that we who represent the Office of the Comptroller of the Currency are glad to have this opportunity to make whatever contribution we can to the work of this committee in its study of the effectiveness and coordination of the monetary, credit, and fiscal policies of the Federal Government. I n common with administrative agencies generally, we necessarily perform our functions in constant and close contact with the details of our job. Although we make every effort to relate our operations to broad underlying principles, it is not always possible to achieve the degree of detachment necessary for effective continuous examination of those principles in the light of constantly changing conditions. This committee, on the other hand, can make a general survey of this important field free from such a handicap. Its members are i n a position, by asking basic questions regarding matters of broad policy and procedure, to open up lines of thought leading to major improvements. Our organization is composed of a closely knit group of people who confine their efforts to supervision and regulation of the national banking system. Perhaps unwisely, our Office does not maintain a publicrelations staff, information service, or even a congressional liaison representative, to keep the general public and Congress informed of our activities, accomplishments, and purposes. Senator DOUGLAS. M a y I interject to say that is a unique distinction and one which is to your credit, and I hope that it has reflected corresponding economies in your operating budget. M r . ROBERTSON. W e think it has, sir. Furthermore, we are so busy with the actual job of supervising banks that we probably do not sit down often enough to think about the fundamental problems with which this committee is concerned. Even i f we did, our thinking might very well be narrow and prejudiced. F o r all these reasons, we welcome a thorough and thoughtful study of our work i n its broadest aspects. The questions submitted to us center about the manner i n which our bureau performs its duties regarding the structure and operation of the national banking system, and the degree of coordination of the work of all Federal bank supervisory agencies. A s you have seen from our answers to the questionnaire, our guiding principle is the preservation of the national banking system which can and does perform its f u l l share i n furnishing the Nation with every proper banking service and convenience, including the supplying of credit adequate to meet all legitimate demands. W e believe that i n view of the nature of our work, we can make our greatest contribution to economic stability and progress through the maintenance of an independent banking system composed of sound individual banks, guided by principles of public service as well as business profit. I shall be very glad to try to answer any questions relating to the work of our Office, and the principles i n accordance with which we seek to conduct our activities. Senator D O U G L A S . I wonder i f I might ask some questions to begin with dealing with the chartering policy. M r . ROBERTSON. Yes. 77 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. I n the statement M r . Delano submitted to our subcommittee some time ago he pointed out that i n determining whether or not to act favorably on an application for a national-bank charter the Comptroller's office took into consideration at least five principal sets of factors: First, the general character and experience of the organizers and of the proposed officers of the new bank. Second, the adequacy of existing banking facilities and need for further banking capital. Third, the outlook for the growth and development of the town or city in which the bank is to be located. Fourth, methods of banking practices of the existing bank or banks,, the interest rates which they charge customers, and character of the service which these quasi public institutions are rendering to their communities. F i f t h , the reasonable prospects for success of a new bank i f efficiently managed. I t is also indicated that in recent years a fairly large percentage of the applicants have been denied national bank charters, ranging from 13 percent, I think, in 1 year to a high of 41 percent in 1947. Now, I wondered i f you could tell us the answers to a series of questions that I should like to ask. I would like to ask, i n the first place, about the policies of the State bank chartering authorities and of your relationships with them, because i f the banks f a i l to get charters from you, they sometimes go over to the State banking authorities. M r . ROBERTSON. T h a t is t r u e . Senator D O U G L A S . I S there any uniformity among the chartering policies of the various State authorities or is there variety ? M r . ROBERTSON. There is variety, but I would say from personal knowledge of the individuals, most of the individuals, who are passing upon State charters in behalf of the States themselves, that they are being very conservative in the granting of new charters. They are not granting charters unless they are satisfied that there is a need for additional banking facilities i n the community. I do not think there is a single State supervisor that I know of today who is running wild i n the granting of State charters. Senator D O U G L A S . D O the State authorities apply the same kind of tests which your office applies ? M r . ROBERTSON. That I cannot tell you. Senator DOUGLAS. I n general, are the States more or less liberal i n granting charters for new banks than the comptroller ? M r . R O B E R T S O N . I could not give a good answer on that, M r . Chairman. M y impression is that it w i l l vary with various States. I doubt i f there is any State which is as conservative as we are i n the granting of new charters. Senator D O U G L A S . N O State as conservative ? M r . ROBERTSON. M o r e conservative. Senator DOUGLAS. Therefore, some States are less conservative? M r . ROBERTSON. I would say that is true. Senator DOUGLAS. And, therefore, there are some States which are more liberal ? M r . ROBERTSON. I think that is true, but I would have to qualify my answer because there are instances where a State bank could be 99076—50 6 78 M O N E T A R Y , CREDIT, AND FISCAL POLICIES chartered with a smaller capital than a national bank, and that might make the difference. Senator D O U G L A S . I w i l l come to that. D o yon have any information as to the number of cases where you have turned down an application for a national bank charter where the organizers have subsequently been able to get a charter from their State banking authorities ? M r . R O B E R T S O N . I do not have that information available, and I doubt i f it would be in the office, because once we turn it down we are through with it and never follow through. Senator D O U G L A S . D O you know of cases where the States have turned down proposed banks for State charters where you have later given the same group a national bank charter ? M r . R O B E R T S O N . I know of no such case. That does not mean there are not some. Senator D O U G L A S . D O you have any agreements, written or explicit, between your office and State banking authorities offices concerning chartering policies? M r . R O B E R T S O N . N O ; there is no written agreement. W e try to work out understandings with individuals whereby we notify them when we get an application for a charter, so they know it is there and they can give us the benefit of their views so we can consider them i n passing upon the charter, and we do likewise. Senator D O U G L A S . W i t h how many States do you have such understandings ? M r . R O B E R T S O N . I would have to guess, but I would say with approximately two-thirds, I would guess, we do have such understandings. A s new supervisors come into the field, there are instances where we have not yet arrived at a new understanding. Senator D O U G L A S . W o u l d you be willing to indicate some of the States i n which you do not have such understandings ? M r . R O B E R T S O N . N O ; because I would be guessing at them. I would be very glad to give you that. Senator D O U G L A S . Then this is all i n the heads of the comptroller and yourself as to what States have informal agreements with you ? M r . R O B E R T S O N . I would be very glad to give you some of the States where we do have very good working arrangements, i f that would help. Senator D O U G L A S . D O you find the Federal Reserve System or F D I C or any other agency interested also i n the question of the chartering of national banks? M r . R O B E R T S O N . Definitely, they are interested i n such chartering. F D I C , of course, must pass upon the chartering of State banks i f i t is going to be an insured bank and, therefore, they are very definitely interested. O f course, the Federal Reserve is interested,'too, to the extent of seeing whether the bank as it comes into the System is going to be a sound institution, and they are advised immediately. Senator D O U G L A S . Does the Federal Reserve bank have the right of veto? M r . R O B E R T S O N . N O ; it does not. Senator D O U G L A S . Y O U take their opinion as advisory only? M r . R O B E R T S O N . That is all. Our responsibility is complete insofar as the chartering of national banks is concerned. Senator D O U G L A S . A r e there any instances where they have advised against chartering a national bank where you have gone ahead? MONETARY, CREDIT, AND FISCAL POLICIES 79 M r . ROBERTSON. Yes. Where one or the other would be opposed; yes. W e feel we must rely upon our own findings. I f upon study of those findings we think the people who are applying for that bank are the kind who will operate a sound institution and there is a need for new banking facilities in that community we grant it irrespective of whether someone has been opposed to it. W e weigh carefully the recommendation which they make. Senator DOUGLAS. Would you speak now about the capital requirements for the national banks, versus capital requirements for the State banks. W h a t is your minimum figure of capitalization? M r . ROBERTSON. I t is $50,000 in places where there are less than 6,000 people. Then it goes up to $100,000. This is common capital; the surplus has to be 20 percent of that. I t goes up to $200,000 in places of over 50,000 population. W e think those capital requirements are not too harsh. We would not like to see them reduced today. Senator DOUGLAS. Have you ever made a comparative study of the capital requirements of the various States? M r . ROBERTSON. Somewhere along the line we have; yes. I remember seeing it but I haven't looked at it in some time. Senator DOUGLAS. Would you submit that for the record ? M r . ROBERTSON. I would be glad to do so. (The material above requested is as follows:) Minimum capital requirements Jurisdiction citation for banks and trust companies Banks (September 19^8) Trust company 12 U. S. C., sees. 51 and Up to 6,000 population From 6,000 to 50,000 248. Over 50,000 20 percent surplus. Alabama, sees. 78 and Up to 3,000 From 3,000 to 6,000 189. From 6,000 to 50,000 Over 50,000 Arizona, sees. 51-202, 51- Up to 5,000 From 5,000 to 15,000 513. From 15,000 to 50,000 Over 50,000 No bank may be required to have over $2,000,000 capital but there is no authority to make any such requirement. Arkansas, sees. 825 and Up to 2,500 From 2,500 to 6,000 858. From 6,000 to 50,000 Over 50,000 California, sees. 23, 82, Up to 10,000 From 10,000 to 50,000 and 90. From 50,000 to 200,000 Over 200,000 25 percent surplus may be required. $50,000 100,000 200,000 Not below State requirements. 25,000 50,000 100,000 200,COO 25,000 100,000 25,000 200,000 Up to 5,000 population $25,000 From 5,000 to 30,000 75,000 Over 30,000 100,000 Bank may do a trust business. Bank may do trust business. 25,000 50,000 100,000 200,000 50,000 100,000 200,000 300,000 Colorado, sees. 3 and 109. Up to 4,000 From 4,000 to 50,000 Over 50,000 10 percent surplus. 25,000 50,000 100,000 County population: Up to 40,000 From 40,000 to 50,000 Over 50,000 Up to 100,000 From 100,000 to 200,000 Trust company plus bank: Up to 10,000 From 10,000 to 50,000 From 50,000 to 200,000 Over 200,000 25 percent surplus may be required. Bank plus trust company: Up to 500 From 500 to 2,500 From 2,500 to 15,000 From 15,000 to 50,000 From 50,000 to 100,000 From 100,000 to 150,000— 150,000 and over Apparently only the last category is operative. 50,000 75.000 100,000 100,000 200,000 150.000 200,000 400,000 500,000 10,000 15,000 20,000 30,000 50,000 100,000 250,000 80 Minimum M O N E T A R Y , CREDIT, AND FISCAL POLICIES capital requirements Jurisdiction citation for banks and 1 9 4 8 ) — Continued companies (Septe?nber Trust company Banks Connecticut, sec. 3875.__ Bank and trust company Up to 50.000 $100,000 Over 50 090 200,000 100 nereent surplus. 50,000 Up to 3,000. . Delaware, sec. 2382 100,000 From 3,000 to 100,000 200, 000 Over 100.000 25, 000 Up to 3,000 .. Florida, sec. 652.06. With permission of comptroller. 50,000 Over 3,000-25, 000 Up to 7,500- . Georgia, sec. 13-901 50, 000 Over 7,500 ... Up to 3,000... 25, 000 Idaho, sec. 25-201; 25-206. 50, 000 From 3,000 to 6,000. 100, 000 Over 6,000-... 10 percent surplus. 25, 000 Illinois, sees. 10.05; 10.11-. Up to 2,500..50, 000 From 2,500 to 10.000 100, 000 From 10,000 to 50,000 200, 000 Over 50,000 10 percent surplus and 5 percent operating fund required. 25, 000 Up to 3,000 Indiana, sec. 18-412 50, 000 From 3,000 to 6,000 100, 000 From 6,000 to 75,000 200, 000 Over 75,000 10, 000 Up to 3,000-.. Iowa, sec. 528.1. 25, 000 From 3,000 to 6,000. 50, 000 From 6,000 to 15,000 100, 000 Over 15,000 Third class citv up to 2,000 — 25, 000 Kansas, sees. 14, 77 Second class city from 2,000 to 35, 000 3,000. First class city from 3,000 to 50,000 6,000. Over 75,000 from 6,000 to 75, 000 10,000. 100,000 From 10,000 to 50,000 200, 000 Over 50,000 20 percent surplus and 5 percent undivided profits. 25, 000 Kentucky, sees. 287.070; Up to 7,500 50, 000 From 7,500 to 25,000 287.080. 100, 000 From 25,000 to 100,000 200, 000 Over 100,000 20 percent surplus. 25, 000 Up to 3,000 Louisiana, sec. 568 50, 000 From 3,000 to 30,000 100, 000 Over 30,000 Bank plus trust company: Maine, sees. 96, 98 50,000 Up to 5,000 75, 000 From 5,000 to 10,000 From 10,000 to 20,000 100,000 From 20,000 to 30,000 150,000 200,000 30,000 and over 50 percent surplus. 25,000 Maryland, sees. 29 and Up to 15,000 75,000 From 15,000 to 50,000 54. 100,000 From 50,000 to 150,000 500,000 Over 150,000 20 percent surplus. Massachusetts, eh. 172, Bank and trust company: 50,000 Not over 6,000 sec. 18. 100,000 From 6,000 to 50,000 200, 000 Over 50,000 25,000 Michigan, sees. 40, 207— Up to 2,500 50,000 From 2,500 to 6,000 100, 000 From 6,000 to 30,000 200,000 From 100,000 to 300,000 300,000 300,000 and over 20 percent surplus. Commissioner may increase or decrease based on condition of assets and adequate capital structure. trust Up to 50.000-. From 50,000 to 150,000 Over 150,000 $50,000 100,000 250,000 $200,000 minimum. Bank and trust company mini- 100, 000 mum. Up to 6,000 50, 000 100,000 Over 6,000 Up to 100,000 Over 100,000 50,000 200, 000 Same. Same. 100,000 and over. Trust company plus bank double the requirements. Same. Up to 25,000 From 25,000 to 100,000 From 100,000 to 250,000 Over 250,000 20 percent surplus. 100,000 150,000 200,000 750,000 Up to 50,000. 50,000 to 100,000.... 100, ,000 to 1,000,000.... Over 1,000,000.. 150, 000 200,000 400,000 500,000 81 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Minimum capital requirements Mississippi, sec. 5159 Missouri, sees. 7944, 7949 and 8018. Montana, sec. 6014.12— 8-205. Nevada, sees. 1 and 8 — New Hampshire, ch. 313, sees. 21 and 25. New Jersey, draft sec. 4_. New Mexico, sees. 50501; 50-214. New York, sec 90 North Carolina, sees. 53-2, 53-39, and 53-159. North Dakota, 6-0203; 6-0503. Ohio, sees. 710-37. Oklahoma, sec. 68 sees. banks and trust companies Up to 500 if no other bank: Capital $10,000 2,000 From 500 to 1,000: 20,000 Capital 4,000 Surplus From 1,000 to 5,000: 25,000 Capital 5,000 Surplus From 5,000 to 100,000: 40,000 Capital 8,000 Surplus Over 100,000: 50, 000 Capital 10,000 Surplus. 25,000 Up to 6,000 35,000 From 6,000 to 10,000 50,000 Over 10,000 15,000 Up to 1,000 25,000 From 1,000 to 5,000 50,000 From 5,000 to 10,000 100,000 From 10,000 to 50,000 200,000 Over 50,000 25,000 Up to 2,000 30,000 From 2,000 to 4,000 50,000 Over 4,000 10 percent surplus. 10,000 Up to 1,000 25,000 From 1,000 to 2,000 35,000 From 2,000 to 5,000 50,000 From 5,000 to 25,000 100,000 From 25,000 to 100,000 200,000 Over 100,000 Minimum surplus, $2,500. $50,000 minimum capital and $10,000 minimum surplus. Bank plus trust company: 25,000 Up to 4,000 50,000 From 4,000 to 10,000 100,000 From 10,000 to 50,000 Over 50,000 200,000 20 percent surplus. No bank may have a capital exceeding $500,000. 50,000 Up to 10,000 From 10,000 to 50,000 100,000 150,000 From 50,000 to 100,000 300,000 From 100,000 to 200,000 Over 200,000 500,000 20 percent surplus. If the bank serves outlying areas the minimum capital requirement may be increased. $25,000. 20 percent surplus. 25,000 Up to 2,000 50,000 From 2,000 to 30,000 Over 30,000 _ _ _ _ 100,000 Up to 3,000 From 3,000 to 10,000 From 10,000 to 25,000 Over 25,000 50 percent surplus. Up to 5,000 From 5,000 to 10,000 Over 10,000 20 percent surplus. Up to 5,000 From 5,000 to 25,000Over 25,000 20 percent surplus. Up to 1,000 From 1.000 to 2,000 From 2,000 to 6,000 From 6,000 to 20,000. Over 20,000 10 percent surplus. (September Trust company Banks Jurisdiction citation Minnesota, sees. 48.02, 48.36. for 1948)— Continued 25,000 30,000 50,000 100,000 15,000 20,000 25,000 — 35,000 50,000 100,000 10,000 15, COO 25,000 — 50,000 100,000 Bank plus trust company: Up to 25,000 From 25,000 to 100,000 From 100,000 to 200,000 Over 200,000 Banks may powers. exercise $50,000 75,000 100,000 200,000 trust Either for trust company or trust company and bank: 50,00 Up to 10,000 100,000 From 10,000 to 50.000 200,000 Over 50,000 $100,000 to $10,000,000. Up to 10,000 From 10,000 to 50,000 Grom 50,000 to 100,000 Over 100,000 25,000 50,000 100,000 200,000 Same. Same. Minimum capital 100,000 $100,000. Up to 30,000 From 30,000 to 100,000.. From 100,000 to 250,000 Over 250.000 Bank may do a trust business. $100,000 minimum. $100,000 minimum. Trust company plus bank. Minimum capital required for both. Same. 100,000 150,000 200,000 500,000 82 Minimum M O N E T A R Y , CREDIT, AND FISCAL POLICIES capital requirements 403. Rhode Island South Carolina, sees. 7833; 7834; 7838; 7831. South Dakota, 6-0303; 6-0305. Tennessee, 5936. sees. sees. 6019, Texas, ch. 3, art. 3 Utah, sees. 7-3-10, 7-4-2. Vermont, sec. 6650 Virginia, sees. 4149 (16), 4149 (67). Washington, sec. 3226 West Virginia, art. 4, sec. 4. Wisconsin, sees. 221.01 and 221.04. Wyoming, sees. 53-105-.. companies $25,000 Up to 3,000 50,000 From 3,000 to 25,000 100,000 From 25,000 to 50,000 200,000 Over 50,000 If the bank is at least 2 miles from the main post office, then the minimum requirement does not exceed $50,000. 50,000 UD to 6,000 100,000 From 6,000 to 50,000 200,000 Over 50,000 50 percent surplus. None. 10,000 Up to 5,000 20,000 From 5,000 to 20,000 Over 20,000 50,000 25 percent surplus. Capital must be adequate for F D I C membership. If 5,000 or less population, only 1 bank may be chartered under above provisions. No dividend may be paid and no branch may be established until capital increased to amount shown below. U p to 3,000 25,000 50,000 From 3,000 to 10,000... Over 10,000 100,000 Up to 1,500 - 15,000 20,000 From 1,500 to 2,500 25,000 From 2,500 to 5,000 Over 5,000 50,000 10 percent surplus. Up to 1,000 20,000 30, 000 From 1,000 to 2,500 50,000 From 2,500 to 5.000 75,000 From 5,000 to 20,000 100, 000 From 20,000 to 50,000 200, 000 Over 50,000 25,000 Up to 5,000-. 50,000 From 5,000 to 15,000 75, 000 From 15,000 to 30,000 100,000 Over 30,000 May require 25 percent surplus. 25,000 Up to 5,000 50, 000 From 5,000 to 25,000 75, 000 From 25,000 to 50,000.100.000 Over 50.000 Surplus 25 percent. Bank plus trust company: $50,000 capital. $50,000 plus $5,000 every 10,000 population above 25,000. U p to 5,000 25,000 50,000 From 5,000 to 25,000 100, 000 From 25,000 to 100,000 150, 000 Over 100,000 25,000 Up to 3,000 From 3,000 to 6,000 50,000 100,000 From 6,000 to 50,000 150,000 Over 50,000 Up to 5,000 30, 000 From 5,000 to 20,000 75,000 From 20,000 to 200,000 100, 000 Over 200,000 Up to 4,000 200,000 25,000 From 4,000 to 6,000 50,000 Over 6,000 100, 000 10 percent surplus. Undivided profits amount for expenses of first 90 days (sumfixed by Commissioner). (September Trust company Banks Jurisdiction citation Oregon, sees. 40-403 for banks and trust 1 9 4 8 ) — Continued Up to 3,000 Over 3,000 $50,000 100,000 U p to 6,000 From 6,000 to 50,000 Over 50,000 50 percent surplus. 150,000 200,000 350,000 $25,000 minimum. Up to 6,000 Over 6,000 - 50, OOO 100,000' $100,000. 20 percent surplus. $50,000. Cities other than first class First class cities 25,000 100, 000 $50,000 minimum. Up to 25,000 From 25,000 to 100,000 Over 100,000 50, 000 100,000 200, 000 $100,000. The capital necessary for national bank in that locality. Same. Senator DOUGLAS. I n general are the State requirements lower or higher ? Mr. ROBERTSON. In general they are lower. 83 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . D O I remember your saying that in localities of under 6,000 population your minimum capital requirement is $60,000, $50,000 of capital plus $10,000 of surplus? M r . ROBERTSON. Yes. Senator DOUGLAS. Might not that figure be excessive i n small localities? M r . ROBERTSON. W e think not. W e think that today, with the volume of deposits which even a small bank has (a million-dollar bank 10 years ago may be today a $5,000,000 bank, or more, and $500,000 bank 10 years ago may be today $2,500,000, or may be $3,000,000), $60,000 is the minimum with which a group of people should begin i n starting off a new banking enterprise. Senator DOUGLAS. B u t there are small communities and trading centers which need the services of a bank, say a trading center of less than a thousand people; would that bank have to have $60,000 of capital ? M r . ROBERTSON. That is right. W e think it should. There are many banks in communities of that size today which are national banks, and they operate profitably. Senator D O U G L A S . I S it the size absolute of the capital and surplus which is the protection or is it the ratio of capital and surplus to deposits ? M r . ROBERTSON. Neither would be correct. I t is really the type of management you have in the bank. Senator D O U G L A S . D O I understand you to say you do not think you could get effective management on a smaller capitalization ? M r . R O B E R T S O N . N O ; I merely wanted to eliminate the question of management in passing upon your question. I t is the amount of capital funds you have i n the institution in relation to the volume and the kind of business which that bank is conducting which determines the adequacy of the capital structure of an institution. Senator DOUGLAS. Isn't it quite possible that communities, say, of 500, 600, or 750 people could operate a bank with a capital, operate a bank that had a capital of $25,000, plus $5,000 surplus, or $30,000, and had deposits for somewhere around $300,000; might not that be the most efficient size of bank for such a small community, and by imposing your requirements do you not shut off access to the national banking system in these small farm-trading centers? M r . ROBERTSON. M y answer would be that I think you w i l l find very few communities where there are banks with only three or four hundred thousand of deposits. Secondly, there was a time when the amount of required capital for a national bank i n this size community was $25,000. A f t e r considerable study, Congress concluded that that was too low and raised the minimum to $50,000. W e have seen nothing which would cause us to think the Congress was not wise i n raising that minimum. Senator DOUGLAS. Sometimes Congress makes mistakes. M r . ROBERTSON. Oh, yes; definitely, but w^e haven't seen any indications which w^ould warrant us in saying that Congress did make a mistake in that instance. W e would not like to see the minimum capital requirement for national banks reduced at this time. Senator DOUGLAS. Couldn't you make another classification, instead of lumping all communities under 6,000? I would agree that, with a community of 6,000, you should have $50,000 capital, plus $10,000 84 MONETARY, CREDIT, AND FISCAL POLICIES surplus; but I don't know that it follows at all that with communities under 1,200, or under 1,500, you should have that amount, and there are hundreds and perhaps thousands of such communities scattered over the country. Aren't you therefore depriving these communities of the advantages of the national banking system by this requirement? Wouldn't it be better to have a separate classification; say, banks i n communities of from 1,200 to 6,000, a minimum capital as at present, but for the banks i n communities of less than 1,200 or X population, whatever the figure is, it could go down to $25,000 ? M r . ROBERTSON. The proposition, I think, would be worthy of study, Senator, but I would offhand have very serious doubts about it, because, i f you get a class as small as the one you have i n mind, it is almost impossible to get satisfactory officers for that bank, because the earnings are so small today, on the volume of deposits which you speak of, as to make it very difficult to even get enough to pay a good officer's salary. Senator DOUGLAS. Aren't you saying that this community shouldn't have a bank at all ? M r . ROBERTSON. I t may be that it cannot support a bank. I f i t cannot, it shouldn't have a unit bank. Senator DOUGLAS. Then, what would you say about the fact that i n most of these cases, where they can't raise the $60,000, that they go to their State, and that the State, with lower capital requirements, w i l l proceed to charter ? Now, a State bank is a bank as well as a national bank. I f you think this bank would be unsafe w^ith a national charter, do you have any greater assurance that it would be safe with a State charter ? M r . ROBERTSON. Not i n the least, but I would have to take the responsibility for the safety of that bank i f it was not able to make enough to hire an efficient man to run it. Senator DOUGLAS. I n other words, you would like to see the State banks come up to your minimum figure ? M r . ROBERTSON. D e f i n i t e l y so. Senator DOUGLAS. Rather than your going down to this ? M r . ROBERTSON. Definitely. Senator D O U G L A S . Y O U would depend on branch banking then i n these communities to provide checking facilities, and so forth? M r . ROBERTSON. There are many instances where branch banking is the real solution today to meet the needs of people i n these very small communities which cannot support an independent bank. Senator D O U G L A S . Y O U would prefer to have the national banks with branches i n outlying trading centers, I suppose not too far removed, than to have separate State banks ? M r . ROBERTSON. O r n a t i o n a l banks. Senator DOUGLAS. Or national banks. M r . ROBERTSON. Either. Definitely so. That doesn't mean that we favor branch banking over independent banking. I am saying that there are communities which are too small to support an independent banking institution. I n those cases, branch banking is the solution. Senator DOUGLAS. W h i l e on the subject of branch banking, what rules do you now observe in the case of State banks with branches which might become national banks ? 85 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . ROBERTSON. They may bring into the System, of course, any branches which were i n existence i n 1927. Beyond that, they must get new branch authorizations. I f they cannot have them under the State law, they cannot have them under the national. So, i f a State bank was operating i n a State which permitted branch banking, and i t has branches, and it wants to convert, we would consider the entire branch set-up i n determining whether to permit conversion. Senator DOUGLAS. M a y I ask this, whether the Bank of C a l i f o r n i a has ever been admitted to the national banking system ? M r . ROBERTSON. The Bank of California, national association? Senator DOUGLAS. Pardon me. The B a n k of America ? M r . ROBERTSON. The Bank of America is a national bank. Senator DOUGLAS. W i t h all its branches ? M r . ROBERTSON. D e f i n i t e l y so. Senator DOUGLAS. W h e n was that admitted? M r . ROBERTSON. The Bank of America was—I would have to guess here and I would like to furnish the exact figures on that—but the B a n k of America became a national association more than 20 years ago. Senator DOUGLAS. W h a t happened to its branches ? M r . ROBERTSON. I t h a s branches. Senator D O U G L A S . I know, but has it added no further branches since 1927? M r . ROBERTSON. I t has added many branches since 1927. Senator DOUGLAS. W h a t power do you have on national banks establishing new branches ? M r . ROBERTSON. Branches cannot be established by a national bank without our consent. Senator DOUGLAS. Then you have the veto power on the extension of branches by national banks ? M r . R O B E R T S O N . V e r y d e f i n i t e l y so. Senator DOUGLAS. W h a t are the standards that you follow i n exercising this veto power? M r . ROBERTSON. Before a national bank can have a branch it must get our consent. I t puts i n an application for a branch i n a given community. W e make an investigation through our field force of the needs of that community for additional banking facilities. I f the needs are there, i f the bank is i n a position, both capitalwise, managementwise, and assetwise, to operate additional facilities, an additional branch, then we grant the branch. W e try to act on a basis which w i l l provide adequate banking facilities for the people safely; we try to avoid competition through branches. T h a t is, i f there are two banks i n a given area, and both are competing through excessive application for branches, we try to cut that off by restricting expansion branchwise. B u t i n a place where there is a definite need for banking facilities, and there isn't an independent bank there, or there is no one who is going to put i n an independent bank i n this particular community, so far as we can ascertain, and the people want a banking facility, we grant the branch, keeping i n mind always the need for preventing a monopoly or undue control over the banking facilities i n a given area. M r . WOLCOTT. Don't you also always conform to State law ? M r . ROBERTSON. Yes. Senator DOUGLAS. Suppose you had a potential group which wanted to organize a national bank i n a community which conformed to all of 86 MONETARY, CREDIT, AND FISCAL POLICIES your standards, and at the same time a bank which wanted to establish a branch there—to which would you give the preference? M r . ROBERTSON. Whether the proposed organizers wanted to have a national bank or a State bank, we would give preference to the independent bank over the branch, even i f it were a State bank and not a national bank. Senator DOUGLAS. Have you been worried at all about the extent of branch banking i n the Pacific Coast States and i n Nevada ? M r . ROBERTSON. I t is a matter to which we have given careful consideration, and I would say we are concerned. Senator DOUGLAS. Do you feel that the degree of concentration i n California, Oregon, Nevada, Idaho, and U t a h has gone pretty far ? M r . R O B E R T S O N . I think it has gone very far. Senator D O U G L A S . D O }^OU think it has gone too far ? M r . ROBERTSON. I f I could limit that to States, I would say that there is a point beyond which further branch expansion by given institutions i n California would not be i n the public interest. Senator DOUGLAS. W h a t percentage of the bank deposits in California are held by the Bank of America ? M r . ROBERTSON. I would want to check on my figures, M r . Chairman, but I think very close to 50 percent ; it may be one way or the other. Senator DOUGLAS. I n Nevada? M r . ROBERTSON. Almost 70 percent i n Nevada. That is a very unusual situation. Senator DOUGLAS. There are only five banks then, I believe. M r . ROBERTSON. Very, very few banks. O f course, i n that particular situation, the State itself asked the bank to come i n and set up banking facilities back i n the days of the bank crisis. Senator DOUGLAS. Branch banking has progressed i n Oregon, too % M r . ROBERTSON. Very much, but you have a different situation there, because you have separate branch systems which are sufficiently large to provide competitive banking. Competition, i n my opinion, is the best safeguard i n the whole banking field. Senator D O U G L A S . H O W many competitors do you have to have ? M r . ROBERTSON. Enough to afford competition. Senator D O U G L A S . H O W many ? H o w many do you have to have to get competition? M r . R O B E R T S O N . Y O U have to have at least two to get competition. Senator DOUGLAS. Naturally. Canada has two major banks, with branches all over Canada. W o u l d you say that they had competition ? M r . WOLCOTT. I think it is five. Senator D O U G L A S . I S it five ? M r . WOLCOTT. Yes. Senator DOUGLAS. B u t some of those are minor banks. I mean those two major banks dominate, in Canada, the banking system; isn't that true? M r . R O B E R T S O N . I wouldn't answer that without being more sure than I am. Senator DOUGLAS. W o u l d you think that two sets of banks would really provide competition ? M r . R O B E R T S O N . I think it would be very undesirable to have all the banking i n any State controlled by two organizations. I would much prefer to have many banks and thus afford better competition, the 87 MONETARY, CREDIT, AND FISCAL POLICIES kind which provides freedom to go to many sources instead of just one of two sources for credit or any other banking service. I am not in favor of permitting just two competitors in any given area. I merely say that the situation in Oregon is different from that in some of the States. Senator D O U G L A S . H O W many chains—that is not the precise term Mr. ROBERTSON. Branch organizations. Senator D O U G L A S (continuing). Branch organizations are there in Oregon ? Mr. ROBERTSON. In Oregon there are two large ones but many independent banks. Senator D O U G L A S . What percentage of the total banking deposits in Oregon are held by these two? M r . ROBERTSON. B y the two ? M r . ROBERTSON. Yes. Senator D O U G L A S . Yes. Mr. ROBERTSON. I wouldn't undertake to answer that but would undertake to furnish that information. Senator D O U G L A S . Will you, please. Senator D O U G L A S . What is the situation in Idaho and in Utah ? Mr. ROBERTSON. It is a much lower percentage. There again I would like to furnish the figures, Mr. Chairman. It is around 80 percent. (The information above requested is as follows:) Percentage of banking Arizona: Largest national bank •California: Largest national bank 2d largest national bank 3d largest national bank. 4th largest national bank. Total Idaho: Largest national bank 2d largest national bank Total... Nevada: Largest national bank -Oregon: Largest national bank 2d largest national bank Total.... Utah: Largest national bank Washington: Largest national bank 2d largest national bank 3d largest national bank Total offices and deposits held by largest Western States, June 30, 1949 Number of banking offices Number of banking offices in State Bank's percent of all banking offices in State 29 59 521 128 26 35 national banks in Bank's percent of all deposits in State Deposits Total deposits in all banks in State 49.2 Thousands $217,864 Thousands $4.13,089 52.7 1,118 1,118 1,118 1,118 46.6 11.5 2.3 3.1 5,321, 607 1, 539,129 445, 289 317,117 12, 615,823 12, 615,823 12,615,823 12,615,823 42.2 12.2 3.5 2.5 710 1,118 63.5 7, 623,142 12, 615, 823 60.4 23 18 96 96 24.0 18.7 127,886 109,073 407, 249 407, 249 31.4 26.8 41 96 42.7 236,959 407, 249 58.2 12 25 48.0 105,268 154,303 68.2 39 45 162 162 24.1 27.8 505, 592 458,206 1, 222,008 1, 222, 008 41.4 37.5 84 162 51.9 963, 798 1, 222,008 78.9 15 77 19.5 120,687 525, 515 23.0 45 30 17 246 246 246 18.3 12.2 6.9 589, 616 328,411 97, 968 1,826, 796 1,826, 796 1,826, 796 32.3 18.0 5.3 92 246 37.4 1,826,796 55.6 1,015,995 88 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. A r e there any other States besides California, Nevada, Idaho, and Oregon where branch banking has been carried to such extremes ? M r . ROBERTSON. None except Arizona. Senator DOUGLAS. A n d the chain banking M r . ROBERTSON. Chain banking is a little different thing. T h e largest chain banks—there are only two i n the country which amount to anything i n the way of size; one is i n Florida, and one is i n M i n nesota and the surrounding States there. The holding-company bank system is a different proposition. Y o u are not referring to that as chain banking? Senator D O U G L A S . I was coming to that. What about holdingcompany banking? M r . ]ROBERTSON. I t is generally spread over larger areas. They go into different States. Y o u r principal holding-company operations i n this country are Transamerica, which operates i n California as well as i n Oregon, Washington, Nevada, and Arizona; and you have the F i r s t Bknk Stock Corp. i n Minneapolis and the Northwest Bancorporation i n Minneapolis; they are the two large ones there. There are not more than a dozen substantial bank holding-company set-ups i n this country. Senator DOUGLAS. W h a t has happened to these very strong holdingcompany groups of banks i n the State of Michigan ? M r . WOLCOTT. There is one very large one. The Michigan N a tional has offices in five and possibly six cities. That is the only one that I know of. M r . ROBERTSON. It is a branch organization and is one that I would consider small i n relation to the systems I have referred to, which have 60 or 70 banking offices. Senator D O U G L A S . D O I understand then that the holding-company type of organization i n banking that flourished i n Michigan i n the twenties has disappeared like the snows of yesteryear ? M r . W O L C O T T . N O . There was the Guardian group, as I recall, about which you heard so much during the crash, and I was going to say it was replaced, but I shouldn't use that word, because there is no affiliation, but there is another organization known as the Michigan National Bank. M r . ROBERTSON. That is a branch organization, M r . Wolcott, rather than a holding-company organization. M r . WOLCOTT. I might say the Guardian apparently was not dissolved because it wasn't solvent. The fact is that since 1933 the Detroit banks have paid off more than 100 percent on all of their obligations. I would suggest i n that respect that you might read M r . Malcolm Bingley's book entitled "Detroit, M y O w n Home Town," which w i l l give you the history of the banking crash i n Detroit. I t is very interesting. Senator DOUGLAS. The Bank of the United States turned out all right i n New York, too. M r . WOLCOTT. I don't know anything about that. S e n a t o r DOUGLAS. Yes. M r . WOLCOTT. There have been bank crashes there, I believe. Senator DOUGLAS. M r . Robertson, M r . McCabe, chairman of the Board of Governors, Federal Reserve System, has recently suggested 89 M O N E T A R Y , CREDIT, AND FISCAL POLICIES certain changes i n the standards that banks are required to meet in order to qualify for membership in the Federal Reserve System. A r e you, in general, familiar with them ? M r . ROBERTSON. I n general. I must confess that I didn't get a chance to read all of that pamphlet. Senator DOUGLAS. I quote from him [reading] : A s a general rule, banks w h i c h are eligible for Federal deposit insurance should not be debarred f r o m membership i n the Federal Reserve by a r b i t r a r y capital requirements. T h e f o l l o w i n g proposed changes are desirable i n and of themselves and necessary i n order to eliminate unwarranted discrimination against membership i n the F e d e r a l Reserve System. Instead of the present capital requirements, w h i c h relate only to the amount of capital stock and are based on population, there should be only one specific c a p i t a l requirement for admission to membership—a m i n i m u m of $50,000 of paid-up capital s t o c k — w i t h the exception that a bank organized prior to the enactment of the proposed legislation might be admitted w i t h paid-up capital of $25,000. T h e adequacy of a bank's capital structure should continue to be included among the factors to be considered by the B o a r d of Governors i n passing upon the application of a State bank f o r membership. That is the end of his quotation. They refer to capital requirements for State banks which wish to become members of the Federal Reserve System. W o u l d you like to pass judgment on the question of whether you think such a change as this would be desirable ? M r . ROBERTSON. Only to say that I think fundamentally a decision on that matter is one which falls within the province of die Federal Reserve. They are i n better position to judge whether a bank with that size capital should be eligible for membership. W e in the Comptroller's Office say that we don't object to reduction of capital requirements for membership. Senator DOUGLAS. F o r the Federal Reserve? M r . ROBERTSON. N O ; we do not. We don't want to reduce our own. W e don't think this is the time to do it. I f they wish to do so, we have no objection on that score. Senator DOUGLAS. Do you think that would have any undesirable effect on the national banking system ? M r . ROBERTSON. I think not at all. Senator DOUGLAS. M a y I pass to a series of questions concerning Federal examination of banks ? M r . ROBERTSON. Yes. M a y I add one comment on the capital requirement for membership. There is i n conjunction with that suggestion, I think, M r . McCabe, a suggestion that the capital for the establishment of branches by member banks be reduced likewise. W e do object to that proposal. W e say i n that respect that State member banks should be on a parity with national banks. Otherwise, national banks are apt to leave the System and become member banks so they can establish a branch system without having as much capital as we must require under our statute. I must say that I am not i n complete accord with the suggestion made by the Chairman of the Federal Reserve with respect to capital. Senator D O U G L A S . D O you think the national banks should have the power to convert into State banks at w i l l ? M r . ROBERTSON. D e f i n i t e l y so. Senator DOUGLAS. Y o u think they should ? M r . ROBERTSON. Definitely so. I think no national bank should be told it has to stay in the national bank system. Banks are not national banks because they are obliged to be so but because they have greater 90 MONETARY, CREDIT, AND FISCAL POLICIES prestige, because of the quality of supervision, because of the fact that they have uniform laws throughout the United States. National banks are not going to leave the System because they are given the privilege of converting into a State bank. They can now leave the System by voluntary liquidation. The tax problem has' been thrown up. I t isn't serious. Y o u are not going to find banks leaving the national system because of the conversion privilege. W e do not object to it. Senator D O U G L A S . Even though the reserve requirements of the States tend to be lower ? M r . R O B E R T S O N . Yes. That would have nothing to do with whether an institution is a National bank or a State member bank. That goes to the question of whether reserve requirements are to be extended to nonmembers. I t may become a member bank, i n which case the reserve requirement would be the same. Senator D O U G L A S . I f the National bank becomes a State bank, then it is optional upon them to withdraw from the Federal Reserve System? M r . R O B E R T S O N . That is right. They might even become an uninsured bank. That is going a long way. Our immediate problem is only whether or not they are to be a State bank or a National bank. B u t we say that is a matter of choice in the banking set-up today. Senator D O U G L A S . D O you think there is no greater safety to depositors in the National system than i n the State system ? M r . R O B E R T S O N . I wouldn't say that. I think the quality of our supervision is very high. I say under a system such as we have i n this country, a dual banking system, where banks can come i n to either system at will, they should be privileged to go out. There shouldn't be a one-way street from a State bank into a National bank. They can convert into a National bank. W e say i f they can do that certainly we are i n no position to say you can't go back out the other way. Furthermore, just from a practical point of view, i f you say that National banks cannot convert, it is only a short period of time until you have every State legislature i n the United States saying, "State banks, you can't convert," and i f they do that you have a fixed pattern all down the line. Then it just depends on which way an institution happens to spring when it enters the banking field, whether it becomes a State bank or a National bank. That I do not think is healthful. Senator D O U G L A S . A S I understand it, the arrangement which has been made is that the Comptroller of the Currency examines the national banks ? M r . R O B E R T S O N . National banks exclusively. Senator D O U G L A S . A n d the Federal Reserve Board examines the State banks which are members of the Federal Reserve System ? M r . R O B E R T S O N . I n conjunction with the State bank supervisors and examiners. Senator D O U G L A S . A n d the F D I C examines State banks which are insured but not members of the Federal Reserve System ? M r . R O B E R T S O N . I n conjunction with the State bank supervisors. Senator D O U G L A S . D O you know anything of the way i n which F D I C and State banking authorities share the actual task of bank examination? M r . R O B E R T S O N . A n y statement which I would make would be clear hearsay, M r . Chairman. I think you should get more expert advice on that from the F D I C itself. The coordination is very good. 91 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. W i l l you give us a picture of the methods now used to coordinate the policies of the Comptroller, the F D I C , and the Federal Reserve i n the fields of bank supervision and examination, and I think you should subdivide your answer into coordination at the top levels, at staff levels, and at the various regional offices. M r . ROBERTSON. I can divide it but i f I do, M r . Chairman, it is going to be just the same, because at the top level here i n Washington, between the Comptroller, the Board of Directors of F D I C , and the Board of Governors of the Federal Reserve Board, there is very close coordination. A t the top staff level here i n Washington—that is, myself and other Deputy Comptrollers, the chief national bank examiner, the chief examiner for the F D I C , the chief examiner for the Federal Reserve—there is very close coordination on every major problem. W e hold conferences and discuss ways and means of solving problems. Even going one step further, the assistant chief examiners i n our organization, the assistant chiefs i n the Federal Reserve, and assistant chiefs in the F D I C , are on the telephone every day conferring about given cases. Senator D O U G L A S . D O you have uniform rules ? M r . R O B E R T S O N . N O ; not uniform rules i n any sense that I can think of. W e do have an understanding between the three agencies on investment securities, on the appraisal of assets, that is, classifying them, putting them into substandard, doubtful, or loss, and to that extent, yes, there are uniform policies, but they are not rules i n any sense of the word. The policies we have are, to a large extent, uniform. Senator DOUGLAS. When you candle eggs you separate the rotten eggs from the good eggs, and then you have an intermediate group of, say, doubtful eggs. Do you have any uniform standards, or when you hold an asset up, would it be pronounced rotten by you and by the Federal Reserve and by the F D I C , or would some of you say it is a moderately good asset, for example ? M r . ROBERTSON. Even within our own force different examiners w i l l come to different conclusions concerning the credit soundness of any given asset, and that would certainly be true i f you would match up the examiners of the F D I C , the Federal Reserve, and our Office. I t would be true i f you took different examiners within the F D I C and the Federal Reserve. No two men w i l l judge credits alike. What we try to do is to instill in them a sense of credit judgment and expect them to apply it. Each case stands on its own footing. Senator D O U G L A S . Y O U have no manuals ? M r . ROBERTSON. There isn't any such thing as a manual which can be used in determining the credit soundness of a given asset, because the factors i n every single situation w i l l vary. I t is impossible to have manuals. Certainly we have books of instruction to our examiners ; so does the Federal Reserve; so does the F D I C . W e have copies of theirs; they have copies of ours. I f you were to compare the.m, as a layman, you would think they were pretty uniform, but that is not an answer to your question. I t is the man i n the field who is applying those instructions who is the large factor in determining the credit soundness of any given asset. I t is impossible to obtain complete uniformity i n the examination of a bank. Senator DOUGLAS. What about loans to new business ? M r . ROBERTSON. L o a n s t o n e w b u s i n e s s ? S e n a t o r DOUGLAS. Yes. 92 MONETARY, CREDIT, AND FISCAL POLICIES Mr- ROBERTSON. They w i l l be viewed exactly on their merits. Senator DOUGLAS. B u t how can you tell what the merits are % M r . R O B E R T S O N . Y O U can't have any general rules about loans to new business. Y o u must look at what the credit factors are i n a given situation and see whether or not that is the kind of asset i n which the funds of the depositors should be invested. Senator DOUGLAS. I t is sometimes said, and I hope you won't take this amiss—it is sometimes said that the national bank examiners are so tough that a good many banks are afraid to make loans, i n appreciable amount, to new business, lest you put them on the carpet. M r . ROBERTSON- I n some cases I hope that is true; i n other cases it is used as an excuse for not making the loans. I would say that national bank examiners are, on the average, possessed of a very high degree of credit judgment, and I am convinced they are exercising it soundly today. Senator DOUGLAS. I n other words, you give yourself a vote of confidence ? M r . ROBERTSON. I give them a note of confidence; not myself. Senator D O U G L A S . I see. % M r . Robertson, i n your written statement, or the statement from your office, your office opposed a unification of all Federal supervisory activities and their concentration i n the Federal Reserve. The principal reason advanced i n support of this opposition was that such a move might lead to a subordination of bank supervision to national credit policy, to an excessive use of bank supervision as an instrument of monetary and credit control. This raises several questions. First, just what is the issue here ? W h a t is the essential difference between the purpose of examinations as seen by your office and the purpose of examinations as seen by the Federal Reserve System ? M r . R O B E R T S O N . I can tell you what the purpose of ours is but I would prefer that they tell you what the purpose of theirs is. The purpose of our examination is, we think, to insure the soundness of each individual bank. W e want that bank to be i n condition so that it can meet any eventuality. Senator D O U G L A S . D O you consider the soundness of the system of banking as well as the soundness of the individual bank ? M r . ROBERTSON. Definitely. W e think the soundness of the system is dependent upon the soundness of the individual bank. Senator DOUGLAS. The soundness of the individual bank, conversely, may depend upon the soundness of the system ? M r . ROBERTSON. It may very well, but I think it works the other way. Senator DOUGLAS. T h e definition once given of a banker is that he is a man who loans you an umbrella when the sun is shining and asks for it back when it begins to rain. M r . ROBERTSON. There have been a lot of jests made about bankers, but I think on the whole they have done a good job of carrying out their responsibilities i n maintaining stability i n our economy. Senator D O U G L A S . Y O U look to the individual bank, not to the total situation ? M r . ROBERTSON. W e look to the individual bank as being the determining factor in the over-all situation at any given time. W e don't think one can sit up on a pedestal and say, " W e think the conditions 93 M O N E T A R Y , CREDIT, AND FISCAL POLICIES are going this way at a particular time and therefore you have to gear your supervision to that particular viewpoint," because the person who makes the decision may be wrong. B u t i f we can look at each individual bank and determine that it is sound, that it is soundly managed, that the standards which it follows i n administering the people's money, in investing that money, are sound, we can be far more certain of obtaining—of having, at any time—a sound banking system, than we can through any other means. Senator DOUGLAS. Well, were you with the Comptroller during the period from 1929 to 1933? M r . R O B E R T S O N . N O ; I joined the office in 1 9 3 3 . Senator D O U G L A S . Y O U heard the stories of bank examinations prior to that time ? M r . ROBERTSON. I have heard the stories. Senator D O U G L A S . I S it possible that i f the bank examiners had been somewhat more lenient there would have been fewer bank failures, and, therefore, the banking system would not have collapsed to the same degree, and some of the banks referred to by my esteemed colleague here, i f they had been treated with greater gentleness, might not have gone down ? M r . ROBERTSON. That is a story that has been circulated to a large extent and I think it is absolutely false. I think during the period, for example, between 1930 and 1933, the examiners were tight. They had to look at loans carefully, because they were made i n a down-trend period, but i f they had been lenient the losses which would have been sustained, would have been terrific, because the principal losses to the banks which were closed i n 1933 were on loans made i n 1931 and 1932, at a time when we were being tough, and i f we had been lenient the story would have been entirely different, because there was no one who knew that period would end at a given time. Senator DOUGLAS. W o u l d the trend by the examiners be to judge the worth of an asset by its market value ? M r . ROBERTSON. The trend at that time, as I understand it, was to take into consideration the market value, but that wasn't the only criterion. Senator DOUGLAS. Wasn't that the predominant consideration? M r . R O B E R T S O N . N O ; I don't think that is right. That may be true i f you refer to an investment security. I t isn't true as to a loan. Senator D O U G L A S . I mean, an investment security. M r . R O B E R T S O N . I think that is true. Senator D O U G L A S . H O W about real estate ? M r . ROBERTSON. Well, real estate would f a l l into an entirely different category, because you have more than real estate behind any loaK: you can only lend a limited percentage of appraised value. Y o u have other safeguards behind most real-estate loans. Y o u have the financial responsibility of the borrower. I don't think you can put those i n the same category. Don't misunderstand. There have been times I think, when bank supervisors have been wrong. There have been times when, i f you look at it by hindsight, you can see that you put the pressure on when it should have been taken off, or that you were too lenient. Senator D O U G L A S . Y O U don't feel, then, that the bank-examining system was too tough on the national banks during the period from 1929 to 1933? 99076—50 7 MONETARY, 94 CREDIT, AND FISCAL POLICIES M r . ROBERTSON. I d o n o t . Senator DOUGLAS. D O M r . ROBERTSON. you think it was too lenient ? NO. Senator D O U G L A S . Y O U think it was just right? M r . ROBERTSON. I f I had been the one making every decision they wouldn't have been the same, but far be it from me to say, even by hindsight, that they were wrong in what they did. Senator DOUGLAS. Does judgment of assets by market value force the liquidation of assets in a depression period and discourage the granting of new credits ? M r . ROBERTSON. There may have been instances where it did; there may be instances where it did not. I don't think you can generalize. Y o u have to take each individual case. Senator D O U G L A S . Y O U can always swamp us on individual cases, because we never know the individual cases. A civil servant can always do that. H e can always stop a congressional committee by saying everything must be judged on the individual case. But we are trying to find general rules. Excuse the vehemence of my statement but this is typically what a skilled Government official gives to a congressional committee. M r . ROBERTSON. I think it is a correct reply. Senator DOUGLAS. Well, it is a very baffling one. It is a reply admirably calculated to retain control i n the hands of administrative officials and deny to Congress the power of making any general rules. M r . ROBERTSON. What we want to do is to help you i n the job you are trying to do of determining what the general rule should b6,; Senator. Senator DOUGLAS. That is what I am groping for, very painfully, and I find only a statement that the bank examiners, i n individual instances, are using their best judgment, and that no general rule can be drawn. M r . ROBERTSON. I f you can find a general rule, Senator, we w i l l be delighted. Senator D O U G L A S . I would like to have you help us. M r . R O B E R T S O N . I would like to help you. Senator DOUGLAS. Fine. What would you say on this question of market value of assets then: Should you judge assets according to what the security w i l l sell for at the moment i n the market ? M r . ROBERTSON. Not exclusively, but that should be one of the factors. Senator D O U G L A S . H O W much weight would you give to it? M r . R O B E R T S O N . I couldn't figure a percentage weight on it. A n y investment security, Senator, has behind it the same credit factors which any loan has, and we say that every banker should know as much about the credit factors involved in an investment security as he does i n a loan, because all it is is a "stranger loan" he is lending money to a foreign corporation, that is, a corporation not doing business in his home town, ordinarily. H e should only buy an investment security i f he would be w i l l i n g to lend to that borrower the same amount of money, and he should know just as much about it in one instance as in the other instance. One looks at the credit factors in determining whether or not despositors' funds should be invested in it. The market value should be considered but it should only be looked at in consideration with all other credit factors. 95 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . N O W , I take it that you do not want the Federal Reserve System to take over the examination of national bank,*? M r . R O B E R T S O N . I think it would be unwise. That is a matter though for Congress to decide. Senator D O U G L A S . I am sure that your decision on this point is not swayed, though it may be, since you are human, it may be influenced by the fact that you are now making examinations yourself, but what considerations would you bring forward to tell us why the Federal Reserve System should not do it ? M r . R O B E R T S O N . I w i l l be glad to tell you why I think it should remain, not necessarily i n our office, but it should remain i n an office which is not concerned with over-all credit control. Supervision, as I view it, and I can be wrong, should look to the individual soundness of each individual bank, and that goes to the assets i n that bank, the kind of management it has, and so forth. The supervision should not be controlled by anyone who is trying primarily to provide general economic stability. There are certain measures which should be used i n that respect: Rediscount rates, reserve requirements, and many others. But supervision is not one of those. Supervision should be completely independent, with no conflicting motive, no conflicting duties. I t shouldn't be used as a means of carrying out what is a Government economic policy of the moment, whatever administration is in power. It should be independent, so that when anyone wants to see what the true condition of the banks is at any given moment, the facts are there. Now, the Federal Reserve has, you see, access to all of our reports of examination. W e are an independent agency i n the sense that we have no conflicting duties; just supervision of banks. They can see what the status of each bank is. I think that is a much sounder basis to operate on than it would be i f the examinations were being: made bv one whose principal duty is not the safeguarding of the soundness of that individual bank, but is providing the atmosphere for stable economic conditions. Senator DOUGLAS. Let's take a bank that has a widely distributed set of investments and, therefore, has not shown undue favoritism toward plunging i n one set of businesses, but has a pretty well distributed set of risks, and during a depression all of them go down. Y o u have said that you do not take market value as the sole test. I take it that it is a pretty strong test. Suppose you apply that test and you find a bank in a very difficult position. Y o u give warning to the bank. The bank therefore will, let us say, i n order to be safe, at least not make loans which it might otherwise make. The effect of your examination therefore w i l l be to exercise a constricting influence on credit, just because you have these conditions as of the moment. But it is also a law of life that just as things which go up must come down, so i n the past things that have gone down come up, that is, on the general average. Therefore have not banks been restricted in expansion of credit and, therefore, recovery impeded by a tendency to take present conditions almost exclusively into account and not have sufficient faith i n the future? M r . ROBERTSON. I t depends on how far you carry that. Certainly I think you have to take into consideration the economic conditions. Y o u just can't have supervision standing out here i n a vacuum. Y o u 96 MONETARY, CREDIT, AND FISCAL POLICIES must have supervision geared to economic conditions because that goes into the credit soundness of any given asset. Suppose you had a depression which extended over, say, a 10-year period. W o u l d you permit a bank to continue investing" depositors' funds in risk assets, assets which held a high degree of risk, i f the market value of the security portfolio was such that the loss would wipe out everything the depositors had i f it continued going down? I f so, how long would you permit it to carry those investments ? T h a t is a pretty difficult decision. I t depends largely on whether the bank is i n a position to carry the securities to their maturity. Senator D O U G L A S . Coming to that, the danger of the depositors losing has certainly been reduced very much by the Federal Deposit Insurance Corporation law? Mr. ROBERTSON. Oh, yes. M r . W O L C O T T . But the depositors lose when the Federal Government has to come i n and make good on the losses, don't they, because most depositors are taxpayers. I t is just a transfer of the obligation for the loss from the depositors to the Federal Government, The point is, there is just as much necessity for maintaining sound banking, regardless of F D I C , as i f we didn't have it. Senator D O U G L A S . W e are, of course, all i n favor of sound banking, just as we are all opposed to sin. The question is, W h a t is sound banking? M y inquiry is whether you can't be so strict on these banks as to impede a policy of credit expansion, which is what the country as a whole may need at the moment. M r . W O L C O T T . I think 160 years of banking i n the United States, a system which has contributed as much as it has to the standards of living in the United States, the position which we hold in world affairs, has proven itself to be a pretty good banking system. I surely wouldn't want to see the Federal Government or the Congress try to write standards into the law for the examination of banks, which up to the present time has done the splendid job they have in making this the greatest Nation in the world. I think we can compare the American system with the Canadian system. The concentration of credit power i n the Dominion of Canada today obviously has prevented Canada from making the economic strides that the United States has. Senator D O U G L A S . That is what I was objecting to in the branch banking system. M r . W O L C O T T . I have been strongly opposed to branch banking, except as the States allow it. I am opposed to it principally because, as seen in the Canadian system, in which the loans were manipulated from one branch to another, to protect the loans of those banks, to the prejudice of the communities. I would hate to see that system grow up i n America, i n the United States. I would hate to see such a loose system of examination on any of our banks that it would prejudice the obligation which the taxpayers have assumed to protect bank deposits. M r . R O B E R T S O N . M a y I give you anothev rep son why I think the supervision should be in an independent agency ? IT seems to me that i f you put bank supervision in an agency which is responsible for monetary and credit control, so that its primary functions is stabilization rather than individual banking, you w i l l destroy the effectiveness of bank supervision, destroy it because you w i l l lose its effectiveness. 97 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Bank supervision today isn't effective because of the legal sanctions which stand behind the supervisor. The effectiveness is there because the banks of this country—all the bankers of this country—know that the sole motive of the supervisor is the soundness of the individual bank, or to aid in making it into a sound bank. I f the bankers of this country thought that the supervisor or the examiner was going to look at loans and other assets not in the light of what they are, but i n the light of what someone in Washington happened to think existing conditions demand (either going down or up, depending upon which individual is deciding that question) the bankers of this country are going to pull back, they are not going to cooperate with the supervisor, I don't care who he is, and are not going to carry out, except with force, the recommendations and suggestions of that supervisor. When a suggestion is made the bankers of this country carry it out, with rare exceptions, and there is no force behind it. They carry it out because they know that our sole interest is in trying to make their bank a good bank and a sound bank. Y o u are going to lose that effectiveness. Senator DOUGLAS. The protection against fraud could be handled by one agency ? M r . ROBERTSON. Yes; and the protection against fraud is an insignificant matter. When we audit a bank we don't go i n with any idea of trying to discover fraud but rather to build up the bank so that they can discover their own frauds. Our principal job is in seeing that the credit standards applied by that bank are sound and that its management .is sound and competent. It is a mistaken notion that bank examination is designed to catch the crook. It isn't at all. Senator DOUGLAS. That is one of its purposes. M r . R O B E R T S O N . A very, very minor function, Senator, very minor. I f that were all there is to it, you could wipe out bank supervision and it wouldn't make much difference one way or another. Senator D O U G L A S . D O you think that i n a period of depression it would be a good thing for the company, for the banking system, as a whole, to expand loans, i n order to give added employment, and added production ? M r . ROBERTSON. That is a difficult question. I t is one which I would like to answer by saying that I think the banker who is on the spot i n his locality is i n a better position to judge its credit needs than is any one person sitting here in Washington. Senator DOUGLAS. O f course, the individual bank, which expands its loans, when other banks do not, has checks drawn against it, which i n turn w i l l find their way, most of them, into other banks, and you, therefore, draw down the reserves of the bank, and yet i t is impossible for an individual bank to swim against the tide, and i f all individual banks are afraid of the toughness of the examination, then none of them w i l l stay in. Y o u have to have sort of a general movement which proceeds by capillary attraction, so to speak, through the system as a whole, to get expansion, no one bank can swim against the tide; you know that. The vast majority of checks, I suppose, drawn against a bank w i l l find their way into other banks and be cleared, and you w i l l therefore draw down the reserves of the bank i n question. It has to be the system as a whole which expands. W e are debating a philosophic issue, but it has great importance. 98 MONETARY, CREDIT, AND FISCAL POLICIES Y o u say that i n order to maintain the integrity of the System you have to maintain the integrity of the individual bank. Isn't it also true that i n order to maintain the integrity of the individual bank you have to maintain the integrity of the System ? M r . R O B E R T S O N . I think that is so. I think my point was misunderstood, Senator. Senator DOUGLAS. Not merely the integrity of the System but the soundness of the System. M r . ROBERTSON. I think that is right, but I think my point was misunderstood. I t was just this, that I think the bankers of this country, not taking one bank, but I am taking the bankers as a whole, they are the ones who set the standards, and not the one which happens to be off the beam. Taking the average of the bankers throughout the country, they are in a better position to determine what is best for their own community than is any one single person sitting in Washington. Senator DOUGLAS. On individual loans I grant you, of course, they are better judges of credit risks, on those individual loans. M r . R O B E R T S O N . N O ; I still don't make my point, Senator. Senator DOUGLAS. That is the great advantage of having banks which retail credit. M r . R O B E R T S O N . I am speaking about general economic conditions. I think that the influence which they wield through the exercise of their own judgment, the judgment of their own officers, in determining what is sound for that bank, realizing their bank is dependent upon the well being of their community, and their nation, what they do i n the way of extending credit, through the exercise of their own judgment, is a far safer course for banking in this country, and for the economy of this country, than to have their decisions either weighed down or pushed up by the judgment of some economist i n Washington. Senator DOUGLAS. Or some bank examiner ? M r . ROBERTSON. It doesn't make any difference. I don't care who it is. I say that power shouldn't exist. I would rather rely upon the soundness of the judgment of the bankers of the country than on the correctness of the opinion of anyone who happened to be i n power at the time. Therefore I say that bank supervision should be geared to the soundness of each one of those banks. Senator DOUGLAS. M a y that not operate at times against the soundness of the System as a whole ? M r . R O B E R T S O N . I think that the chances of it doing good are much better and I w^ould prefer to risk my own stake i n this country on that basis than I would in having it determined by someone at the top because I would be afraid he might be wrong. Senator DOUGLAS. Fear is contagious too. M r . R O B E R T S O N . I think that is right. Senator DOUGLAS. There is no doubt there was a contagion of fear amongst the members of the banking fraternity from 1930 to 1933. M r . ROBERTSON. Yes; I think that is definitely so. O f course, they weren't exclusive in this field. Fear was pretty general throughout the country. Senator DOUGLAS. B u t the fear on the part of the banking community resulted i n a cumulative contraction of credits and therefore a progressively worsening of conditions which i n turn increased their fear, and it is possible that the strictness of the bank examinations may have contributed to that fear. 99 M O N E T A R Y , CREDIT, AND FISCAL POLICIES W h a t would be your attitude toward a concentration of all Federal examinations in one agency i f you were reasonably assured that this examination would not be converted into an instrument for credit management ? Suppose we say we won't have anything to do with credit management, we w i l l just consider the soundness of the individual bank. M r . ROBERTSON. Then I would have no objection to it whatsoever. I would say that you aren't gaining much by doing it but one Federal agency can do it, can examine all those banks, just as easily as the existing three. W h a t it would be doing is taking the examiners from the other forces, putting them into one group, which wouldn't do the job any faster, or any more effectively; but there would be nothing wrong with one agency examining all those banks and advising the F D I C , and so forth. I would have no objection to that. Senator DOUGLAS. Wouldn't it save expense ? M r . ROBERTSON. Not at all. None of the three agencies are paid out of public moneys at all. The banks pay Senator DOUGLAS. W a i t ; just as Congressman Wolcott said, bank failures have been paid out of taxes, these cross railroad fares have to be met by someone, and i f not met by the public have to be met by the bank authorities, so that we are anxious to save private money as well as public money. M r . ROBERTSON. That is true but I think i f you would make inquiry you would find, from bankers of this country, that they think the examining functions are being carried on as economically as can be done. W e w i l l be glad to have you, or anyone else, show us ways of economizing. Y o u see we are i n a position where, to a certain point, we are responsible to the bankers who pay the costs of supervision. They aren't going to sit by and have us squander money. Senator DOUGLAS. I am not charging you with squandering money. This is a question of whether it is the most economical method of operation. It is obvious that on a division on the basis of concentric circles, with you taking national banks and the Reserve taking State bank members of the System, and F D I C taking insured State banks which are not members of the System, it is quite obvious that you w i l l have i n one community, let us say, three sets of examiners coming in, even though you don't have three sets of examiners in the same bank, you have three sets of examiners i n the same community, with separate regional organizations; it would seem to me that that is obvious. M r . ROBERTSON. I don't think it is obvious at all, Senator. I am trying to be frank about this. Senator DOUGLAS. Well, I guess I must be stupid. M r . R O B E R T S O N . N O ; I don't think so at all. Senator DOUGLAS. Where do I fall off ? M r . ROBERTSON. They do examine different banks, as you know, They are never all in the same bank. Senator DOUGLAS. That is right. But wiiat I say is they w i l l be i n the same town. M r . ROBERTSON. They may be i n the same town but i f they are they merely have to stay longer, and that raises your per diem. W e have thought about that a lot. We have yet to have anyone show us or be able to discover for ourselves where you wTould save any money by pooling them all together. 100 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Don't cross railway fares come into it; is there no saving in railway fares? M r . ROBERTSON. W e don't think so. Maybe it is possible. I would say, i f it is possible and more efficient, let's do it. Senator DOUGLAS. W o u l d there be no saving i n branch organization ? M r . R O B E R T S O N . I don't think so, because in each of the agencies the supervisory force in the field is small—cut right down to the core. W e operate with a very limited force. Senator DOUGLAS. I am quite prepared to believe that you are very thrifty, but I have never yet found a Government agency that operated right down to the core. M r . R O B E R T S O N . Y O U come down and we w i l l show you one. Senator DOUGLAS. Good. M r . ROBERTSON* W e would be delighted to show you. W e think we have one. Let me say this, i f there would be an economy of that sort, i n that sort of an organization, I would be in favor of it. I f any expert can show us where it is economical and efficient I w i l l stand here and testify in favor of that sort of a consolidation. Senator D O U G L A S . I haven't read all of the Hoover reports. What do they recommend on that matter, do you remember ? M r . ROBERTSON. The Hoover Commission itself, as I recall, not having read it for a number of months, recommended only that the F D I C be placed i n the Treasury, in some wa}^ the same sort of a relationship that the Comptroller is in, that it operate under the direction of the Secretary of the Treasury, and that is all. Senator DOUGLAS. That might carry with it a consolidation of investigatory functions, so that you would take the inner circle, and the outer circle, leaving the Federal Reserve with the circle in between the two. M r . ROBERTSON. I doubt i f that was contemplated, because i n the staff report it was recommended that the examining functions of the Comptroller, and I think the F D I C , be concentrated in the—— Senator D O U G L A S . Y O U mean the staff report did recommend a consolidation ? M r . ROBERTSON. Definitely so, and the Hoover Commission itself did not. Senator DOUGLAS. But did not reject it ? M r . ROBERTSON. Yes; they did reject it, and advocated instead of that that the F D I C be placed under the direction of the Secretary o f the Treasury; but rejected entirely the staff report. Senator DOUGLAS. D i d they reject it or simply f a i l to mention it? M r . R O B E R T S O N . I w i l l have to go back and read the report but it is my recollection that they rejected it. Senator DOUGLAS. I t is my recollection that they failed to mention it. Overburdened committee members sometimes f a i l to notice the f u l l intricacies of staff reports, and their failure to include should not be construed as an outright action. M r . ROBERTSON. That is a matter easily ascertained by looking at the record, Senator. I wouldn't say that I can repeat verbatim what was i n the report. I haven't seen it since it was issued. Senator D O U G L A S . N O W , these are some questions about the relationship between the Comptroller and F D I C . I n the absence of M r . Delano, I don't know whether you want to reply to these questions or not. 101 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . R O B E R T S O N . I would be glad to i f I am in possession of the answers. Senator DOUGLAS. The Comptroller is an ex officio member of the Board of Directors of the F D I C ? M r . ROBERTSON. That is correct. Senator DOUGLAS. What do you think of the system of having ex officio members of the Board of the F D I C ? M r . ROBERTSON. I n this particular case I think it is good. Ordinarily I am opposed to ex officio members, and maybe I am being very one-sided in this decision, but his membership in the F D I C does provide that Board with first-hand knowledge of the entire banking system, you see, because they get virtually the entire banking system, they get the national banks through him, they get the State banks through their close contact with the primary supervisors of the State banks. So that in this particular case I think it is worth while. A s you may or may not know he is not an ex officio member who attends just once in a while. H e attends every meeting. H e takes an active part in the proceedings and the deliberations of the Board of Directors of that Corporation. Is that a sufficient answer, Senator ? A r e there any other facts you would like ? Senator DOUGLAS. What would you say to having the Chairman or Vice Chairman of Federal Reserve as an ex officio member of the F D I C Board? M r . ROBERTSON. I wouldn't object. Y o u don't get additional knowledge of a definite group of banks through such a member like you get through the Comptroller with respect to national banks. Senator DOUGLAS. W a i t a minute. Y o u get the State banks, which are members of the Federal Reserve System. Y o u would get that point of view. M r . ROBERTSON. I didn't make the first point clear. The F D I C works directly with the primary supervisors of both State and National banks. They coordinate with the State bank supervisors themselves. They make their examinations in conjunction with the State bank supervisors and with respect to the State member banks they still have the State supervisors with whom they coordinate and obtain information. National bankwise they don't have contact with the System except through the Comptroller. So you don't have that same reason for placing a member of the Board of Governors on the F D I C . That is the only reason. It may not be as valid as I think it is. Senator D O U G L A S . D O you think the primary basis of classification is as between the national banks and State banks rather than between members of the System and nonmembers of the System ? M r . R O B E R T S O N . I would have to have the background for that question. Senator D O U G L A S . Y O U inspect national banks? M r . ROBERTSON. That is right. Senator DOUGLAS. But the responsibility for national supervision of State banks is divided between the Federal Reserve System which takes State banks which are members of the Federal Reserve System and the F D I C which inspects State banks insured but not members of F D I C ; isn't that true? M r . ROBERTSON. Yes. 102 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. W h a t I am t r y i n g to say is that we have a threelayer cake, so to speak. T h e middle tier is not represented. M r . ROBERTSON. M y point is that the F D I C does not get their knowledge of these State banks exclusively through their own examinations. T h a t isn't as important, i n some ways, as is the contact that they have w i t h the State bank supervisors. They have close contact with the State bank supervisors themselves, irrespective of whether the banks are members or nonmembers. W i t h respect to the national bank system, they have direct contact through the presence of the Comptroller on the Board. T h a t is my point. Senator DOUGLAS. Well, may I ask one final set of questions on the relationship of the Comptroller of Currency i n the Treasury Department ? Have you found that the inclusion of the Comptroller's Office w i t h i n the Treasury Department has i n any way tended to subordinate sound examination and supervision policies to the fiscal policies or needs o f the Treasury? M r . R O B E R T S O N . I would say without any qualification, " N o . " T h e Comptroller does operate under the general direction of the Secretary of the Treasury. B u t that means general direction and not special direction. There are very, very few cases i n which the Treasury takes any part i n deliberations w i t h respect to bank supervision. Senator D O U G L A S . D O you think there is any reason to believe that placing the F D I C under the general supervision of the Treasury Department would lead to a subjection or subordination of deposit insurance to the fiscal policies of the Treasury ? M r . R O B E R T S O N . I don't think so. B u t I see no great gain to be made by putting it under Treasury. Senator D O U G L A S . Y O U don't see any harm ? M r . ROBERTSON. N O ; I do not. Senator DOUGLAS. Thank you very much. Congressman Wolcott. M r . W O L C O T T . I have just one thought. A s to the reason why the F D I C was not put under the Treasury i n the first place, when they were not affiliated w i t h the Federal Reserve, it was the thought that it Avasn't the proper thing to do, to turn the administration of the insurance over to those who were being insured, any more than i t would be proper for a person who carries fire insurance being able to write the terms under which his losses should be liquidated. T h i s is why the F D I C was set up as i n independent agency of the Government, so that it would be just that, independent of any influence which might be brought to bear upon those who were vitally interested i n the manner i n which the insurance would operate. Senator DOUGLAS. W h a t is this identity of interest that you mention ? M r . WOLCOTT. I didn't mention any identity of interest. W h a t do you mean by it ? Senator D O U G L A S . I thought you said that the people being insured would also act as a supervisor. M r . WOLCOTT. I w i l l explain it. I f you put the members of the Federal Reserve Board, or the Chairman of the Federal Reserve Board, on the Board of the F D I C , Federal Reserve member banks being insured by the F D I C , then you would have a situation where the Board of Directors of the F D I C would be writing the regulations i n respect to the operation of the insurance agency which insures deposits i n the banks, and I used fire insurance as an example, of a man insured 103 M O N E T A R Y , CREDIT, AND FISCAL POLICIES in a fire-insurance company, he being put i n a position of writing the manner in which his losses should be liquidated. I thoroughly disagree with the staff recommendations of the Hoover Commission. I am not sure but what I thoroughly disagree with the recommendation of the Hoover Commission that F D I C be transferred to Treasury for that very reason. These are not new questions. These matters were thoroughly discussed in 1933 when we set up the F D I C and when we set it up as an independent agency of Government for that reason, to take any influence by the banks, by those who supervise the banks, out of the operation of the F D I C , and make certain that the regulations under which depositors' deposits were to be insured, would be independent of any other interest. SO far as I am concerned, so long as I am in Congress I w i l l fight to my last breath to keep the F D I C from being transferred to Treasury or Federal Reserve, because I don't think it is any place for it. Senator DOUGLAS. I can understand the objection as applied to the consolidation of F D I C and Federal Reserve, or possibly the question of having the Chairman or Vice Chairman of Federal Reserve on the Board of F D I C , but my questions were addressed to whether there would be difficulty in having F D I C under the supervision of the Treasury, and I didn't see that the people who were being supervised would be hurt. M r . WOLCOTT. The Treasury, as M r . Robertson has suggested, has general authority over the Comptroller's Office, and there is an affiliation of interest between the Treasury and the Comptroller's Office. 1 remember when, just a few short years ago, a transfer was made i n personnel from Treasury to the Comptroller's Office, to bring the Comptroller's office into closer affiliation with the Secretary of the Treasury himself, because the Treasury, under the law, did not have what the Secretary considered sufficient supervision over the banks. So one of his staff was transferred to the Comptroller's office, obviously to bring the Comptroller's office in closer affiliation with the Treasury, and give the Secretary of the Treasury more jurisdiction, i f I may put it that way, over national banks. So to put F D I C i n the Treasury would be no assurance that it would continue to be as independent as the Comptroller's office is now. There is a much closer affiliation there now than there was before. This book, The Romance of Banking, gives a very interesting history. I think we should all read that before coming to any conclusions as to whether to consolidate these agencies. I have in mind also one very bad mistake, in my opinion, which was made when we put the Secretary of State on the Board of the Export-Import Bank, i n one of our weak moments, thereby so affiliating the Export-Import Bank with the dollar diplomacy of the State Department as to make it possible for the State Department to dominate the loan policy of the Export-Import Bank. I have seen just enough of these examples i n government so that I do know that strong men in strong places do wield unusual influences on subordinate agencies. Senator DOUGLAS, Thank you very much, M r . Robertson. M r . ROBERTSON. Thank you, Senator Douglas. (Whereupon, at 4: 30 p. m., a recess was taken until 10 a. m., Thursday, November 17,1949.) MONETAE Y, CEEDIT, AND FISCAL POLICIES THURSDAY, NOVEMBER 17, 1949 CONGRESS OF T H E U N I T E D S T A T E S , SUBCOMMITTEE ON M O N E T A R Y , CREDIT, AND F I S C A L POLICIES, J O I N T C O M M I T T E E ON T H E E C O N O M I C REPORT, Washington, D. C. T h e subcommittee met, pursuant to adjournment, at 10 a. m. i n the caucus room, Senate Office B u i l d i n g , Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senators Douglas (chairman of the subcommittee) and Flanders; Representatives Buchanan and Wolcott. A l s o present: D r . Grover W . Ensley, acting staff director, and D r . Lester V . Chandler, economist to the subcommittee. Senator DOUGLAS. Gentlemen, I think it might be well i f we would get under way. I wonder i f you would come forward, M r . H a r l . I f you would like to have anyone w i t h you either to help you w i t h detailed material or to testify directly we w i l l be very glad, indeed, to have them. STATEMENT OF MAPLE HARL, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION, ACCOMPANIED BY EDISON H. CRAMER, CHIEF, DIVISION OF RESEARCH AND STATISTICS, FDIC M r . HARL. Senator, as you know, the Comptroller of the Currency is the Vice Chairman of our Board. So, i n addition to those members of the B o a r d who spend their entire time at the F D I C , we have had the benefit of the advice, counsel, aid, and assistance of the Comptroller of the Currency i n the preparation of our answers to the questionnaire. T h e three of us have worked very closely w i t h our staff i n the preparation of the text. D r . Cramer and I w i l l be h a p p y to answer such questions as you or other members of the committee want to direct to me. W e have brought along, i n addition to the text, a few charts which we think w i l l be interesting to you, together w i t h a very brief report to the insured banks of the Nation, which has been boiled down and requires only 12 minutes to read. W e know that everybody connected w i t h the committee is tremendously busy and has heavy demands on his time, and therefore we have tried to do a thumbnail sketch of the Corporation, which is the picture as it was on June 30 of this year. Senator DOUGLAS. I n other words, you would like to introduce this report and these charts and files them w i t h the committee ? M r . HARL. Y e s , sir. Senator DOUGLAS. W e w i l l be very glad, indeed, to have them. 105 106 MONETARY, CREDIT, AND FISCAL POLICIES (The report with the charts above referred to, entitled, "June 30, 1949, Report to Insured Banks, Federal Deposit Insurance Corporation," is to be found in the files of the committee.) M r . HARL. The chart on the back of this is most unusual because it shows the amount of disbursements that the Corporation had to make from the period 1934 down through December 31, 1948. That is the period since the Corporation was established. I t is extremely significant, if you look at that chart, to see that in that period of January 1934 to December 31, 1948, the number of banks requiring aid has been reduced from year to year. However, you w i l l notice that the amount of money up to 1940 had increased, from 1934 through 1940. I n other words, it would seem that W o r l d W a r I I , which came on in 1941, together with any inflation attributed to that war, saved the Corporation a great many dollars from the standpoint of disbursement, because certain paper, due to inflationary processes, became collectible, which might have resulted i n a disbursement from the Corporation had not our economy started to enlarge or balloon i n the 1940 period. Senator DOUGLAS. I think it is historically true that very few banks, or comparatively few, f a i l during a period of inflation.. I t is i n a period of falling prices that the strain comes. M r . H A R L . Y e s , sir. Then we would like to present a chart showing the percentage composition of assets of insured commercial banks, December 31, 1934, to June 30,1949; likewise a percentage composition of assets of insured mutual savings banks, which shows the structure of these institutions by years from 1934 to 1949. That is broken down into loans and discounts, other securities, United States Government obligations, and cash reserves, and shows that on June 30,1949, the insured commercial banks of this country had 65 percent of their assets i n cash and reserves or i n Government obligations which could be converted to cash reserves almost instantaneously, and which shows the very fine condition of our insured banks as of June 30. That condition, in our opinion, prevails today. W e thought that your committee would like to have the benefit of these charts, which you w i l l find on pages 38 and 39, of our Report No. 31, showing the assets and liabilities, June 30, 1949, of all operating insured commercial and mutual savings banks. (The report above referred to, entitled "Assets and Liabilities, June 30, 1949, Operating Insured Commercial and Mutual Savings Banks, Report No. 31," is to be found in the committee files.) Senator DOUGLAS. W o u l d you begin your testimony then, M r . H a r l ? M r . HARL. I t is my understanding that the testimony desired here this morning is an amplification of our reply to the questions which were propounded i n the questionnaire by your committee to the Corporation. Senator D O U G L A S . T O which you replied. M r . HARL. W h i c h is set forth on page 207 of the committee print on Monetary, Credit, and Fiscal Policies. Senator DOUGLAS. That is correct. 107 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . HARL. Our answers are found on pages 207 through 215, inclusive. W e have endeavored to make them brief and at the same time make them all-inclusive of the subject of the question. One of these questions in which we are particularly interested is that pertaining to the examination policies of the Federal Reserve System, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. The question is question No. 9, on page 212. I would like to read the question: 9. I n your review of the examinations made by the Federal Reserve and the Comptroller of the Currency, what have you found to be the principal differences, i f any, between the bank-examination policies of the F D I C and those of the F e d e r a l Reserve and the Comptroller of the Currency? Our answer speaks for itself, to the effect that there are no important differences between the bank-examination policies of this Corporation and those of the Federal Reserve or the Comptroller of the Currency. I t reads: T h e existing differences are unimportant and are attributable mainly to the difference i n the functions and the purposes of the three agencies. Complete cooperation exists between a l l three agencies. U n i f o r m i t y of examination policy is gradually being achieved and close liaison now obtains w i t h respect to a uniform approach to connective programs. I would like to amplify our answer to that question by stating that we also work very closely with the National Association of Supervisors of State Banks. A s you know, we have the 48 State bank supervisors plus a supervisor in Alaska, as well as Puerto Rico and Hawaii, making 51. We meet with this group twice a year. I n addition thereto, in the spring meeting, their executive committee comes in here and sits down with our examination staff and we make every effort to coordinate the examination programs. However, I would like to call attention to the fact that we, as an insurance corporation, make our examination as to our hazard, or exposure, as we call it. It consists of loans and discounts which are reflected by the composition previously called to your attention on pages 38 and 39 of our report No. 31. Experience has taught us that the solvency, stability, and safety of the banks, as well as that of the 93,000,000 depositors, is wrapped up in that 28 percent of the assets comprising loans and discounts. I f those loans and discounts are good, then we have no exposure. Therefore we are constantly, i n examinations, looking at the exposure of the Corporation, and the bank's ability to meet its commitments to the depositors. Senator DOUGLAS. A S I understand it, you inspect those State banks which are not members of the Federal Reserve System? M r . HARL. That is true. Senator DOUGLAS. W h i c h are insured with you. M r . HARL. That is right. Senator D O U G L A S . N O W , when you come to inspect the banks, do you time your inspection so that it is at the same time as the State examiner's? M r . HARL. W e work very closely. I n some cases we examine with the State bank commissioner. I n most of the States by State law there is required two examinations per year on behalf of the State bank commissioner. That is mandatory. I n some cases we make one examination per year for the State bank commissioner and he makes the other one. That is on the basis of requests from the State bank 108 MONETARY, CREDIT, AND FISCAL POLICIES commissioner. I f he does not make that request, and we examine a bank by ourselves, the examinations coincide, and we call them joint examinations. I n some cases the bank commissioner and our examiner sign reports together. I n others the report is signed by ourselves. Senator DOUGLAS. A n d when you serve as a State examiner you are deputized by the State authorities ? M r . HARL. That is taken care of by the statutes of those respective States, which provide that in lieu of the State bank commissioner making two examinations per year, he can make one examination himself and accept our examination, in lieu thereof, for his second one. Senator D O U G L A S . According to my figures, of the some 9 , 2 0 0 State banks, about 2,000 of which are members of the Federal Reserve System, you examine about 6,500 State banks, since there are only about 700 noninsured State banks ? M r . HARL. That is right. There were, as of December 31, 1948, a total of 14,753 banks in the country, of which a total of 13,419 were commercial banks insured by us. The balance were uninsured banks and mutual savings banks, some of which are insured, and some of which are not. However, the large mutual savings banks in New Y o r k are insured. Over a third of the mutual savings banks, which have 70 percent of the deposits in mutual savings banks are insured. Senator DOUGLAS. I was speaking primarily of commercial banks. M r . HARL. A l l right. Speaking of commercial banks, you are correct, Senator. I n other words, 6,504 are not members of the Federal Reserve System. Senator DOUGLAS. But members of the Deposit Corporation. M r . HARL. Yes. On that date, December 31, there were 1,924 what we call member banks, which are State banks. Senator D O U G L A S . S O that, of the 13,400 commercial banks in the System, you inspect just a little short of half of the total number. M r . HARL. That is correct, sir. Senator DOUGLAS. But the deposits at those banks, since they tend to be smaller banks, are about 14 percent of the total deposits? M r . HARL. That is correct. A large percent of all deposits are i n Federal Reserve member banks. Senator D O U G L A S . D O you want to say anything else in your direct statement ? M r . HARL. NO, sir. Senator D O U G L A S . A S I understand it, your insurance covers the first $5,000 in each deposit account in an insured bank and the annual premium charge is one-twelfth of 1 percent on all deposits; that premium charge is not merely on the insured deposits, but on all; is that correct ? M r . HARL. That is correct. Senator DOUGLAS. What is the total in the insurance account now ? W h a t reserves do you have ? M r . HARL. W e have brought that, and it can also go into the committee file (June 30,1949, Report to Insured Banks, F D I C ) . • Senator DOUGLAS. $1,138,000,000; is that correct ? M r . HARL. Yes, sir. Y o u w i l l notice the statement of assets on June 30 shows we hold that amount of cash and Government obligations ; and i f you go to the second page, you see the capital account, and the total capital account and reserves comes to $1,134,213,000. Senator DOUGLAS. What is the sum total of the annual premiums which you collect ? 109 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . HARL. That premium varies, Senator. Senator D O U G L A S . H O W has it been running in recent years ? M r . HARL. O n page 21 of our annual report for 1948 you w i l l see a picture of that. O n page 19 you w i l l see the income from year to year since the inception of the Corporation. W e would like to call the attention of everyone to page 21, which shows the ratio of F D I C capital surplus to deposits in insured banks is now 69 percent. Senator D O U G L A S . Y O U mean page 20, don't you ? M r . H A R L . P a g e 21. Senator DOUGLAS. Page 21 is the statement of assets, but page 20 is the statement of income. I was asking about the annual income. Y o u r figures on page 20 show annual income as of the calendar year 1948 as $146,800,000. M r . HARL. That is correct. Senator DOUGLAS. A n d the reserve has been growing at the rate of something not far from $100,000,000 a year. M r . HARL. That is right. W e call attention, on page 21, the last column to the right, i n 1934, when the Corporation began to insure deposits, we had a 0.73-percent ratio of F D I C capital and surplus to deposits of insured banks. That reached an all-high point of 0.83 percent in 1938 and then receded to a low point of 0.59 percent in 1945. I t has now gotten up to 0.69 percent as of December 31,1948. Senator DOUGLAS. I n other words, the ratio of the reserve to the deposits has not increased, though the capital amounts have increased ? M r . HARL. That is correct. Percentagewise we are not i n as good a condition as we were in December, 1938. I n other words, on that date it was 0.83 percent. O n December 31, 1948, it was 0.69 percent. O r a difference of 0.14 percent. Senator DOUGLAS. These ratios which you have given are ratios of the reserve funds to total deposits. What about the ratio of the reserve funds to the insured deposit? Y o u insure only the first $5,000 of each account. Mr. HARL. I n practice, Senator, and we have checked a lot of techniques over the last 15 years, we are now i n the sixth year in which there has not been a failure of a bank from the creditor's standpoint, or the depositor's standpoint, because what we do i n effect is give 100 percent insurance. I f a bank gets involved we immediately restore the losses of that bank and liquidate the remaining assets. Senator DOUGLAS. That was not my question, M r . H a r l . Y o u have the figures of total deposits i n insured banks. B u t I wanted to get the ratio of your reserve to insured deposits, and that involves the question as to what is the total of insured deposits, or, to get at it indirectly, what is the ratio of the insured deposits to the total deposits. M r . HARL. Dr. Cramer might speak on that. Dr. CRAMER. That requires a special study and we have made four such studies, the last one in October 1945. Senator DOUGLAS. Good. Dr. CRAMER. W e are now conducting another study. Senator DOUGLAS. What does your October 1945 figure show ? Dr. CRAMER. I t shows that 46 percent of all deposits were insured. Senator DOUGLAS. Therefore, that 54 percent of the total deposits were i n excess of the first $ 5 , 0 0 0 . Dr. CRAMER. 99076—50 Yes. 8 MONETARY, 110 CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. Therefore, as a rough figure, you should approximately double this ratio, to get the percentage of the reserve upon the insured account, approximately that ? Dr. CRAMER. Yes. Senator DOUGLAS. I n other words, it looks as though it would be around 1.4 percent on the insured deposits, i f this ratio holds. Dr. CRAMER. That is correct. M r . WOLCOTT. M a y we have the percentage of depositors? Senator DOUGLAS. Yes. Dr. CRAMER. The percentage of depositors that are fully insured, and both of these figures include mutual savings banks as well as commercial banks, was, on October 10, 1945, 96.4 percent. I f you would like the commercial bank figures separate, I have those. Senator DOUGLAS. That would be fine. M r . HARL. I n this connection, gentlemen of the committee, we have a questionnaire out in the banks' hands now asking for the total number of accounts they have. W e can then give you, when this comes back, the number of bank accounts in the banks of this country, as No. 1; and, as No. 2, the number of accounts of $5,000 or less, and the number of accounts of $5,000 or over. The figure that Dr. Cramer gave just now, that 96 percent, is the number of accounts insured in f u l l by the Corporation at the present time. Senator DOUGLAS. M a y I ask one question. I noticed that you said that i n most of the cases where the banks fell into trouble that you would resort to a purchasing of assets, mergers, and consolidations, and pay off the depositors in full. Now, the inquiry I should like to raise is this: Is this developing a precedent so that, in practice, i f we should have widespread bank failures the Government would be committed, by precedent, not merely to guaranteeing the first $5,000 of the accounts, but guaranteeing all deposits ? M r . HARL. I don't think so. The question has never been raised. Senator DOUGLAS. But it would be raised i f there were to be widespread failures. A r e you not now establishing a precedent to pay off all of the depositors and accounts in excess of $5,000 ? Suppose that you get widespread failure and you decide merely to assume your legal liability. I think we can be quite certain it would be said, well, why are you changing your policy now, after you have given f u l l protection up to this point ? M r . H A R L . I would like to amplify my answer in considerable detail on that. W e have a very excellent review board, and as fast as the examination reports come over from the Federal Reserve and the Comptroller, or from our field, those reports are studied, the results tabulated, and a chart is maintained on every insured bank in this country. We have the results of those examinations twice a year. W e have set up i n our organization three categories of banks: The banks which we think are sound, the banks which we think are problem cases, and the very serious problem cases. When a bank reaches the serious-problem case we immediately contact, and have had the wholehearted cooperation of the State bank supervisors, the Comptroller, and the examining officials of the Federal Reserve System. W e endeavor to stop the erosion right then and there, and we have been successful in doing it. 111 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Therefore, we think that as a result of this system we w i l l be able to, and are very sanguine that we w i l l be able to, meet this issue as it comes along. Senator D O U G L A S . Y O U have been sailing in very good weather for these last 10 years—that is, good financial weather. There haven't been many storms. B u t suppose we were to have a depression comparable to that of 1929-33. W o u l d you be able to maintain, or do you feel a moral obligation to maintain, 100 percent guaranty, or would you f a l l back on the legal liability ? M r . HARL. I n answer to the Senator's first question, we believe that we can prove, by studies i n conjunction with the Federal Reserve Board, the State supervisors, and the Comptroller, that as the result of F D I C we w i l l never drift into the situation i n which we found ourselves from 1929 to 1933. Senator D O U G L A S . I wish you would develop that. M r . HARL. I n these years we have developed, for example, penicillin, the sulfa drugs, and so forth. W e still have sick people; but what I want to say is that, as compared with physical ills, we believe that we have made great progress in the correction of our economic ills. W e still believe i n the old adage that coming events cast their shadows before. W e are not a bunch of shadow dodgers, but are watching those shadows to see that they do not lengthen in front of us. When we stop to think that the first National Bank A c t was i n 1863, and it was only 70 years old when this thing hit us in 1933, we feel that we have made great strides in the protection of the depositors and in the solvency of the banks, through our review system and our examination system, from 1933 to 1949, more strides than we made i n the 70 years from 1933 back to 1863. I n that respect I am satisfied that we have had the whole-hearted cooperation of the banking fraternity. When we get into these situations, when we see credit policies expanding too rapidly, we have had the wholehearted cooperation of the bankers association. N o more than a year ago all of us, the Comptroller's office, the Federal Reserve, and so forth, felt as i f the credit policies might be expanding too rapidly. The bankers association had a credit conference; they did a splendid job. This chart is our criterion. A s this exposure goes up our exposure becomes greater. A s long as we watch this factor we are not going to get into trouble. I f you notice, back in 1934, 31 percent of the assets of banks were loans and discount, while i n 1949 only 28 percent, and i n that 28 percent was F H A paper, V A paper, R F C participation, and commodity credit loans. Therefore, i f we watch the exposure, and i f all agencies do so, we can never drift into the situation we were in i n 1929. I n that connection, i f you go back to 1929, you had a tremendous percentage in brokers' loans. There was a lot of trading on the 10 percent basis. A s you know, the Federal Reserve last year exercised its prerogatives and is controlling the brokers' loans. Senator D O U G L A S . D O I understand from what you are saying that in your belief depressions w i l l be impossible in the future ? M r . HARL. It is our belief that we can control or meet any issue with which the banks are confronted coming from a depression. Senator DOUGLAS. I n other words, there w i l l be no problem in the future of bank failures ? 112 MONETARY, CREDIT, AND FISCAL POLICIES M r . H A R L . I am not that sanguine. I believe we w i l l have bank failures, but we believe we can control them. Senator D O U G L A S . H O W do you control bank failures? A r e you saying that you think the banks of the country are now completely stable and that we w i l l never have any widespread problem of bank failures in the future? M r . H A R L . I w^ould like to say this: I do not think banks or bankers cause depressions. I don't think that, at any time, we can attribute the last depression to the credit policies of banks or bankers. Senator DOUGLAS. But suppose that a depression breaks out—we won't go into the question of whether the banks cause depressions, but it is certainly true that the banks suffer from depressions, and suppose a depression breaks out and the security of the banks is imperiled. A r e you saying the banks won't f a i l even though the economic condition of the country is deteriorating? M r . H A R L . I do, because the failure of the bank is determined by the note case, and i f the note cases are policed properly, we are i n a sound situation. The thing a bank has to meet its obligations with comes from reserves i n cash or Government securities. A s long as bankers keep their loans and discounts i n line, and as long as the supervisory agencies see that they do, and that they do not unduly expand their credit or take chances, the banks w i l l not suffer from depression, as they w i l l contract as rapidly as the circulation goes down. M r . B U C H A N A N . A S to the question of coverage, the smaller banks, according to newspaper reports, seem to be advocating an increase of coverage from the present figure to a figure of about $10,000 to $25,000, w hereas the larger banks seem to want to continue the present figure. W o u l d you care to express your opinion on that ? M r . HARL. Congressman, there has been considerable agitation by the smaller banks to increase their coverage, for this reason: They say the chain stores, utilities, and so forth are foreign to the town but do business in the town. Their comptrollers watch the accounts. When they get to $5,000, they draw down. Take North Dakota, for example, where you have a certain chainstore operation. W h e n the deposit gets up to $5,000, they w i l l p u l l it down and then redeposit in a metropolitan bank. The comptrollers of these large corporations are constantly calling the metropolitan banks for their statements and analyzing them. T h a t is what we call smart money—wise money. I f you go back to the previous depression, you w i l l find that as a rule smart money, or wise money, got out, because they watched these statements, and they sent what we call a creeper through clearings, and you had creeping runs, because it went through chains. Y o u didn't see a line outside the bank. T h e country bankers feel that i f this is elevated to $10,000, that these large accounts, like the utilities and the chain stores, and so forth, w i l l elevate their sights to where they w i l l carry $10,000 i n that country bank rather than $5,000. So we have considerable agitation from that standpoint. Senator DOUGLAS. Y o u r reply raises a very interesting line O£ thought. W h a t you are saying is that runs are initiated by withdrawals by the large depositors. I believe i n your written reply, on page 208, you pointed out that i n a group of banks studied the average 113 M O N E T A R Y , CREDIT, AND FISCAL POLICIES withdrawal was 40 percent in deposits, but i n accounts of more than $100,000 the withdrawals were TO percent, and then the percentage withdrawals diminished as the size of the account diminished, until when you reached accounts of less than $500, the withdrawals there were only 6 percent. I n other words, your statement now bears out or is i n line with the analysis that you presented that runs are initiated by withdrawals of large accounts. M r . HARL. I was referring to before the inception of the FDIC.. W e state that no bank runs of any consequence have occurred since the F D I C . I f you go back and study what happened in Detroit and in Cleveland prior to the advent of the F D I C , you w i l l find out the large corporate balances were not hurt. Senator D O U G L A S . I didn't understand that. M r . H A R L . I say that these runs, these so-called creeper runs, took place prior to the inception of F D I C . S e n a t o r DOUGLAS. Yes. M r . H A R L . Y O U see, the big difficulty, i f you go back and analyze it, started in the larger banks, primarily i n Cleveland, and then it spread around the lake to Detroit. This is prior to 1933. S e n a t o r DOUGLAS. Yes. M r . HARL. NOW M r . BUCHANAN. W h y wouldn't that happen again ? M r . HARL. The reason why we don't think it w i l l happen again is because the average corporate balance, as I said, saws off at the $5,000 level. M r . BUCHANAN. They are siphoning off funds ? M r . HARL. That is right. That is the reason why the country bankers want the level raised to $10,000, which evidences the confidence that the large corporation has i n the $5,000 level. Y o u remember, prior to the F D I C , you had to have a depository bond for State funds. A l l States now do not require a depository bond until after they hit the $5,000 level. When they do, they require pledges and/or depository bonds to insure their funds above $5,000. F o r example, i n the State of Pennsylvania, the treasurer deposits tax money i n the various banks. I think you w i l l find, Congressman, that he does not require any depository bond or pledge of any assets until the deposit exceeds $5,000. M r . BUCHANAN. Has the Board taken any position about the suggested increase? M r . H A R L . A S yet, Congressman, we have not, because we are making this study. These studies have been made periodically about every 5 years. A s to how many accounts are now in the $10,000 category or less—in 1945, 96 percent and a fraction of the accounts insured were $5,000 or less, and 98 percent were $10,000 or less. So, i f you raise the coverage to $10,000, you would almost insure in full, because our study in 1945 shows 98 percent of the accounts were $10,000 or less, which would leave a fraction of the accounts over $10,000. So, i f you went to $10,000, it is safe to say that you would insure in f u l l 98 percent of the accounts. Senator DOUGLAS. M r . Harl, what puzzles me i n your statement is this: Y o u have said that i n the past runs have been initiated quietly by the withdrawal of large accounts, so-called smart money. Now, it 114 MONETARY, CREDIT, A N D FISCAL POLICIES is these accounts which only get very partial insurance. The account of $100,000 only has a $5,000 insurance. What is to prevent the withdrawal of the large uninsured accounts from the big banks ? M r . HARL. The statement I made was predicated before the advent of F D I C . Senator D O U G L A S . The F D I C only insures the first $5,000. Suppose there is a depression and the large depositors take fright and withdraw, knowing that they are not insured. W h a t is going to maintain the solvency of the bank ? M r . HARL. The large accounts today, Senator, as I explained, i n the country banks, are frightened off. Senator D O U G L A S . Y O U could have runs on the big banks. M r . H A R L . A S I said, the larger corporations are constantly asking for statements of the larger banks, and they are constantly checking on the condition. Senator DOUGLAS. I f you get a depression, and i f the value of Government obligations, for example, which you have treated as being completely solid, suppose those should shrink along with loans and discounts, and the banks find themselves with declining assets, as compared with the deposit liabilities which they have set up through loans, and the big depositors take fright, knowing that they are not insured, and withdraw, what is there to protect the solvency of the bank? M r . H A R L . Y O U have raised a policy question there which is beyond the entire control of the F D I C . Senator DOUGLAS. W e are all groping. M r . HARL. We have labored under the policy that Government securities w i l l be supported at all times. I n 1940 and 1941, when the war came on, I was a State bank commissioner. I was assured by people i n high places that the Government bond market would be supported. I n that connection we went to our banks and asked them to participate i n the war effort by making certain purchases. Naturally, the bankers who were there in 1929 to 1933, in those days, and particularly i n 1920 and 1921, when Liberties dropped to, I think, 85, were reluctant to participate until we, as State bank commissioners, told them that we were told that the bankers of this country would be protected on a stabilized Government market. Senator DOUGLAS. Was that protection a guaranty for an indefinite period of time, world without end, or was it for a stated period ? M r . HARL. There was no statement made as to the length of guaranty or the time involved. W e were told that the Government bond market would be protected. A s you remember very well, i n those early twenties, Liberties went to 85. Therefore, you know, i f you discount 15 percent of your Government holdings i n the banks of the country, it would materially affect their capital structure. Senator DOUGLAS. But suppose the Federal Reserve, for example, should decide either to end the system of support price or to lower the support price. Where would you be then ? M r . H A R L . I think, if that were done, that good faith would have been broken with the banking fraternity which has supported, by large investment, Government bonds. I don't think we could have won the war i f the bankers of the country hadn't gone i n and bought these bonds like they did. I understand that it cost us one-tenth of 1 percent to dispose of our Governments. The bankers rallied and bought 115 M O N E T A R Y , CREDIT, AND FISCAL POLICIES these bonds. I know, frankly, that I would have not recommended to any bank under my supervision at that time that they invest heavily i n Governments unless there was some assurance that they would be protected. A s you notice in the statement, on December 31, 1948, nearly half of the resources of the banks i n this country were i n Governments. That reached an all-time high i n 1945 when we had a total i n insured mutual savings banks of 63 percent, and 56 percent i n commercial banks. I n 1945 the insured commercial banks of this country had 56 percent of their assets in Government securities. I think that the bankers of this country believed, and had a right to believe, that their Government would see that the bond market was supported at par, or they would not, as trustees of these large sums and these large deposits, have invested 56 percent of their assets i n the securities of this Government. Senator DOUGLAS. But this is what puzzles me further, that the move to have the Federal Reserve either discontinue or lower the support price on Government bonds seems to be coming, i n large part, from the bankers, who you say should be protected from such an action. M r . H A R L . I think, frankly, that move is coming from a very few bankers. Senator DOUGLAS. What bankers do you think are initiating it ? M r . H A R L . I would not care to say at this time. Senator DOUGLAS. W i l l you meet me behind one of these pillars after the session is over and whisper in my ear where this movement is coming from ? Y o u may not want to say it publicly, but you should not conceal such a secret privately. Is this a date, that we may meet behind one of the pillars ? M r . HARL. A t your convenience, sir. Senator DOUGLAS. A l l right. Well, without identifying them, have you any surmise as to the motives of these groups, why they should want to lower the support price ? M r . H A R L . I can't conceive of any reason why any banker would want to reduce the support price of Government securities. I frankly cannot see why. Senator DOUGLAS. It would mean an increase i n the interest rate, would it not ? M r . HARL. Then I would say, i f that is the case, it is a profit motive. Senator DOUGLAS. Profit motives are not necessarily bad. The question is whether they work for the benefit of the community or not. M r . HARL. The profit motive is, naturally, a tremendous incentive for anything you do. I n other words, the pocket nerve is the most sensitive nerve the average man has. Senator DOUGLAS. W h a t you are saying is this, i f you can maintain the price of Government bonds at par there w i l l be no great runs on banks, and that even i f we had future depressions, you would not have widespread bank failures, and that therefore the F D I C present policy is competent to deal wTith the situation % M r . H A R L . Y e s , sir. Senator DOUGLAS. There are a lot of "if's" i n that. M r . WOLCOTT. M r . Chairman, I don't think we have i n the record what the Government bonds are pegged at. They are pegged over par now, are they not ? 116 MONETARY, CREDIT, AND FISCAL POLICIES M r . H A R L . Y e s , sir. M r . W O L C O T T . D O you know the exact price ? M r . H A R L . N O , sir. That is a matter over which we have nothing to do. T h a t is a juatter of monetary policy which is regulated by the Treasury and Board of Governors. M r . WOLCOTT. Something over 101. M r . HARL. The Open Market Committee of the Federal Reserve, i n conjunction with the Treasury, handles that matter. M r . WOLCOTT. W h y are these bankers advocating pegging of Governments at less than par ? M r . H A R L . Y O U have among certain bankers, as among other people, advocates of a free-bond market, the same as you have of a free-gold market. I happen to come from Colorado. Out there we constantly hear about a free-gold market. Our people advocate a free-gold market, not because they figure gold is going down, but because they figure gold is going up. It is the profit motive. M r . WOLCOTT. Could we get the figures at which Governments are pegged ? S e n a t o r DOUGLAS. Yes. M r . HARL. That is controlled by the Open Market Committee and the Treasury. Senator DOUGLAS. They reduced it a few months ago. M r . WOLCOTT. I do not know that M r . H a r l w i l l want to put it i n the record, but I think we should have also the average interest rate on Government bonds and the average yield of the banks on Government holdings. M r . HARL. W e would be very glad to get M r . WOLCOTT. I wonder i f we could not have that covering the last 3 or 4 3^ears, to show the increases in years and the interest rates. Senator DOUGLAS. M r . Harl, in view of the fact that runs seem to be initiated by the large depositors, would not a greater degree of security be given to the large depositors and hence less danger of bank runs i f the coverage were increased from $5,000 up either to total coverage or a larger figure? M r . HARL. I would say that since the inception of the Federal Deposit Insurance Corporation, either because of the confidence i n the Corporation's ability to pay or because of psychology, there have been no runs. Senator DOUGLAS. M r . Harl, I would like to go back to the parable in the Bible of the foolish man who built his house upon the sands. The rains descended and the winds blew and beat upon that house and it fell and great was the f a l l thereof; but the house that was founded upon the rock did not fall. Now, the question I am raising—and my mind is open about it—is this: I f bank runs are initiated by the withdrawal of large deposits and i f only the first $5,000 of these deposits are insured, what guaranty is there, i f the country should get into trouble in the future, that we would not have the same process repeated and the banks would crash ? Y o u have had sunshine, but we may be going into a period of storm. M r . HARL. I would say the old adage, " I n time of peace, prepare for war"—we have had from the banking standpoint 10 years of remarkable peace and we have built up not only in the F D I C but the capital structures of the banks have increased from $6,000,000,000 to better than $10,000,000,000. Therefore, your supporting structure all 117 M O N E T A R Y , CREDIT, AND FISCAL POLICIES the way along the line has been materially increased to where I am very confident that the Federal Deposit Insurance Corporation can protect the bank depositors. AT no time do we ever attempt to speak for the banks. Senator D O U G L A S . I do not want to interrupt constantly, but the bigger the house, the bigger the fall. Samson was i n quite a large palace, you know, and he is presumed to have brought it down. M r . H A R L . A S you remember, Samson was a b l i n d man, and I believe the bankers of this country have their eyes wide open to conditions. Senator DOUGLAS. Let's turn from the O l d Testament to the New Testament. I use this rock and sand analogy. The point I am trying to get at is this, and I repeat: I f bank runs are initiated by the withdrawal of large accounts and i f only the first $ 5 , 0 0 0 is insured, what is to prevent this from happening again ? M r . HARL. I n the first place, i n the last 15 years the Federal Deposit Insurance Corporation has eliminated large runs. Senator DOUGLAS. Because there has been no doubt about the solvency of the system, but suppose you do get a serious depression. Y o u have been i n the period of inflation, rising prices, f u l l employment— and we hope, so far as f u l l employment and rising production is concerned, that w i l l continue, although not rising prices—but suppose we were to get into a period of declining production, declining employment, f a l l i n g prices, shrinkage of assets, fear, and panic. Now, would your house stand when only the first $ 5 , 0 0 0 is insured? M r . HARL. Y e s , sir. Senator D O U G L A S . I S this an affirmation or a hope ? M r . HARL. T h i s is based on 14 years of operating procedures. Senator D O U G L A S . I say, with all deference to you, M r . H a r l , I say the experience of 14 years of sunny weather is no guaranty that i n a period of storm you necessarily can stand. M r . HARL. T h e chart here on this last page—I am trying to illustrate by that, Senator, our exposure is entirely i n the bond accounts and the discounts. Therefore, i f the Government bond market is maintained at par, the Federal Deposit Insurance Corporation, i n our opinion, can meet any strain on the banking structure. Senator DOUGLAS. Then your hopes are based upon the continuance by the Federal Reserve B o a r d of the present price-support program for Government bonds ? M r . HARL. M y statement is predicated on what the bankers of this country were led to believe by those i n high authority at the time they made these tremendous investments i n Government securities. Senator DOUGLAS. Suppose the Federal Reserve B o a r d were to take the position that these assurances d i d not bind them i n perpetuity and that while they had followed this policy for a period of years, now it was time to allow "natural forces" to determine the price of bonds. The price of Government bonds, let us say would fall, we do not know how much they would fall. Y o u would not be so certain that the banks could stand up then, would you? M r . H A R L . I f you had $ 5 0 , 0 0 0 , 0 0 0 invested i n Government securities and you were informed or you picked up a rumor that that market might be 90 cents next week, as based on the dollar today, you would immediately start selling. Senator DOUGLAS. Naturally. 118 MONETARY, CREDIT, AND FISCAL POLICIES M r . H A R L . SO the old case of the law of supply and demand goes into gear. Now, whether it is Government bonds or the free gold market, i f you have more gold offered than you have purchasers, you naturally are going to have a sliding market. Theref ore, I think it is most essential that those who are handling our monetary policies and credit policies of this country maintain Government bonds not only from a banker's standpoint but for those individuals who took their savings and put them into Government bonds, and I think they are entitled, just as much as the $5,000 depositor is guaranteed, to have their bonds guaranteed at par. Senator DOUGLAS. A l l I am trying to find out is this: Is not your assumption that your present guaranty w i l l maintain the system based upon a further assumption that the Federal Reserve Board w i l l maintain the support on Government bonds ? M r . HARL. That assumption is correct. I n insurance you always have something that might happen. Senator DOUGLAS. Suppose, however, your assumption concerning the Federal Reserve Board is wrong and that for reasons, whether good or bad, the Federal Reserve Board decides to remove the peg either completely or partially. W o u l d you have as much confidence i n the insurance system taken by itself to maintain the solvency of the banks as you otherwise would ? M r . HARL. I n that case you would have to have dollar for dollar for everything you guaranteed, because i f Government bonds are not worth par you would then have to have—if you guarantee anything, you would have to have almost the equivalent in cash. B y that same token, i f you look at our financial statement, you w i l l note on this assumption that you mentioned there, you w i l l also see what would happen to the Federal Deposit Insurance Corporation, which has roughly $1,000,000,000 invested i n Governments, and I will say the Congress, when they enacted this law, definitely stated we had to invest our money i n Governments. Therefore, it would seem that the Congress at that time felt as i f the most gilt-edged and safest investments i n the country were Government securities. B y the same token, i f you w i l l pull the ping, so to speak, on Governments, you would not only hurt every man and woman who invested in Governments but you would likewise do a great injustice, whoever pulls that plug, to this Corporation, because i f you look at the statement you w i l l see the investments of the Corporation are primarily, and statutorily so, i n Government securities. So, getting back to that assumption, i f this market slides off, it would not only hurt the banks per se but the insurance corporation and every man, woman, and child i n this country, including some large trust funds. Senator DOUGLAS. Here is the point I am trying to get at, and I am afraid I have not done any too well i n the form of the questions I have asked. Y o u have no power over the Federal Reserve Board to determine their policy, but you do have power to make recommendations concerning F D I C policy. Now, since you cannot control Federal Reserve policy, should you not take into account the possibility that the Federal Reserve System may remove the price support or reduce the price support on Government bonds? I n which event, you would be i n trouble. Therefore, to guard against that trouble, might it not be ad 119 M O N E T A R Y , CREDIT, AND FISCAL POLICIES disable to increase the coverage of insurance as a hedge against such a possibility occurring ? M r . HARL. Sir, i f we increase the coverage—and we are not opposed to it, as yet we have not taken a position opposed to increased coverage—but i n the event we increase coverage to $10,000 and the Federal Reserve or the other authorities involved should remove the support of the bond market, the very foundations of what this Corporation is predicated on, entire resources of a billion dollars, would be affected by any such policy. I f we had them insured—if we had the banks insured i n f u l l and the reserve which we are utilizing to pay those was depreciated by some action, manifestly that would curtail our ability to pay because we manifestly would not be i n a position—of course, it would not be policy to carry a billion dollars i n cash; so Congress decreed wisely that we invest i n Governments, which we have done. Now, i f they remove the support, suppose you left the coverage to $10,000 on the one side and remove the support on bonds on the other, you w i l l find this Corporation has a greater liability with less ability to pay. M r . BUCHANAN. W o u l d there be inflationary tendencies i f Congress were to increase the coverage to $10,000. T e l l us what it would do to country banks to increase bank deposits there and the potential availability of bank credit. M r . HARL. Congressman, I do not think that increasing the insurance coverage to $10,000 would be inflationary at all. I think it might cause a shifting of deposits. It would have the effect M r . B U C H A N A N . N O W , a siphoning off of funds, and i f funds remained with country banks, it would be an increase i n remaining bank deposits. M r . HARL. I t w^ould not be an increase in deposits in total, but there would be a shifting of deposits. Mr. BUCHANAN. Which would cause an increase i n bank credit. M r . HARL. The deposit level would be the same. I f you have $142,000,000,000 i n deposits and the corporation or the operator has $5,000 in 50 banks over the country and the rest of it i n a metropolitan institution, the chances are that if you raise the coverage to $10,000, he would not consolidate his overage in a metropolitan bank. M r . BUCHANAN. It would cause a shift? M r . HARL. That is our answer. Y o u would have a shifting of deposits. Y o u raised a question a minute ago, Senator Douglas, about the larger corporation. The larger corporation draws its money off in many cases to the metropolitan bank, because they are insured up to $5,000, but as you well know, coming from Chicago, the directors and the boards of directors of these larger metropolitan banks are made up of those corporation officials from the corporations in the city; so they are on the inside of their own bank. Senator DOUGLAS. What conclusion do you draw from that ? M r . HARL. The conclusion is that you can watch much more closely the money i n your pocket than you can the money in Congressman Wolcott's pocket. Senator DOUGLAS. Does that facilitate withdrawals or impede withdrawals ? M r . HARL. It would depend entirely on how Congressman Wolcott wants to invest your money. 120 MONETARY, CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. Does that impede withdrawals or facilitate withdrawals ? M r . HARL. That is a policy Congress would have to determine. M r . B U C H A N A N . N O W , as to the premium rate, what is your position on the reduction of the premium rate? M r . HARL. W e are endeavoring to analyze one thing, the premium,, as to whether or not the premium should remain as it is if your coverage goes up. Manifestly, i f you increase coverage from $5,000 to $10,000, it would seem by all rules of exposure, that your premium should either stay in status quo or be increased. Therefore, we believe the premium or the so-called assessment is tied very closely to the increase in coverage. A s Dr. Cramer stated a few minutes ago, we have a questionnaire out to all banks asking for the amount of deposits in total and the number of depositors. Likewise, the number of depositors, $5,000 or less, $10,000 or less, and so forth. It would seem from the 1945 questionnaire that i f you go to the $10,000 bracket, you w i l l then insure in f u l l 98 plus percentage of accounts. Senator DOUGLAS. But the question is, W h a t percentage of deposits w i l l you insure % The present insurance, which covered 96 percent of the accounts, only insured 46 percent of the deposits. M r . HARL. That w i l l also be determined by the questionnaire. Senator DOUGLAS. M r . Harl, I was interested i n your statement that the Corporation took no stand on increase in coverage, which you have made verbally, and then I turned back to page 209, i n which you made a statement on this, in which you said, and I quote: Therefore, we are of the view that the Corporation, under the present insurance coverage, is making a maximum contribution to f u r t h e r i n g the purposes of the Employment A c t and i n this respect there w o u l d be no benefit to be gained i n changing the coverage of deposit insurance. Now, these two statements of yours seem to be i n conflict. I am not interested in indicating conflict or putting you on the spot, but I am i n some doubt as to which represents your point of view. M r . H A R L . A S I said before, the matter is being predicated on the results of this last questionnaire. The answers here were predicated on the questionnaire that was gotten out i n 1945. Senator DOUGLAS. Then do I understand that the Corporation is open-minded ? M r . H A R L . I t is. Senator DOUGLAS. O n this question of whether we should raise the coverage of the $5,000 limit ? M r . H A R L . Y e s , sir. Senator D O U G L A S . Y O U are not opposed to it ? M r . H A R L . N O , sir. W e are open-minded all the way through. W e are working with this questionnaire. The savings banks of this country as well as commercial banks have an F D I C committee, and they are working with us, and anything that we come to you gentlemen with or anything that you gentlemen come to us with after this questionnaire comes in, we can discuss more intelligently than we can today, because our answers here are predicated on the last study we made. 121 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES M r . WOLCOTT. I wonder i f your 1945 study shows what percentage of the deposits would be insured had you insured the first $10,000 intoto? M r . CRAMER. F i f t y percent approximately. M r . WOLCOTT. About 4 percent more than shows under the $5,000 insurance ? M r . CRAMER. I was speaking of the commercial banks only. Senator DOUGLAS. Then, i n other words, the deposits over $10,000, which form most of the residue of deposits over $ 5 , 0 0 0 — — M r . WOLCOTT. Over $10,000. H e said i f $10,000 were covered. Senator DOUGLAS. Fifty-four percent are over $5,000 and 50 percent over $10,000; so that the overwhelming proportion is in the group above $10,000. M r . HARL. W e have some cities out West where you have some small country banks. They in turn deposit, we w i l l say, i n Grand Junction, Colo.; Grand Junction deposits i n Denver; Denver deposits i n Chicago ; Chicago deposits i n New York. Senator DOUGLAS. I f you eliminate the interbank deposits and dealt only with the deposits of individuals and corporations M r . HARL. That is what we are going to do. W e w i l l take entire bank deposits, and after you do that, it boils down to: What are the real honest-to-goodness deposits in this country ? Senator DOUGLAS. D i d these 1945 figures include interbank deposits or were they deposits of individuals and corporations ? Mr. HARL. W e used the entire amount of deposits at that time. W e are going to eliminate -that and get right down to what are deposits without interbank deposits. Senator DOUGLAS. That would show, of course, a much higher percentage in the $5,000 to $10,000 limit of total primary deposits. M r . HARL. That is right. I t w i l l show that 98 percent of your depositors on the basis of $10,000, that 98 percent of your depositors are insured i n full, and those 2 percent which are not fully insured come in this category of interbank deposits as well as corporate deposits. Senator DOUGLAS. A r e you open-minded on the question of increasing the coverage for the savings and loan associations as well as the commercial banks ? M r . HARL. We have not made a study of it, but the savings and loan associations do not come under our supervision. Senator DOUGLAS. But the Administrator of the Housing and Home Finance Agency, as I understand it, has recommended an increase of coverage to $10,000 i n that type of institution, and I wonder i f you have given any thought to that. M r . H A R L . A S you know, the mutual savings banks have a ceiling on the amount of deposits they w i l l accept. I n New Y o r k their ceiling is $7,500. Therefore, we are interested i n going along with what the mutual savings banks recommend. Senator DOUGLAS. What do you mean by "ceiling" ? M r . HARL. They do not take accounts larger than that on which they pay interest and the mutual savings banks are very much interested in $7,500 accounts, because as you know, we have some tremendously large mutual savings banks. They feel there should be a ceiling of $7,500 on the coverage. That gives them 100-percent protection. 122 MONETARY, CREDIT, AND FISCAL POLICIES M r . BUCHANAN. Suppose the $10,000 figure were suggested for savings and loan, what would be your position? W o u l d you approve or take the position against it ? M r . HARL. W e would not w^ant the savings and loan associations to have any greater advantage than the savings banks, because, as you know, when you put your money in the savings and loan association, you get a share or ownership interest. When you put your money i n a bank, you have a debtor-creditor relationship. There is quite a difference there. Senator DOUGLAS. M r . H a r l , i n your written statement, on pages 212 and 213, you opposed the Hoover Commission proposal that F D I C be placed under the supervision of the Treasury Department on the ground that it was a mutual insurance fund and that it should be independent of the Treasury or any other agency or department. Now, as you know, the Comptroller of the Currency is also under the Treasury, but the deputy comptroller testified yesterday that the Treasury had never attempted to control its policies or to go into the matter as to whether or not a given bank was solvent. I think it is on record that the examiners for the Comptroller of the Currency are about as incorruptible as any set of men i n the country. Now, are you afraid that the integrity of your examinations would be impaired i f you also went into the Treasury, maintaining the same degree of independence in the examinations that the comptroller's staff maintains ? M r . H A R L . T O begin with, we choose to stand on our replies here on the pages you mentioned. No. 2, we have never impugned the integrity of any examiner, be he comptroller, Federal Reserve, and/or State supervisor. Senator DOUGLAS. Well, you are much more charitable than I am on that point, because I have had enough experience with State banks to know that supervision in the case of State banks is not always of an extremely high level; not always. M r . H A R L . A S a matter of judgment, we think, and not integrity. Senator DOUGLAS. Well, the national bank examiners certainly have a very high reputation for integrity and competence. W e may disagree with them as to whether a sound banking system is made up solely of sound individual banks or whether sound individual banks are not also affected by the system as a whole. W e may disagree with them on that point of policy, but no one, I think, can question their technical competence or integrity, and I wondered i n view of that fact, just why you did not want to be put in a status comparable to them under the Treasury? M r . HARL. The comptroller charters national banks, as you well know. S e n a t o r DOUGLAS. Yes. M r . HARL. Then you open up the whole matter of States' rights, because you would have the control of Federal chartering policies vested i n the same group that does insuring. A s you know, we approach each and every insurance situation on its own merits. The commissioner of New Y o r k charters a bank, and then i f the bank desires and wants insurance, it is entirely voluntary. The bank can apply for insurance and we make the examination, and i f we find a bank meets our standards, it is insured. 123 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I would like to say i n that respect that of the 12 largest banks i n New Y o r k City, and they are large, nine of them are State-chartered banks. Senator DOUGLAS. Does your reply boil down to this: That you think i f F D I C went into the Treasury, that the independence of the State banking systems might be endangered ? M r . HARL. I think you w i l l find the 48 State banking commissioners likewise share that view. Senator DOUGLAS. Then it is your view ? M r . HARL. I t is my view that the Federal chartering authority and the insuring authority should not vest i n the same group. Senator DOUGLAS. What I am trying to get at is this: D o you think i f F D I C went into the Treasury that that might be the camel's nose under the tent, i f I may use weighted language, the camel's nose under the tent to extend added Federal control over the State banks ? M r . HARL. I would think that would be a pencil i n the dike. Senator DOUGLAS. I f we may get away from these figures of speech, I take it that is what you do think, that it would be a possible prelude to added Federal control over State banks. M r . H A R L . I do, sir. Senator DOUGLAS. We finally get that point established. W h y do you feel that? M r . H A R L . A S I said before, our answers' are given here on this questionnaire. That is No. 1. No. 2 Senator DOUGLAS. Well, I read your reply last night and I may have been somewhat tired. I gathered that you were opposed to it, but I did not quite gather why you were opposed to it, and I am a little bit fresher this morning and probably could understand these reasons better if you were to repeat them. M r . HARL. I can say it in a very few words. W e do not believe that the Federal chartering authority should vest with the insuring group or vice versa, We do not believe the insuring group should have the power to charter. We believe the two should be separate and apart. Senator D O U G L A S . I do not think the Hoover Commission proposed that you be given the power to charter State banks. A r e you afraid that you would have the State system wiped out i f F D I C came i n the Treasury and that you would become the chartering agency or Comptroller of the Currency ? M r . HARL. We feel if the Federal chartering authority were the insuring authority, that it would be a step toward eliminating the dual system of banking. Senator DOUGLAS. I do not see that the chartering authority would be involved at all. M r . HARL. It is very much involved, sir. Senator D O U G L A S . I do not see how it would be involved at all in your transfer to the Treasury. Chartering authority would still, i n the absence of other legislation, remain in the hands of the States. M r . HARL. The chartering authority for a State bank would still remain in the hands of the State, but the chartering authority for the national banks Senator DOUGLAS. That is already there. ^ M r . HARL. It is, but the F D I C is not there. Suppose you place the Federal Deposit Insurance Corporation under the same authority and 124 MONETARY, CREDIT, AND FISCAL POLICIES the same policy operating group that does the chartering of national banks you would find that you would have a conflict immediately. Senator D O U G L A S . N O W , you are speaking not of State banks, but of national banks. M r . HARL. That is right. Senator DOUGLAS. A n d you want to have one agency to charter and another agency to insure? M r . HARL. That is right. Senator DOUGLAS. W h y do you want that, aside from the well-known American desire for checks and balances and distributing authority all o\er the lot, so that A watches B and then i f anything goes wrong can say that it is B's fault? M r . H A R L . Y O U have in this system Senator D O U G L A S . Y O U see, we in Congress would like to get away from this "Button, button, who's got the button" game and be able to find who is responsible, because whenever we want to put someone on the mat—that is a polite term—and find out who is responsible, the responsibility is always shifted to someone else. So that frequently Congressmen feel that they are being exposed to an administrative shell game in which the pea is always underneath another shell, and the civil servants face one with a frozen face saying it is someone else's responsibility; and, as a result, we feel frustrated and that at times may account for the impolite behavior of Senators and Congressmen toward administrative officials. M r . WOLCOTT. A n d also toward each other. Senator DOUGLAS. Sometimes the frustration laps over. M r . HARL. Neither the Comptroller of the Currency, the Governors of the Federal Reserve Board, or the "directors of the Federal Deposit Insurance Corporation are under civil service and, therefore, they are subject to removal. Senator D O U G L A S . I am sorry, who is under civil service ? M r . HARL. None of the bank supervisory authorities. Senator DOUGLAS. That is, none of the officials of the Comptroller of the Currency? M r . HARL. The Comptroller of the Currency is not, the Board of Governors of the Federal Reserve System are not, and the directors of the Federal Deposit Insurance Corporation are not. Senator DOUGLAS. A r e your employees under civil service ? M r . HARL. W e are by Executive order. Senator DOUGLAS. W e l l ? M r . HARL. But the policy end of it, the staff naturally follow policy as laid down by the Comptroller or by the Board of Governors of the Federal Reserve or by the F D I C directors, and they are all Senator DOUGLAS. A r e you saying that the purity of your employees would be contaminated by their being brought into the Treasury because the bank examiners are not under civil service ? M r . H A R L . I am not implying any such thing, but you made the statement, i f the record is correct, that the Congress is sometimes frustrated by the acts of civil servants and also by acts of the bank supervisory authorities. Senator DOUGLAS. Not bank supervisory authorities—civil-service employees i n general. It is a matter of genus rather than species. 125 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . H A R L . I would like to get down to the three or four bank supervisory agencies, and we did not know that we had ever frustrated the acts of Congress. Senator D O U G L A S . I did not say you had frustrated the acts of Congress. I say civil servants frustrate Congressmen. I sometimes think the first is true also. M r . W O L C O T T . M a y I suggest, Senator, that after you have been here 10 or 12 years you do not get frustrated about anything. Y o u get the rough edges worn off, and you take a good many things for granted. Senator D O U G L A S . That may be the trouble. M r . W O L C O T T . Y O U build up an immunity to frustration. Senator D O U G L A S . That may be the trouble. I think a healthy frustration is very good, but the objects of frustration should be removed. New ones w i l l develop. Go ahead. M r . H A R L . Sitting on your left and sitting on your right are two Members of the Congress, and I believe they w i l l testify that so far as the Federal Deposit Insurance Corporation is concerned, we have endeavored at all times to work just as closely as possible with the Congress and with their respective committees. Is that not true ? M r . B U C H A N A N . It is true, M r . H a r l . M r . W O L C O T T . I concur. Senator D O U G L A S . I am sorry, M r . Harl, my attention was diverted. M r . H A R L . I just asked the two members of the committee i f we have not at all times as members of the Corporation and as individuals endeavored to work closely with them on matters of policy as well as procedure. M r . B U C H A N A N . M y affirmative "yes" was emphatic. I do not know whether M r . Wolcott's was as emphatic as mine. M r . W O L C O T T . I confirmed it without going into conference about it. Senator D O U G L A S . Y o u r virtue has been affirmed by my two colleagues, W e are not trying to put anyone on the spot, but we are trying to work our way through a maze of Government departments and policies, and so forth, and try to integrate them, which is presumably the function of the legislative body. I take it from your replies that you do not want to go into the Treasury, but as I say, I also take it that your reason for it is very similar to the little poem by Henry Wadsworth Longfellow, which he wrote as a young man: I do The But I do not l i k e you, D r . F e l l reason w h y I cannot t e l l this I k n o w a n d k n o w f u l l w e l l not l i k e you, D r . F e l l . I n other words, you do not want to go into the Treasury. M r . H A R L . M a y I ask you: Have you asked the Treasury whether they would like to have us or not ? Senator D O U G L A S . N O ; they are going to come later, but we are exploring the possibilities of marriage between you two gentlemen. M r . H A R L . I believe marriage is a contract which requires the assent of both contracting parties. Senator D O U G L A S . Not necessarily, not in this case, because it so happens that the legislature is still supreme in theory in this country, and we can compel, i f we should choose to do so, the combination, even though the two parties did not choose. 126 MONETARY, CREDIT, AND FISCAL POLICIES M r . HARL. A shotgun wedding? Senator DOUGLAS. W e sometimes perform shotgun weddings. Now, I take it that you are a very strong believer i n the dual banking system. That is, the system of State banks i n addition to the system of national banks. M r . H A R L . I am a strong believer and a supporter of the dual system of banking. Senator DOUGLAS. T h a t is really 49 systems of banking, is that not right, because you have 48 States and the Federal Government, and rules among the States are not uniform. M r . HARL. W e might expand it and call it 51, then. Senator DOUGLAS. Yes. W h y do you believe i n that ? M r . H A R L . T would say that as compared w i t h other countries, it has been successful; I think the greater number of banking systems that you have i n the country, the greater protection you have from nationalization or centralization of banking and credit and, after all, that credit is the lifeblood of this country. Senator D O U G L A S . I would as a follower of Andrew Jackson—I would agree it would be very dangerous to have the lending facilities of the country concentrated, but you could still have the lending facilities diffused but all the banks members of one system. L e t me ask you a question about the percentage of failures under the State banking systems and the percentage of failures of national banks. Have you ever collected figures on that point ? M r . HARL. W e have, but I think it would be more important not to deal i n percentages. I think it would be more important to deal i n dollar volume. Senator D O U G L A S . N O ; because the State banks are the small banks, so that i f you dealt i n dollar volume, you would not have a picture of the comparative risk of failure of the two systems. Now, has anyone ever collected figures on the relative percentage of failures among State banks as compared with National banks ? M r . HARL. W e would be very glad to get them, but I still go back to say Senator DOUGLAS. Say the last 20 years. Go back to 1929 i n order to include the stormy years as well. M y own impression, subject to check and correction, is that the percentage of failures of the State banks is very appreciably in excess of the percentage of failures among national banks and that the percentage of deposits i n State banks which are lost through failure is much greater than the percentage i n nationals. That is a simple fact, and I presume it is available. M r . HARL, I t is available. M r . WOLCOTT. M a y I make an observation, what I consider an interesting observation along that line: T h a t i n Michigan at the time of the bank closings, there were twenty-some-odd private banks being liquidated as the owners of them died and were being dissolved otherwise. The private banks are under no supervision at all. They are strictly on a local basis, dependent entirely upon the integrity of the manager of the bank and his judgment. A very strange thing happened i n Michigan. W h e n all the other banks throughout the United States closed, these private banks were the only ones who remained open, and I think the 127 M O N E T A R Y , CREDIT, AND FISCAL POLICIES record w i l l show that there has not been a dollar lost i n any of these little private banks for over 20, 25, or perhaps 30 years. Senator D O U G L A S . I was not speaking of the private banks, which are not subject even to State inspection and examination, but I was speaking of the State banks which are subject to State rules, not national rules, and those State rules are generally much less, or, rather, the rules for State banks not members of the Federal Reserve System are much less stringent. M r WOLCOTT. T h e point I wanted to make was that the solvency or liquidity or soundness of the bank does not always depend upon the quality of the examination. I t depends largely upon the efficiency and integrity of the management. Senator DOUGLAS. W e l l , I would agree that it does not always depend upon that, but I would say that the rules concerning assets are certainly one factor i n determining the solvency of banks. Here is a statistical fact that can be settled one way or the other. I would like to have M r . Chandler, who is adviser t© our subcommittee, prepare material on this point and have it checked by the Comptroller of the Currency and by your office. M r . WOLCOTT. W o u l d you want to bunch all nonmember banks into one package, or would you want to break it down by States, because State laws vary tremendously ? Senator DOUGLAS. W e could have subdivisions to indicate the States which have been lax, but I think it would be very interesting to get figures on national banks, on State banks which are members of the Federal Reserve System, and on State banks which are not members of the Federal Reserve System. D o you have those, D r . Cramer ? M r . CRAMER. I thought you might be interested i n these figures. W e have through December 31, 1948, 15 years' experience. W e have aided 407 banks, a total of 407 banks. Senator DOUGLAS. F a i l e d ? M r . CRAMER. W e can very easily supply you w i t h those, showing how many of those were national banks and how many Senator DOUGLAS. A n d the deposits ? M r . CRAMER. A n d b y years. Senator DOUGLAS. A n d the percentage of those deposits of the total deposits of the category of banks i n question. I n addition to that experience, I would also like to get the experience of 1929 to 1933, which is the real period of storm and stress. (The information referred to above, furnished by the F D I C , is as follows:) I n the f o l l o w i n g table the data since the beginning of deposit insurance are shown not oaly for the entire 16 years but also for the first and second 8-year periods. D u r i n g the first of these periods, the suspended insured banks were largely banks w h i c h were reopened after the banking holiday i n the expectation that they w o u l d recover successfully, but proved unable to do so. I t should be noted that during the past 8 years there has not been, as was the case formerly, a significant difference between the failure rates of the various classes of banks. W e believe this is attributable to the great improvement w h i c h has been brought about i n the examination and supervision of State banks. Since M a y 1944 no insured bank has been placed i n receivership; a l l insured banks i n such financial difficulty that closing was necessary have been merged w i t h the assistance of the Federal Deposit Insurance Corporation. 128 Number MONETARY, and deposits CREDIT, AND FISCAL of suspended commercial since 1865 banks Commercial banks Number of suspended banks: Total National banks Other members Federal Reserve System Not members Federal Reserve System. Deposits of suspended banks (millions of dollars): Total National banks Other members Federal Reserve System.-. _ Not members Federal Reserve System. Average annual number of suspensions per 100 operating banks: Total National banks Other members Federal Reserve System Not members Federal Reserve SystemAverage annual deposits of suspended banks per $100 of deposits in operating banks: Total National banks __ Other members Federal Reserve System. . Not members Federal Reserve System. POLICIES for selected periods Insured commercial banks i 1865-1920 (56 years) 1921-33 (13 years) 1934-49 (16 years) 3,767 733 2 14,807 2,713 410 70 369 51 41 19 592 11, 502 22 318 18 300 4 18 8,453 2,798 527 105 464 70 63 36 1,464 4,192 188 234 176 218 11 16 4.37 2.74 0.19 .08 0. 33 .12 0.04 .05 3. 49 5.16 .09 .29 .20 .51 .03 .03 $1. 52 1.10 $0.04 .01 $0.12 .03 .05 .14 .14 .45 () 3,034 1,180 324 2 () 865 (3) 0.32 (3) $0.25 .14 .35 .95 2.86 1934-41 (8 years) 1942-49 (8 years) $0.01 .01 .004 .01 1 To Nov. 15,1949. Includes banks merged with thefinancialassistance of the Federal Deposit Insurance Corporation. 2 For 1914-20 included with banks not members Federal Reserve System. 3 Not available. Deposit data for operating State and private banks during a substantial part of the period, 1865-1920, were derived from tax records. Comparable information on the number of those banks is not available. Senator D O U G L A S . N O W , i f it were to be shown M r . W O L C O T T . Be careful about that, because I am not so sure but what during that period there were many more Federal banks went under than State banks. Senator D O U G L A S . I do not have an idee fixe on this. I f it should develop there were more Federal failures than State failures during that period, I want to find it out. I am not starting out with the assumption M r . W O L C O T T . I assumed you wanted a little more concentration of power on the part of the Federal Government over banking. Senator D O U G L A S . I am an inquirer after truth rather than one who seeks to impose a policy. I am sure you w i l l give me credit for that. M r . W O L C O T T . I have up to the present time. Y o u have not done anything yet to cause me to change my mind in that respect. Senator D O U G L A S . I am delighted that thus far I h&ve not lost prestige with you. I should feel badly i f that were to occur. M r . B U C H A N A N . O n the question of bank reserves, M r . McCabe i n his statement from the Federal Reserve Board proposed legal reserves—proposed on page 61 here in his statement that the legal-reserve requirements of commercial banks should rot depend on whether or not the banks were members or nonmembers of the Federal Reserve. I n short, the Federal Government should prescribe reserve requirements for all banks. Now, since you are an advocate of the dual system of banking, how do you feel about raising the reserve requirements of State banks ? 129 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . HARL. W e are very much i n favor of raising the reserves of State banks, but I think you w i l l find, i f you take all the deposits and add them up, you w i l l find that better than 75 percent of the State bank supervisors have reserve requirements equal to or better than the Federal Reserve requirements. F o r example, i n the State of Colorado any bank which is a depository bank has to carry at all times and has had to carry since 1927 at least 25 percent reserves. I n other words, to rephrase this answer, Congressman, I would say that the State laws and/or the regulations promulgated by the State bank commissioners in those States having at least 75 percent of the total bank deposits, their reserve requirements are equal to or greater than those presently required by the Federal Reserve System. M r . BUCHANAN. I was under the impression that Federal Reserve requirements ran on the rough of about 15 to 22 percent; whereas the average of the State bank reserves was around 10 to 12 percent. M r . HARL. I f you go back into the situation in the States of New York, New Jersey, Connecticut, and a great many other States, the bank commissioner by promulgation has always insisted that the reserves of his banks run coincident with or coincide with the requirements of the Federal Reserve, and in other States it is fixed by statute. M r . BUCHANAN. I n how many cases ? M r . H A R L . I would not know the number of cases. M r . BUCHANAN. I was thinking in terms of State statutes rather than administrative regulation of the State banking commissioner. M r . H A R L . I think we can get the answer to your question in probably 1 hour. M r . B U C H A N A N . I would like to see it in the record. M r . HARL. W e w i l l get the answer and have it i n for the record. M r . B U C H A N A N . I wish you would. (The information referred to above is as follows:) Reserve requirements of State commercial banks and trust companies, deposits (demand and time), Dec. 31,19481 by kind of [Percent of deposits specified] Uniform reserve requirements on all deposits 2 State Alabama Arizona Arkansas California Colorado Connecticut Delaware _ __ _ District of Columbia Florida _ _ Georgia Idaho Illinois 4 Indiana Iowa Kansas,. Kentucky Louisiana Maine. Maryland Massachusetts Michigan Minnesota See footnotes at end of table, p. 130. 12, 15, 18---. 15, 25 20 15 . ___ 12 Demand deposits 2 15 15, 20 - 15, 20, 50 . Different reserve requirements on— _ Time deposits 2 4. 10.3 5.3 16 16 22 0.3 m. 7H. 15 5. 123,4 7, 10 121$, 20,25— 7, 10 20 14 16 15,20 .. 3. 3. 5, 10. 3. 0. 6. 6. 0.3 12, 15 5. 130 MONETARY, CREDIT, A N D F I S C A L POLICIES Reserve requirements of State commercial banks and trust companies, by kinds of deposits (demand and time), Dec. SI, 19481—Continued Uniform reserve requirements on all deposits 2 State Mississippi Missouri ___ Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York _ . North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas _ __ - _ Utah Vermont5 Virginia Washington West Virginia Wisconsin Wyoming 10, 15 __ 15, 25 _ . _ __ 12 __ ___ __ _ 17H ... __ ___ __ _ 15 _ 12, 20 Different reserve requirements on— Demand deposits 2 15, 25 15, 18 . . Time deposits 2 7, 10. 3. 15,20 5.3 15 . 15 5. 3. 14, 20, 26-.-- 7H. 15 5. 10 5, 10. 15 10. 15, 18 5. 15 5, 10. 14 6. 15 0.3 7 3. 10 _ 15, 20 15, 20 20 10 3. 5. 5.3 6. 3. 10 5. 20 10.3 1 In most cases these are the rates prescribed in the State law itself. Where the law empowers banking authorities to change reserve requirements, the rates actually in effect on Dec. 31,1948, were ascertained by correspondence or otherwise. 2 Where two or three percentages are shown, the second and third apply to banks designated or approved as reserve depositaries, or to banks in central reserve or in reserve cities, specified cities, cities with specified population, etc., as follows: Arizona: The 20 percent requirement applies to banks in places with population of 50,000 or more. Arkansas: The 20 percent requirement applies to banks designated as reserve agents; 50 percent to banks in places with less than 1,500 population with capital of $10,000 or more but less than $25,000. California: The 18 percent requirement applies to banks in places with population of 100,000 or more; 15 percent to banks in places with population of 50,000 to 100,000. Colorado: The 25-percent requirement applies to banks designated as Reserve banks. Iowa: The higher requirement applies to banks in Reserve cities (designated as such under the Federal Reserve Act). Kansas: The 20-percent requirement applies to demand deposits due to banks in State banks. For all trust companies, the reserve requirements are 25 percent of demand and 10 percent of time deposits, but there are only 4 trust companies (with little or no deposits) in the State. Kentucky: 13 percent of demand deposits for central Reserve city banks, but there never has been a central Reserve city in the State. Massachusetts: The 20-percent requirement applies only to trust companies acting as Reserve agents. Minnesota: The higher requirement applies to banks in Reserve cities (designated as such under the Federal Reserve Act). Mississippi: The 25-percent requirements against demand deposits and 10 percent against time deposits apply to banks in places with population over 50,000. Missouri: The 18-percent requirement applies to banks in places with population of 200,000 or more. Nebraska: The 20-percent requirement applies to banks in places with population of 25,000 or more. Nevada: An additional reserve of 10 percent is required against reserve deposits due to other banks, but no State bank reported any such deposits on Dec. 31, 1948. New York: The 26-percent requirement applied on Dec. 31,1948, to banks in the Borough of Manhattan: 20-percent requirement applied to banks in the Boroughs of Brooklyn and Bronx, in New York City, and Buffalo. North Dakota: The 10-percent requirements in the time deposits column applies to secured savings deposits. Oklahoma: The 18-percent requirement applies to approved depositaries. Oregon: The 10-percent requirement applies to time deposits in noninsured banks, but thre was only one such bank in December 1948 and it had no deposits. Texas: The 20-percent requirement applies to banks with capital stock less than $25,000. Utah: The 20-percent requirement applies to banks in places with population of 50,000 or more. Wisconsin: The 20-percent requirement applies to banks designated as reserve banks. 3 The reserve requirements shown in the time deposits column for Arizona, California, Connecticut, Massachusetts, Nebraska, Rhode Island, Utah, and Wyoming apply only to deposits in the asvings departments of commercial banks and trust companies. Other time deposits are subject to higher requirements, but inspection of State banking department annual reports discloses that such deposits in California, Connecticut, Massachusetts, and Rhode Island are relatively small in comparison with deposits in savings departments; the same thing probably is true in the other States, to the extent they have separately operated savings departments in commercial banks. 4 No statutory reserve requirements. 5 The 20-percent requirement against demand and 6 percent against time deposits became effective Feb. 15,1949. 131 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . BUCHANAN. B y statute, by banking commissioner regulations, administrative regulations, as compared to here where we have the Federal Reserve figures. Senator DOUGLAS. M r . H a r l , I was called to the telephone for a minute, and I did not gather whether you favored M r . McCabe's proposal of minimum reserve requirements for all banks, including those not members of the Reserve System. M r . HARL. W e are very strong for reserves. A s I told Congressman Buchanan, I think a survey w i l l show that requirements, either administrative or statutory, of all States, at least covering 75 percent or more of the deposits, that they are equal to or greater than the present requirements of the Federal Reserve. Senator DOUGLAS. The reserve requirements under the Federal Reserve city banks are now 18 percent; is that correct? M r . BUCHANAN. It runs from 24 Senator DOUGLAS. Reserve city banks ? M r . BUCHANAN. Twenty, and country banks 14. Senator DOUGLAS. Well, in connection with another matter, I have had the reserve requirements in a number of States studied; and, with the exception of Louisiana, District of Columbia, Vermont, and Wyoming, I found no State which had reserve requirements in excess of 15 percent. M r . BUCHANAN. B y statute ? Senator DOUGLAS. B y statute, which would be 1 percent higher, it is true, than country banks, but 5 percent lower than Reserve city banks, and Reserve city banks cover quite a wide range. I n a number of cases the reserve requirements were below this. I n Iowa, 7 percent; Kentucky, 7 percent; Montana, 10 percent; California, 12 percent; North Dakota, 10 percent; New Mexico, 12 percent; South Carolina, 7 percent, Tennessee, 10 percent; Virginia, 10 percent; West Virginia, 10 percent; Wisconsin, 12 percent; and, further, that this composition of the reserve under the State laws for the major part could not only be cash but balances with depository banks. So there seems to be quite an area, at least, i n which the reserve requirements of State banks not members of the System are very appreciably below the requirements of banks which are members of the System. Now, that gives to the nonmember banks greater earning power for any given amount of reserves; they can extend more credit upon a given amount of reserves; and their multiplier is greater, and one can understand why bankers would favor that; but there is always the question (a) as to whether it is adequate for safety and (5) whether it does not exercise an inhibitory influence upon attempts to check inflation through alteration of the reserve requirements. Those are the problems of public policy which we have. I wonder i f you would be w i l l i n g to comment on that. M r . H A R L . I believe the Senator earlier i n the conference made the statement that 84, between 84 Senator DOUGLAS. Eighty-five percent. M r . HARL. Eighty-five percent were Federal Reserve members. Senator DOUGLAS. Eighty-five percent of the deposits were i n banks which were Federal Reserve members, M r . HARL. That means 85 percent of deposits are affected by those reserve requirements, does it not ? 132 MONETARY, S e n a t o r DOUGLAS. CREDIT, AND FISCAL POLICIES Yes. M r . HARL. T h e n we are talking about 15 percent of the aggregate. Senator DOUGLAS. Yes; but it is also true that since the State banks, 2,000 of which are members of the Federal Reserve System, and which have roughly 35 percent, roughly 35 percent of the deposits, have the right of withdrawal from the Federal Reserve System at any time, and the B o a r d is always faced w i t h the possibility that i f they raise the reserve requirements and thus reduce the earning capacity of the banks, that the State banks w i l l exercise their option and w i l l get out of the System M r . HARL. H a s that ever happened ? Senator D O U G L A S . I S that proof that it does not operate upon the minds of the members of the Board ? M r . H A R L . I naturally do not know what is i n the back of their minds, because that Board changes, you know, quite rapidly. There have been three or four people appointed there since I have been here in a very brief time, and therefore the policy would change as they go along; but I think we have to operate on the basis of antecedent practices and what has happened i n the past. A s you know, the reserves of the banks i n the Federal Reserve System have varied over the years, and I think that you w i l l find there is a constant upstreaming, I think you w i l l find banks containi n g a greater amount of deposits now i n the Reserve System than before. A s you said correctly a few minutes ago, 85 percent of the deposits were i n the Federal Reserve System. Based on $147,000,000,000 i n assets, you would see that that leaves about $20,000,000,000 not i n the Federal Reserve System. However, you w i l l find i n those States that it is safe to say that better than 90 percent of the deposits of this country are i n banks which require reserves equal to or better than the Federal Reserve System. I n my State of Colorado a State bank has to maintain a 15-percent reserve and has had to maintain that reserve since 1927, and the bank which accepts bank deposits i n Colorado has to maintain a reserve of 25 percent, whether it is i n the Reserve city or not. Senator DOUGLAS. Denver banks under the Reserve System would have to maintain 20 percent ? M r . HARL. Under the Federal Reserve System but under the State system they have to maintain 25 percent i f they take bank deposits. Senator DOUGLAS. W e l l , let me come b a c k - — M r . HARL. I n other words, a Reserve bank i n Colorado at the present time has to maintain 25 percent greater reserves than that presently prescribed by the Federal Reserve. Senator DOUGLAS. T h a t is rather a unique case. M r . H A R L . I do not know. W e would be very glad to present a study for you. Senator DOUGLAS. The list I read—I think i t is correct—indicates a considerable number of States where the reserve requirements are below the Federal Reserve requirements, not only for the Reserve city banks but for the so-called country banks. M r . HARL. W e would be glad to make that study, but I took a small Western State to bring across that point. 133 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . I was not clear whether you favored M r . McCabe's proposal of minimum reserve requirements across the board or not. I wondered if you w^ould state whether you favor it or not ? M r . HARL. That members have a 20 percent, 18 percent, or Senator D O U G L A S . N O . I do not know that it is tied to definite figures, but that it would be uniform at any one time, so that you could still have State chartering and State banks, but uniform reserve requirements. M r . H A R L . I w i l l go further and say this board has never opposed any bank joining the Federal Reserve System. Senator DOUGLAS. This is not a proposal of M r . McCabe that they join the System, but i f they stay outside the System, that they should observe the reserve requirements which are imposed on the banks which are i n the System. M r . HARL. I think that is a matter for the States to decide. Senator DOUGLAS. Not for the Federal Government? M r . H A R L . Y e s , sir. Senator DOUGLAS. Not a matter for Congress to legislate? M r . HARL. I do n o t t h i n k so. Senator DOUGLAS. W h y not? Y o u mean it is not constitutional for Congress to pass on it ? M r . H A R L . I do not know anything about the constitutionality of it at all. I think, since you quoted Andrew Jackson a few minutes ago, I believe that the theory is to keep as much as you possibly can at the State level. But I w i l l go further and say I think an analysis w i l l disclose that reserve requirements for better than 90 percent of the deposits of the country, either by State or Federal Reserve requirements, are as high as the Federal Reserve requirements are at the present time. Senator DOUGLAS. Therefore, that there is no need for such a proposal ? M r . HARL. That is my theory. I want to amplify that further. The Federal Deposit Insurance Corporation is very much i n favor of all banks maintaining substantial reserves i n cash and/or Governments at all times, but I think there is a difference in the sterilization of reserves and the nonsterilization of reserves. Senator DOUGLAS. O f course, M r . McCabe had a second feature to his proposal, which was that the nonmember banks should have the same access to reserve loans as member banks. That would give a privilege which might make this more attractive to the State banks, since they would be getting something in return for the higher reserve ratios which might be imposed; and, i n the case of banks which already had reserve ratios equal to those in the System, it would give them a privilege without any loss of earning power. M r . HARL. O n that basis, every bank i n Colorado today would have the right to borrow from the Federal Reserve, because i n Colorado, as I said before, you have to maintain a 15-percent reserve i n the country banks, and the banks which take deposits of other banks have to maintain 25, and the Federal requirement is 20; therefore, Colorado banks which take deposits of banks have to carry the difference between 15 or 20 and 25, or 25 percent greater reserves than required by the " F e d " at the present time. That has been on the statute books 22 years. 134 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. There is involved not only the amount of the reserves but also the form of the reserves; i n an analysis which we made of the various States, i n virtually all the States the vast proportion, and i n some cases the exclusive amount, of the reserves could be i n the form, not of cash but of deposits i n other banks, which is a very different thing from a reserve with the Federal Reserve System. M r . H A R L . Y O U mentioned 85 percent are controlled. Do you think that 15 percent which is not under their supervision has any detrimental influence on our economy ? W e do not. Senator DOUGLAS. I am an inquirer, not an arguer. M r . WOLCOTT. H e answered the question. Senator D O U G L A S . I beg your pardon ? M r . H A R L . I asked the question and then answered it. I said we do not. Senator D O U G L A S . I beg your pardon. M r . HARL. W e testified, I believe, before the Banking and Currency Committee to that effect. Senator DOUGLAS. W h a t would you say to the national banking system lowering the minimum capital requirements from $ 5 0 , 0 0 0 to $ 2 5 , 0 0 0 on banks which have already been organized under the State banking laws, under the Federal Reserve ? M r . HARL. F o r some reason which we do not know, the Congress, probably with the advice and counsel of the authorities, enacted the present capital requirements at a time when you had smaller deposits and greater capital ratios than you have at the present time. I believe the capital ratios i n this country were better or about 25 to 1, or $1 of capital to $4 of deposits, when these laws were written. A s of December 31, 1948, the capital ratio was 6.7, or $16 roughly, i n depositors' funds to $1 bank capital. Therefore, i f they saw fit to raise these standards at that time, when the capital ratios were greater, we cannot understand why they seek to reduce those standards when the capital ratios are much less. Senator D O U G L A S . Here is my question: I f $ 2 5 , 0 0 0 is enough to qualify a bank safely under a State banking system, why is it not sufficient to admit them into the Federal Reserve System ? M r . H A R L . I t m a y be. Senator D O U G L A S . D O you want to express an opinion ? M r . HARL. W e do not think so because we stand for greater capitalization, and the record of the Federal Deposit Insurance Corporation has been at all times for heavier capitalization. Senator D O U G L A S . B u t you insure the $ 2 5 , 0 0 0 bank. M r . HARL. W e do not insure every bank that applies for insurance. Senator D O U G L A S . Y O U w i l l insure a $ 2 5 , 0 0 0 bank, w i l l you not? M r . H A R L . W e do at times. Senator D O U G L A S . D O you discriminate against the bank because it has only $ 2 5 , 0 0 0 ? M r . HARL. W e make a survey of the community. Senator DOUGLAS. There are only 700 State banks which are outside yotir insurance, and i f a $ 2 5 , 0 0 0 bank is good enough for the States and good enough for you, why shouldn't it be good enough to be admitted to the Federal Reserve System ? M r . H A R L . I think you w i l l find i n the last 3 or 4 years we have insured very few banks that have had only $ 2 5 , 0 0 0 capital. They have had more capital than that i n practically every case. 135 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . D O you have a statement of the division of State banks which are insured by you according to capital ? M r . McCabe's proposal is not to lower the requirements on newly formed banks, but to permit State banks already formed with the capital of $25,000 to come i n i f in other respects they are satisfactory. M r . H A R L . I w i l l say to your committee, Senator, we would gladly subscribe to the matter of capital structure. I f the law were so enacted, we would be very glad to go along with the law if, i n order to obtain insurance, the capital requirements were raised. Senator D O U G L A S . Y O U do not want them lowered, but you would like them raised? M r . HARL. W e would like them raised; yes, sir. Senator DOUGLAS. And, therefore, you do not agree with M r . McCabe in his proposal? M r . HARL. W e can see no reason for it. A t the present time 85 Senator D O U G L A S . This is what puzzles me. I f a $ 2 5 , 0 0 0 bank is good enough under the State laws—and you think the State laws on the whole are correct—and i f this $ 2 5 , 0 0 0 bank already formed is good enough to be insured by you, then why is it not good enough to be admitted to the Federal Reserve System ? M r . HARL. W e have never said it was not good enough for the Federal Reserve System. Senator DOUGLAS. That is what I am trying to find out. M r . HARL. W e want to be shown the advantage of that because it has been developed here this morning that banks containing better than 85 percent of the deposits are members of the Federal Reserve System. W e have no quarrel with the Federal Reserve System whatsoever. Senator DOUGLAS. Then you would not oppose this proposal to lower the entrance requirement into the Reserve System? M r . H A R L . I w i l l go further. T o my knowledge this Corporation has never opposed any bank at any time joining the Federal Reserve System. Senator DOUGLAS. A n d you would not oppose lowering the requirement on State banks already organized by nonmembers of the System to $ 2 5 , 0 0 0 so that they could come i n ? M r . H A R L . I would not make the statement until I could discuss the matter with my Board of Directors, because, as you know, one member of this Board happens to be the Comptroller of the Currency, and his requirements Senator DOUGLAS. A r e for national banks but not for State banks ? M r . HARL. That is very true; and, as you know, any bank he charters, they have not only Federal Reserve membership but likewise F D I C membership at the same time; and I would rather reserve that question until I talk to my colleagues. Senator DOUGLAS. I n other words, you want to have deferred judgment on that? M r . HARL. That is right. Senator DOUGLAS. B u t what would you say as a person withoujt committing your organization to this query of mine that, i f a $25,000 bank already in existence is good enough for the States and good enough for F D I C , why should it not also be eligible for membership i n the Federal Reserve System? 136 MONETARY, CREDIT, A N D FISCAL POLICIES M r . H A R L . I think my judgment i n that case would be absolutely predicated on discussion with the other two members of our Board, bearing i n mind that one member is the Comptroller of the Currency and the other member is past president of the National Bank Division A B A and has always operated i n a national bank. Senator DOUGLAS. There is one final question I should like to ask you, and I want to state it as precisely as I can. A s I go over the Federal laws and regulations which are applicable to banks which are members of the Federal Reserve System, I find that many of these laws and regulations do not relate directly to monetary and credit control, but to a series of technical requirements such as the adequacy of bank capital, soundness of bank lending and investi n g operations, and the maintenance of competition i n banking. I can see why these Federal laws and regulations were attached to membership i n the Federal Reserve System when that was the only Federal agency attempting to increase the uniformity of standards applying to State chartered banks. B u t now we have your organization, the Federal Deposit Insurance Corporation, whose primary purpose it is to insure the safety of deposits and to try to raise banking standards so as to avoid losses on deposits. I n view of that fact, would it not be appropriate to cease attaching these laws and regulations to membership in the Federal Reserve System and transfer them instead to the privilege of deposit insurance ? Thus taking in some 13 percent of the deposits which are i n your system but not in the Federal system. M r . H A R L . Y O U understand when a bank fails, whether it is a State bank, a National bank, or a member bank, we have to pay the bill. Senator DOUGLAS. Should you not, therefore, be given the safeguards ? A t present you have the liability i n these cases. M r . HARL. Yes, sir; we would leave the monetary and the credit policies to Federal Reserve, but we think we should have the right to examine those 1,900 banks. Senator DOUGLAS. It is not merely a question of examination, but it is a question of the adequacy of bank capital, soundness of bank lending and investing operations, and maintenance of competition i n banking as laid down by Federal laws and regulations. Should not those rules be attached to your organization, which is primarily concerned with safety of deposits rather than to the Federal Reserve System covering a smaller area, whose primary function is monetary and credit control? M r . H A R L . A S you know, the Federal Reserve System leaves examination of the national banks to the Comptroller of the Currency. Senator DOUGLAS. That is right. M r . HARL. The Comptroller of the Currency is a member of our Board, which is the policy-making end of the Federal Deposit Insurance Corporation. Therefore, it can be said that we do exercise considerable influence over every bank i n the United States except 1,960 banks to which you referred. Senator DOUGLAS. That is the point. M r . HARL. W e feel we can do the same examining job for the Federal Reserve as is now done by the Comptroller of the Currency. Senator D O U G L A S . I am a very literal man, I am afraid. W o u l d you say that these laws and regulations concerning soundness of bank 137 M O N E T A R Y , CREDIT, AND FISCAL POLICIES lending and investing operations and maintenace of competition i n banking, which are now attached to the Federal Reserve System, should be transferred to F D I C , and, therefore, cover this wider area of state banks not members of the Reserve System but members of the insurance system ? M r . HARL. Well, i f I knew what those laws and regulations were, we would be very glad to undertake to enforce those laws and regulations as laid down by the Congress. Senator DOUGLAS. Well, we have made a listing of provisions which apply to National banks and to State banks which are members of the Federal Reserve System, but which do not apply to State banks not members of the System, but members of the F D I C . Y o u say that i f you knew what they were—well, I have a list of 30 which I should like to read. [Reading:] 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. Limitations on total loans to one borrower. Regulations governing purchase of investment securities. P r o h i b i t i o n against purchasing stocks. P r o h i b i t i o n against engaging i n u n d e r w r i t i n g of investment securities a n d stocks. Restrictions on loans to executive officers. Restrictions on dealings w i t h directors. Restrictions on interlocking directorates or other interlocking relations w i t h other banks and w i t h securities companies. P r o h i b i t i o n against bank having less than 5 or more t h a n 25 directors. Provision authorizing supervisory authority to remove officers and directors f o r continued violations of l a w or continued unsafe or unsound practices. P r o h i b i t i o n against affiliation w i t h securities company. Restriction on holding companies affiliates. Restrictions on bank stock representing stock of other corporations. L i m i t a t i o n s on loans to affiliates. Requirements of reports of affiliates and publication thereof. Requirements f o r examination of affiliates. L i m i t a t i o n s on investment i n bank premises. M i n i m u m capital requirements. M i n i m u m capital requirements for branches. Prohibitions against loaning on or purchasing on stock. Restrictions on w i t h d r a w a l of capital and payment of unearned dividends. Requirement that reserves specified i n the F e d e r a l Reserve A c t be maintained. P r o h i b i t i o n against making loans or paying dividends w h i l e reserves are deficient. Requirement f o r specific number of condition reports annually and for publication thereof. Requirements i n connection w i t h the par clearance collection system. P r o h i b i t i o n against false certification of checks. Limitations on acceptance powers. P r o h i b i t i o n against acting as agent f o r nonbanking institutions i n making loans to brokers and dealers i n securities. L i m i t a t i o n s on loans to one borrower on stocks or bonds. L i m i t a t i o n s on aggregate loans to a l l borrowers on stocks or bonds. L i m i t a t i o n s on deposits w i t h nonmember banks. Now, it may be that some of these restrictions are unduly severe, but I would think probably the vast majority of them were designed to get greater security and safety. Now, i f these are good for the banks within the System, why should they not be also good for the residue of banks which are not i n the System but are in the Federal Deposit Insurance Corporation? M r . HARL. Senator, I think you w i l l find by your statement a few minutes ago that 90 percent or more of these very regulations are written into the State statutes. 138 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Then you think the State laws are sufficient on this point? M r . H A R L . I think we can take what you read item by item and you w i l l find that 90 percent of those provisions are statutory in respective States at the present time. Senator DOUGLAS. W o u l d you have these repealed, therefore, at the Federal level for the State banks which are members of the Federal Reserve System? M r . HARL. Not necessarily, but I think you w i l l find a great many of those Senator DOUGLAS. I f the State laws are adequate, then why should you require them for State banks which are members of the System, since they would be covered by these State laws ? M r . H A R L . I did not require them. That is the Federal Reserve requiring them. Senator DOUGLAS. W h y should they be required ? M r . HARL. That is a question I think that the Board of Governors of the Federal Reserve should answer. Senator DOUGLAS. Fundamentally, it is Congress which makes the laws on these points, and we are seeking guidance, and i n a problem i f we depend solely on the judgment of the agency concerned we get a partial view. So we are trying to get the opinions of others. M r . HARL. W e have no complaint with those regulations. Senator DOUGLAS. W h y not extend them ? I f you have no complaint with the regulations, why not extend them to the State banks wl^ich are members of the insurance system but not members of the Reserve System ? M r . H A R L . A S I said before, 90 percent of those very same edicts or regulations or statutes are on the State books at the present time. Senator DOUGLAS. I t would be interesting to get a comparative analysis on that point, but what about the rules which are not on the State statute books, rules which are desirable but which are not on the State statute books ? M r . HARL. I think any rule which is desirable should be on the State statutes, and I w i l l say this: When you come to a law which is beneficial to banks, we have found the State banking commissioners sincerely interested in having those statutes passed i n their local States. I do not believe the Federal Reserve or the F D I C Senator DOUGLAS. O r the Congress? M r . HARL. O r the Congress has ever had any opposition from the State banking advisers to passing any legislation which was constructive at the State level, and i n your own State you have a thing which has really upset things very much. Senator DOUGLAS. Please do not think for one minute that I am making any apology for the State banking laws of my State, which are i n many ways, I want to say, about as bad as you could get i n any section of the country. M r . H A R L . A S you know, for many years a stockholder i n a bank was always faced with a liability, an assessment liability. The Congress, after the passage of the Federal Deposit Insurance Corporation Act, dissolved that liability for national banks. I n many States they had assessments up to 200 percent by statute for which bank stockholders were liable. 139 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Unfortunately, in the State of Illinois, that was written into the constitution, as the Senator, I believe, is familiar with, with the result that nobody out there wants to organize a State bank. It has not been too long ago that certain officials of the Illinois Bankers Association came down here and wanted to know why the Comptroller was chartering so many national banks i n his State as compared with State banks. The Comptroller and members of our Board sat in that conference, and we told them because there is discrimination i n Illinois against the State banker. Senator DOUGLAS. I may say that the Governor of Illinois and other members of my party have been doing the best they could to get the Constitution of Illinois altered and a new constitutional convention called, but we are having some difficulties i n that respect. I am very glad you have furnished this further evidence as to the need for constitutional revision i n the State of Illinois. M r . HARL, I do not believe, Senator, that bankers as a rule are affiliated with the same or belong to the same party that you and I happen to belong to, but I think you w i l l find that both parties subscribe thoroughly to what you said a few minutes ago. I think it transcends party philosophy in the State of Illinois. Senator D O U G L A S . Y O U mean the desire for constitutional reform? M r . H A R L . I am talking about the banks. I do not know about the rest of it. Senator DOUGLAS. I wish the desire for constitutional reform did transcend the party lines in the State of Illinois, but that is neither here nor there. M r . W O L C O T T . I think the Republicans—and I cannot speak for them—and, of course, I am sorry politics have been brought into these hearings—would be perfectly i n favor of the amendment of the constitution in that respect. I think that is i n keeping with our philosophy of government. M r . HARL. Congressman, I w i l l say everybody is working wholeheartedly out there and has for many years to get that constitutional prohibition out of there, because it discriminates against the dual system of banking. M r . WOLCOTT. I n that connection, of course, it aids this movement toward centralization of power in the Federal Government. M r . HARL. Yes. M r . WOLCOTT. Which, of course, every Republican would be violently opposed to. Senator D O U G L A S . A S followers of Alexander Hamilton, I am surprised that you favor decentralization. M r . W O L C O T T . Y O U referred to Andrew Jackson. I finished reading the biography of Andrew Jackson by Marquis James, and I think my father and my grandfather would have considered it sacrilegious i f they knew I read it, but I was amazed to find out what close affiliation there was between his advocacies and the Republican P a r t y policies at the present time. I do not think you Democrats have any more right now, after that book has been written and the facts have been brought out, to claim him as your patron saint. W e are going to adopt him. Senator DOUGLAS. Probably departing from the principles of Alexander Hamilton. M r . WOLCOTT. Union now and forever. 140 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. One and inseparable. M r . BUCHANAN. O n the question of concentration of all Federal bank examinations in one agency, you are opposed, of course, to that concentration; are you not ? M r . HARL. W e are. M r . BUCHANAN. A n d for what reasons? W o u l d you care to give them? M r . HARL. Again you transcend and cross the Andrew Jackson philosophy of State rights. The Comptroller, of course, should have a right to examine banks he charters. Senator D O U G L A S . I have always believed that Andrew Jackson was a great man in his day, even willing to concede reluctantly that Alexander Hamilton may have been a great man in his day, but we are now living i n 1949 and not in 1799 or 1834. M r . B U C H A N A N . A hundred years to convert some Republicans. Senator DOUGLAS. I n view of the present situation, this is what we have. Y o u are supposed to insure the soundness of these banks and yet we find a rim of banks which have about 13 percent of the deposits which are State banks but not members of the Federal Reserve System, that do not have imposed on them the requirements for soundness— and I am not speaking of monetary and credit control, I am speaking simply of soundness—which are imposed on banks which voluntarily come into the Federal Reserve System. M y query is whether you are not being held financially liable for possible failures of these banks while you are being denied the safeguards which the majority of the other deposits have, and in view of the fact that this deposit insurance is not a perfect protection, and is only a partial protection, I am wondering i f you would be opposed to having such regulations as are reasonable—I do not say every one of these 30 restrictions is perfect—such regulations as are reasonable, designed to get the security of deposits extended to the some 4,500 banks and to the $20,000,000,000 of deposits which are i n your system but not i n the Reserve System ? M r . HARL. Senator, I believe it is fundamental that the insurer has the right to look at his risk. Senator D O U G L A S . S O that you can decline to accept these risks ? M r . HARL. Once they are insured, we have the right to continue to appraise and otherwise look at our risk. W e look at those risks i n all but 1,900 members through our examiners or those of a member of our Board of Directors. Therefore, we believe that you are correct that we should not be denied the right to look at our risk in those other 1,900 banks. Furthermore, we again believe that you are correct i n that we are for every one of those regulations which are reasonable and we also believe, as we said a few minutes ago, that you w i l l find 90 percent of those regulations which you read and put i n the record are now i n the statutes of the various 48 States. Senator D O U G L A S . S O would you be willing to prepare a memorandum on this point, covering what regulations you believe are reasonable and which are not now adequately provided for under State laws? M r . HARL. W e would be very glad to. Senator DOUGLAS. Thank you very much. 141 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES (The following memorandum to Senator Douglas was later supplied for the record. The September 1948 tentative draft of the model State banking code with notes, statutory references and index are i n the files of the Joint Committee on the Economic Report:) F E D E R A L D E P O S I T I N S U R A N C E CORPORATION, Washington, Hon. PAUL H. December 6, 19Jf9. DOUGLAS, Chairman, Subcommittee on Monetary, Credit, and Fiscal Joint Committee on the Economic Report, United States Senate, Washington, D. C. DEAR SENATOR DOUGLAS : D u r i n g my testimony before your Policies, subcommittee on November 15, 1949, you mentioned certain Federal statutory provisions some of which were applicable only to national banks and some of which were applicable to national banks and to State banks which are members of the Federal Reserve System. Y o u inquired whether I would favor the extension of these provisions to the insured State banks which are not members of the Federal Reserve System. A t the hearing I stated in effect that I believed that most of these provisions were covered by the laws and regulations of most States. The most recent general research on this whole question of State banking laws was made in connection with the drafting of a model State banking code by a special committee of the American Bankers Association. There is enclosed, for your committee's use, a copy of the September 1948, tentative draft of that model State banking code w i t h notes, statutory reference, and index. W e have been advised by the American Bankers Association committee on this code that the draft is i n tentative form and is now being put i n final shape w i t h hopes of completion i n 1950. T h e notes accompanying the enclosed tentative draft of the model State banking code set forth the various State banking statutory requirements and the States in which certain requirements are made. In the varied requirements of the banking laws of the 48 States naturally some of the provisions are less restrictive than the present requirements for national banks and State banks which are members of the Federal Reserve System. However, in some respects the State banking requirements are more restrictive. State bank supervisory authorities and State banking associations have been very cooperative in making necessary improvements i n State banking laws. Because of this and because of the effective powers which Congress has given this Corporation we have not felt the necessity of requesting Congress to extend to State-insured banks which are not members of the Federal Reserve System the particular Federal banking statutes mentioned by you. A f t e r our operations from 1933 to 1935, this Corporation recommended and Congress enacted an entire revision of our law to make our deposit insurance more effective. Congress authorized this Corporation to consider the following factors in admitting a bank to insurance and i n approving the establishment of branches: "The financial history and condition of the bank, the adequacy of its capital structure, its future earnings prospects, the general character of its management, the convenience and needs of the community to be served by the bank, and whether or not its corporate powers are consistent w i t h the purposes of this section." W i t h our authority to consider the adequacy of the capital structure we are not limited to the minimum State capital requirements but may require capital which we consider adequate i n relation to the expected deposits of a new bank. T h i s makes possible a somewhat uniform capital requirement for a l l Stateinsured banks which are not members of the Federal Reserve System i n spite of the existing differences i n State requirements. I n considering whether a bank's corporate powers are consistent w i t h the purposes of our l a w we consider its powers and the applicable State banking laws. Where the bank's corporate powers are inconsistent or where the State banking laws are inadequate i n any matters this Corporation requires the bank to agree not to engage i n certain powers or to restrict its activities i n certain respects. (See 12 C F R , pts. 332 and 333.) T h i s Corporation is authorized to terminate the insured status of any insured bank found to be continuing unsafe or unsound practices i n conducting the business of the bank or to knowingly or negligently permit any of its officers or agents to violate any law or regulation to which the insured bank is subject I n this connection provision is made for a period i n which the bank may make correction and for a hearing prior to any order terminating insured status. 99076—50 10 142 MONETARY, CREDIT, A N D FISCAL POLICIES Statutory requirements and restrictions are but minimum aids i n maintaini n g a sound banking system. Successful banking operations and bank supervision are grounded on the good judgment of bankers and examiners. It is to them that we attribute the present excellent condition of banks and the success of deposit insurance. W i t h the existing State banking laws, the cooperation of the State banking authorities, the statutory powers of this Corporation and the effectiveness of our examiners i n dealing w i t h the individual banks, this Corporation sees no necessity, at this time, for the general extension to insured State nonmember banks of Federal banking laws now applicable to national banks and State banks w h i c h are members of the Federal Reserve System. A s matters may arise needing correction we would prefer to seek needed changes i n the State banking l a w s or request Congress to enact appropriate legislation applicable to a l l insured banks. W e are reconsidering the Federal statutory requirements mentioned by you w h i c h are applicable to national banks and State banks w h i c h are members of the F e d e r a l Reserve System for the purpose of recommending to Congress the extension to insured nonmember banks of any particular provision w h i c h may be desirable and w h i c h w o u l d improve the soundness of the Federal deposit insurance system. W i t h kindest regards, I am, Sincerely yours, MAPLE T . HARL, Chairman. Senator DOUGLAS. M r . Wolcott ? M r . WOLCOTT. I assume that Senator Douglas has been referring to i n respect to the lack of regulation he implies is a lack of regulation on the part of the Federal Government. Y o u r contention is that the nonmember banks are regulated at least 90 percent as much under State laws as member banks are; is that correct? M r . H A R L . Y e s , sir. M r . W O L C O T T . SO the issue seems to boil down as to whether the Federal Government shall promulgate the regulations, either statutory or otherwise, or whether the State governments shall do the same job. I think perhaps the record is f u l l of it, but may I ask you, M r . H a r l , i f you can tell us offhand what the losses have been i n F D I C . I know there are not many losses, have not been many—you know what I mean by losses—the losses you have had to suffer. Y o u do not show any loss on your statement, of course, because of your reserve and capital, but what losses have there been to the Corporation ? M r . HARL. Around 8 percent. M r . WOLCOTT. Eight percent of what? M r . HARL. O f the total deposits i n the closed banks. I n other words, we have liquidated up to 92 percent. M r . WOLCOTT. Those are the banks which have been closed ? M r . HARL. Yes, but I w i l l say furthermore that i n the last 6 years we have had very fair weather because of economic conditions and i n many cases we are taking banks now which pay out 100 percent. M r . WOLCOTT. I n terms of dollars about how much would that be ? M r . HARL. It is going to boil down, we think, when we get through this liquidation, to where we are going to lose between 26 and 30 million dollars. M r . W O L C O T T . Y O U have ample reserves ? M r . HARL. Those reserves have been set up for that now, and are included i n this statement, and this statement is net. M r . W O L C O T T . Y O U think your somewhat-over-a-billion dollars of reserves is sufficient for all ordinary purposes ? M r . H A R L . N O , sir; we do not. W e came to the Congress as you remember, Congressman, 2 years ago and asked for the right to obtain from the Treasury up to $3,000,000,000 by the debenture route, i n the 143 M O N E T A R Y , CREDIT, AND FISCAL POLICIES event that money was needed, and that was predicated on the following formula. A s a result of the 1 9 2 9 - 3 3 depression it took over $ 4 , 0 0 0 , 0 0 0 , 0 0 0 to put a floor back under the banks. Now, with our billion dollars i n reserves, plus the $3,000,000,000 that we can get from the Treasury through debentures, we feel that that $4,000,000,000 makes the corporation invulnerable to these depressions. T h a t was the reason for our statement a few minutes ago that we felt we were invulnerable. M r . WOLCOTT. W a s that three times the reserves ? M r . HARL. I t is spelled out, $3,000,000,000. M r . WOLCOTT. I n figures, not three times your reserves ? M r . H A R L . N O , sir; so that we have absolutely at the present time i n reserves or contingent reserves $4,000,000,000. Now, as we accrue more money i n our f u n d we would have to borrow less money from the Treasury. Predicated on what happened—and you can only judge the future by the past—with our present insurance coverage and assessment rate our actual reserves or contingent reserves are probably ample to take care of and protect us against any storm we have i n the future, provided that storm is not greater than 1933. W e do not believe it w i l l be greater than 1933 because we think there are better practices i n the banks. M r . WOLCOTT. Under the l a w — I should know, but I do not—what is the obligation of the Federal Government over and above your reserve i n respect to your losses ? M r . HARL. T h e only obligation we have w i t h the Federal Government at the present time is that the Treasury is mandated to purchase from the Federal Deposit Insurance Corporation, when, as, and i f offered, up to $3,000,000,000 i n our evidences of indebtedness. M r . WOLCOTT. A n y loss to depositors over that, there is no obligation upon the Federal Government to pay them ? M r . HARL. There is no obligation on the Federal Government at the present time to pay any loss. T h e whole obligation vests i n the Corporation's guaranty. M r . WOLCOTT. Where do you get your capital ? M r . HARL. Our capital has come from the banks. They pay, as you know, one-twelfth of 1 percent of deposits per year, and our capital comes from the amount of the assessment paid i n annually, plus income from our investments, which are Government securities. M r . WOLCOTT. Where d i d you originally get your capital? M r . HARL, Originally i n 1933, when the act was initiated, we sold $ 1 5 0 , 0 0 0 , 0 0 0 common stock to the Treasury and $ 1 3 9 , 0 0 0 , 0 0 0 common stock to the Federal Reserve System, or $ 2 8 9 , 0 0 0 , 0 0 0 from the Treasury and the Federal Reserve System. M r . WOLCOTT. Has that all been retired ? M r . HARL. Yes, sir. The act was introduced i n the House by, I think, you and Congressman Spence, repaying the Treasury and repaying the Federal Reserve System, and that has all been consummated. Senator DOUGLAS. W h a t about the earnings on this capital ? Have those been repaid ? M r . HARL. T h e earnings have accrued to our reserves. Senator D O U G L A S . S O that while the loans of the Treasury and Federal Reserve to the Corporation have been repaid, you retain among 144 MONETARY, CREDIT, AND FISCAL POLICIES your assets the earnings which accrued 011 these assets prior to retirement ? M r . HARL. That is correct. M r . W O L C O T T . I recall very indefinitely that this $ 1 3 9 , 0 0 0 , 0 0 0 , which the Federal Reserve put up, was the so-called profit of the Federal Reserve System. M r . HARL. I t was half of their surplus at that time from their earnings. M r . WOLCOTT. The law provides that shall be paid into the Treasury, as I recall it, but it does not say when; and the Federal Reserve Board interprets that to mean they pay i n any profit they have upon liquidation. M r . H A R L . This $ 1 3 9 , 0 0 0 , 0 0 0 went direct to the Treasury. The act provided that would go to the Treasury. M r . W O L C O T T . Y O U paid it to the Treasury and not to the Federal Reserve ? M r . H A R L . W e paid $ 2 8 9 , 0 0 0 , 0 0 0 to the Treasury. M r . WOLCOTT. The Congress i n that manner settled the question as to whether the profit of the Federal Reserve should be paid to the Treasury now or upon liquidation. M r . H A R L . That $289,000,000, of which $ 1 3 9 , 0 0 0 , 0 0 0 came from the Federal Reserve, by that act you decreed we pay the entire amount to the Treasury, which we did. M r . WOLCOTT. O f course, we have no way of knowing whether even this $4,000,000,000—is that it, your billion reserve and $3,000,000,000 you can get on debentures from the Treasury—we have no way of knowing whether that would be adequate. That would depend somewhat upon how deep the depression was and how much of the reserves of the banks had been used or otherwise dissipated previous to the crash. W e w i l l call it a crash, because it would have to be a crash to absorb that much, probably. H o w far would you go i n times of stress i n supporting the bond market? H o w far would you recommend that we go i n supporting the bond market i f and when the conditions of the banks were such that for their normal purposes they had to unload an unusually large amount of Governments? M r . H A R L . I think the bond market should be supported always at par. M r . WOLCOTT. Regardless of the amount of sales by the banks of Governments? M r . HARL. That is right. M r . WOLCOTT. I guess that is all. M r . BUCHANAN. I f there are no further questions, the committee w i l l adjourn until 2 o'clock this afternoon. (Whereupon, at 12:45 p. m., a recess was taken until 2 p. m., of the same day.) A F T E R N O O N SESSION Senator DOUGLAS. W e welcome this afternoon representatives of the Reconstruction Finance Corporation, M r . Gunderson, one of the directors; M r . Dougherty, General Counsel; and M r . Considine, Comptroller. I would appreciate it i f you gentlemen would take seats here. 145 M O N E T A R Y , CREDIT, AND FISCAL POLICIES W e originally invited M r . Harley Hise, the Chairman of the Board of Directors of the Reconstruction Finance Corporation. H e said that he would be prevented from coming and asked i f these representatives might come i n his stead. W e replied that we would be very glad to see them personally and would be glad to welcome them officially, provided it was understood that they spoke as representatives of the Reconstruction Finance Corporation and not merely as individuals. W e have since received a letter from M r . Hise saying that these three gentlemen have the right to speak for the Reconstruction Finance Corporation, and that M r . Gunderson w i l l be spokesman. STATEMENT OF HARVEY J. GUNDERSON, DIRECTOR, RECONSTRUCTION FINANCE CORPORATION, ACCOMPANIED BY JAMES I. DOUGHERTY, GENERAL COUNSEL, AND JAMES W. CONSIDINE, COMPTROLLER Senator D O U G L A S . D O you want to add anything, M r . Gunderson. to the statement that M r . Hise made in reply to our questionnaire ? (Mr. Hise's statement is found on p. 218 of the committee print on Monetary, Credit, and Fiscal Policies.) M r . G U N D E R S O N . N O , sir. W e think M r . Hise's statement covers the questions that you propounded to us, perhaps not as fully as you might wish, but we think that it covers the points, at least briefly, and we are here to answer additional questions the committee might wish to ask. Senator DOUGLAS. M r . Gunderson, the Reconstruction Finance Corporation was originally set up, I believe, in the summer of 1931, as a means of helping to meet the business depression or cataclysm which was breaking upon the country and to make available to private business funds which would enable them to continue and which were not available through security issues or from bank loans. A t that time the security market was flat and the banks were contracting rather than expanding. Undoubtedly the Reconstruction Finance Corporation saved many businesses and contributed a great deal to the stability of the business structure. I think the question which is i n the mind of a great many people, and which I should like to probe, is this: The depression has been over for at least 10 years now; the Reconstruction Finance Corporation is still in business, it is still making loans. I wondered what the reasons in your mind are for the continuation of direct lending by the Government. Before you go into that, I would like to say that I assume you have the same presumption that I have; namely, that the retailing of credit should i n the main be i n private hands rather than i n public hands, because any public agency which retails credit is necessarily i n a difficult position to determine who gets credit and who doesn't get credit, and is liable to be damned i f it does and damned i f it doesn't. So that I wondered if you would make a statement as to why you regard direct Government lending as a continuing function of the Government, i n good times as well as i n bad times. M r . GUNDERSON. Senator Douglas, commencing with the statement that you made, when the Reconstruction Finance Corporation was originally set up it did not make any loans to business. Senator DOUGLAS. I t insured loans? MONETARY, 146 CREDIT, AND FISCAL POLICIES M r . G U N D E R S O N . I t d i d not insure. I t d i d no operation except i n financing banks, savings banks, insurance companies, and railroads. T h e first authority to assist industrial businesses was put i n the act by Congress i n 1934. One of the provisions was that R F C could not make any loan i f private sources of financing were available. T h a t provision continues i n the act today and is a condition precedent to any financing of business by the Reconstruction Finance Corporation. I n the original act it was required that adequate security be obtained for the making of any loan, and at a later date—I believe i t was 1936 or 1937—Congress eliminated the requirement of f u l l and adequate security and inserted into the act the provision that any loan to a business enterprise should be so secured as to reasonably assure repayment; and although the act has been changed and amended and rewritten and readapted by the Congress, i n 1947, those provisions, as they affect loans to business, have remained substantially the same, for about the last 12 years. T h i s leads up to the question as to why the Reconstruction Finance Corporation would continue to make loans. I t is a question that I am not sure I can answer satisfactorily but it is a fact that d u r i n g the years of our lending to industrial enterprises there seems to have been a fluctuating availability of money to business. I n the authority of the Reconstruction Finance Corporation to lend money, the two requirements that Congress has imposed—the first one being that we have to be sure that business has exhausted the private sources, and the second, that it has to be secured so that we are assured that it w i l l be repaid—have really restricted the lending operation to a very narrow field, namely, those cases where the borrower, who is unable to secure his needs privately, still has sufficient collateral so that we feel the loan could be made, even i n the event the business fails and we have to realize on the assets. Senator D O U G L A S . W h a t is the total amount of your outstanding loans at the present time ? M r . G U N D E R S O N . $ 4 3 3 , 0 0 0 , 0 0 0 i n business loans at September 3 0 , 1949. Senator D O U G L A S . W h a t is the total of the losses suffered by the Reconstruction Finance Corporation since its beginning ? M r . G U N D E R S O N . Maybe M r . Considine can give you the dollar figure. Percentagewise I believe i t is less than three-quarters of 1 percent. Senator D O U G L A S . Three-quarters of 1 percent of the loans ? M r . G U N D E R S O N . Three-quarters of 1 percent of our loans. Senator D O U G L A S . T h e n the interest upon the loans p a i d more than offsets the losses ? M r . G U N D E R S O N . S O f a r our profit on lending operations is about $560,000,000. Senator D O U G L A S . S O that the Government to date has not had any losses and the profits are i n excess of the total volume of present outstanding loans? M r . GUNDERSON. Y e s , sir. Senator DOUGLAS. M r . GUNDERSON. Senator have. DOUGLAS. By $100,000,000 ? Yes. Well, I think these are very valuable figures to 147 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I wasn't quite able to gather i n what way you thought the private banking system failed to furnish adequate or selected credit so that you regarded direct Government lending as a continuing necessity. M r . GUNDERSON. M r . Chairman, I think it is necessary to qualify the type of lending you are talking about. F o r example, the bulk of lending, i n banks, is i n the form of commercial loans, open lines of credit to borrowers, loans on receivables and warehouse certificates, and most well-run banks confine themselves to short-term credits of a year or less, and i f they do enter the field of making loans for more than a year, or for a term of years, they usually confine the dollar amount to a percentage of their capital, their capital structure, so that they w i l l always be i n a position to meet their depositors5 needs for funds. The Reconstruction Finance Corporation almost never makes a loan of this type. I f you were describing a typical business loan made by the Reconstruction Finance Corporation it would be a loan for between twenty-five and fifty thousand dollars, because 87 percent of our loans are under $100,000, and about 52 percent are under $20,000. So the typical loan is one of $20,000 to $50,000, then it is usually to a business to allow it to expand its facilities or put in more machinery, or do something that is strictly a term debt and requires, on the average, from 3 to 5 years to repay out of earning. Senator DOUGLAS. What you are saying is that the commercial banking system does not have a type of commercial paper sufficiently long to permit such loans to be made ? M r . GUNDERSON. That is my belief. Senator DOUGLAS. What about the ability of these concerns to finance themselves through stock or bond issues, which would be the normal recourse for longer term capital ? M r . GUNDERSON. O f course, Senator, I think our type of lending more closely approximates some of the investments i n business loans by insurance companies. A n d the insurance companies, as a matter of expense of operation, prefer loans, it has been our experience, if they are of $1,000,000 or larger. They can handle just as many of the larger loans as the smaller ones, on a cost basis. I think some of us feel that our loans of $25,000 to $50,000 cost us money to put on the books. That was gone into before the Ranking and Currency Committee at some length during the past few years and was one of the reasons that Congress left our capital and surplus where it is, to take care of that part of the work. Coming down to the question of the equity market, it is our opinion, based on information we have received from our borrowers, and some knowledge that I think is generally prevalent, that the equity market is almost nonexistent, regardless of the soundness of the enterprise, particularly with regard to small businesses. Since the beginning of the war, under our present system of income taxation, it is not attractive for a person with money to invest in small business, because it is unremunerative to him in proportion to the risk. Senator DOUGLAS. Then what you would say is that small business has such difficulty in borrowing for capital improvements, from the banks, getting money from insurance companies, or floating security issues, that there is a gap left, and that the Reconstruction Finance Corporation performs very useful functions in enabling this type of business to get capital, which otherwise would not be the case? M r . GUNDERSON. Y e s , sir. 148 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. I personally tend to agree with you on that but I am in more doubt about your loans to larger businesses. Y o u mentioned the fact that 5 2 percent of your loans are for less than $ 2 5 , 0 0 0 and 87 percent M r . GUNDERSON. Less than $100,000. Senator D O U G L A S . Less than $ 1 0 0 , 0 0 0 . What percentage of the loans, however, are for these small businesses and what percentage of the loans are i n large magnitudes ? M r . G U N D E R S O N . I would say that we are making an increasing number of loans of larger amounts. I f the situation of the first part of this year had continued—what I would call the frightened condition of people who have money, their belief that economic conditions were going to demand that they preserve and keep their cash—we would have had a considerably increased number of much larger loans, because we would be the only place left that could make them. Senator DOUGLAS. Then the argument now turns away from small business to the drying up of the banking system for big business. M r . GUNDERSON. I n our act, Senator, any business concern, where we think it w i l l continue employment and increase the economic stability of the United States, can get a loan from us, i f it can't get it privately. That is the way the act reads. Senator DOUGLAS. Let me ask you this: What proportion of your loans are made to firms to whom you have loaned a million dollars or more? M r . GUNDERSON. I n the last quarter we made 1,273 loans and 28 were for over a million dollars. Senator D O U G L A S . H O W much of the total was loaned to those 28 ? M r . G U N D E R S O N . The gross amount was $ 2 0 5 , 0 0 0 , 0 0 0 . Senator DOUGLAS. H o w many ? M r . G U N D E R S O N . Twenty-eight received $ 1 2 2 , 0 0 0 , 0 0 0 . Senator DOUGLAS. I n other words, 60 percent. M r . GUNDERSON. O f the dollar amount. Senator DOUGLAS. O f the dollar amount went to firms which borrowed more than a million. M r . GUNDERSON. Yes. Senator DOUGLAS. A n d of the total of approximately 450 millions of outstanding business loans, what proportion of those are i n concerns which had borrowed more than a million dollars ? M r . G U N D E R S O N . I would have to get that information for you, Senator, but I would venture a guess that it is that much or more. Senator DOUGLAS. Sixty percent? M r . GUNDERSON. Y e s , sir. Senator D O U G L A S . I S it not true that one of your loans, the KaiserFrazer loan, amounts to almost one-third of the total amount which you have loaned ? M r . GUNDERSON. That is not correct. Senator DOUGLAS. The Kaiser-Frazer loan M r . GUNDERSON. About 10 percent. Senator DOUGLAS. The Kaiser-Frazer loan M r . G U N D E R S O N . I think you are thinking of the steel loan, the loan to the steel division of the Kaiser Co., and which I believe was a war loan. I don't believe we carry that as a business loan; it is a national defense loan; it was made during the war. That loan, though, is approximately $ 9 6 , 0 0 0 , 0 0 0 , against which the corporation holds approxi 149 M O N E T A R Y , CREDIT, AND FISCAL POLICIES mately $8,000,000 of unapplied funds, pending completion of certain construction. Senator DOUGLAS. W h o collects the interest on it ? M r . GUNDERSON. P a r d o n me ? Senator DOUGLAS. W h o collects the interest on it ? M r . GUNDERSON. W e collect it. W e carry it Senator D O U G L A S . Y O U did not authorize the loan originally but interest payments are made to you; and to whom w i l l the principal payments be made? M r . G U N D E R S O N . I don't want any misrepresentation. W e made the loan but it was made under our wartime authority that Congress passed in June of 1940 and rescinded, I mean, revoked in 1947. Under that we could make 100-percent loans, build plants, buy materials ; we could do anything needed for the war effort. Senator D O U G L A S . I S that 96 million included i n the figure of 450 million which you gave me ? M r . GUNDERSON. Y e s ; i t is included. Senator D O U G L A S . S O that i f you take the 4 5 0 million what is the total now loaned to Kaiser-Frazer, or to Kaiser, i n their various enterprises—aluminum, steel, and automobile? M r . GUNDERSON. About 140 million. Senator D O U G L A S . 1 4 0 million ? M r . GUNDERSON. Yes. Senator DOUGLAS. Does that include the new loans just authorized ? M r . GUNDERSON.- Yes, sir. The loans the Reconstruction Finance Corporation has to any Kaiser enterprise is the loan made as a national defense loan to the steel corporation of 96 million and the recent loans to the Kaiser-Frazer Co. for 44,000,000. Senator DOUGLAS. That is 96 plus 44; 140 million dollars. Then any other loans that the Kaiser-Frazer group may have owing to the Government have been borrowed from other governmental agencies? M r . GUNDERSON. I am not aware that they owe the Government anything else other than perhaps part of the purchase price of the plant that they have purchased from W a r Assets Corporation. Senator DOUGLAS. D i d you give to Kaiser-Frazer an initial loan to get them started i n business ? M r . G U N D E R S O N . N O , sir. The first loan to Kaiser-Frazer was made this fall, within the last 2 or 3 months. Senator D O U G L A S . A loan to help them i n business rather than a loan to start them i n business ? M r . GUNDERSON. There was this distinction, Senator, i n the case of the steel company: That is a wholly owned part of Kaiser. I n the case of Kaiser-Frazer, the Kaiser interest is less than 10 percent; the balance is owned by the public. Senator DOUGLAS. I understand. B u t i f you have $140,000,000 loaned to the Kaiser steel interest, plus the Kaiser-Frazer automobile interest, that means that 30 percent of your loans are, approximately, given to one set of interests. M r . GUNDERSON. Well, i f you assume that they are one set of interests, I think the interests i n the car are a lot different than in the other. Senator DOUGLAS. They are certainly under central management control. M r . GUNDERSON. That is correct. 150 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Have you ever had any qualms as to whether you were not putting too large a proportion of your eggs i n one basket? M r . GUNDERSON. I think such qualms as we have had, Senator, have been our desire to see that each loan we make comes under the act and is properly collateralized, and we are confident that they are. Senator D O U G L A S . Let me ask you, what is the total of loans to Lustron as of this date ? M r . G U N D E R S O N . Approximately $ 3 7 , 0 0 0 , 0 0 0 . Senator D O U G L A S . S O that we have a further 8 percent loan to another M r . GUNDERSON. Senator, I would like to point out, i n the Lustron case, that the initial loan to Lustron was not made under the Reconstruction Finance Corporation lending authority; it was made under the war powers pursuant to the Veterans Emergency Housing Act, and that the recent loans have been made pursuant to the congressional enactment of section 102 of the National Housing A c t of 1948, which gave us $50,000,000 without any collateral requirements to help the prefabricated-housing program. Senator DOUGLAS. A r e there any other large individual loans which the Reconstruction Finance Corporation has made ? M r . GUNDERSON. I would like to go back for a minute, Senator. W e have 127,000 loans outstanding, which include mortgages M r . B U C H A N A N . 127,000? M r . GUNDERSON. Y e s , sir. M r . CONSIDINE. That includes F H A and V A mortgages. M r . GUNDERSON. O f which 246 are for a half million or more, and the 1 2 7 , 0 0 0 are for loans representing a total of $ 1 , 6 8 2 , 0 0 0 loaned. The 2 4 6 for a half million or more, represent $ 7 5 0 , 0 0 0 , 0 0 0 . Senator DOUGLAS. Y e s . M r . GUNDERSON. Approximately. I t is a little less than half. B u t included i n here are a lot of mortgages loaned through the " F a n n y M a y . " I f you took it out of the business loans it would be 60 percent or better. Senator D O U G L A S . I S it a matter of secrecy, or a matter of public record, as to some of the other large loans which you have made to individual companies ? M r . G U N D E R S O N . N O ; W^e report the loans of over $ 1 0 0 , 0 0 0 to Congress. Senator D O U G L A S . W o u l d you read some of the loans over $5,000,000? M r . G U N D E R S O N . Over $ 5 , 0 0 0 , 0 0 0 ? Senator DOUGLAS. Yes. W e w i l l start on that end and then get down to over a million. M r . G U N D E R S O N . M r . Considine, w i l l you read those ? M r . C O N S I D I N E . Y O U wish the amounts authorized over $ 5 , 0 0 0 , 0 0 0 or the amount outstanding over $ 5 , 0 0 0 , 0 0 0 ? M r . GUNDERSON. I think the amount outstanding. M r . CONSIDINE. The first I come to is the Lustron Corp. Senator DOUGLAS. $38,000,000? M r . C O N S I D I N E . $ 3 7 , 4 8 6 , 0 0 0 . That involves the complete loan, both under section 102 of the Housing A c t and under the prior act. Senator DOUGLAS. Y e s . M r . CONSIDINE. The M c L o u t h Steel Corp. 151 M O N E T A R Y , Senator DOUGLAS. H O W M r . CONSIDINE. CREDIT, AND FISCAL POLICIES much to them? $11,723,000. Petrol Refineries, Inc., $5,240,000. Carthage Hydocol, Inc., $11,100,000. Glen L . M a r t i n Co., $11,177,000. Reynolds Metals Co., $30,700,000. These balances are as of September 30. Kaiser Co., Inc., $95,865,000. Senator D O U G L A S . The loan of $ 4 4 , 0 0 0 , 0 0 0 recently authorized to them would bring that total to approximately $ 1 4 0 , 0 0 0 , 0 0 0 . M r . CONSIDINE. Not to them. This is to the Kaiser Co., Inc. The other loan was to Kaiser-Frazer, of which the Kaiser interests are only 10 percent. Senator DOUGLAS. Well, to the group of companies i n which M r . Kaiser is one of the dominant figures, let's put it that way. M r . CONSIDINE. That was an October loan. These are September 30 loans. Senator D O U G L A S . SO, we would add to the Kaiser-Frazer Co., $44,400,000? M r . CONSIDINE. That is right. Senator DOUGLAS. M a k i n g a total to the two groups of companies, however we manage this semantically, of $140,000,000. M r . C O N S I D I N E . Northwest Airlines, Inc., $9,143,000. This amount that I am reading to you is R F C ' s share i n those cases i n which a private bank or banks participated. F o r instance, i n the Northwest Airlines the total amount of the loan was $21,000,000. R F C ' s share outstanding at September 30 was $9,143,000. M r . B U C H A N A N . Is that on a 7 5 - 2 5 basis ? Was it originally ? M r . G U N D E R S O N . N O . W e have four-sevenths. Banks took $9,000,000; we took $12,000,000. Senator DOUGLAS. What about the Waltham Watch Co. loan ? M r . G U N D E R S O N . Probably isn't up to $ 5 , 0 0 0 , 0 0 0 yet. I t is about $3,000,000. M r . CONSIDINE. Waltham Watch, the amount outstanding is $2,916,000. Senator D O U G L A S . I don't know how well I can add, but I bring these totals of outstanding loans of over $5,000,000 to the nine companies that you read, to $256,000,000. M r . GUNDERSON. That is right. Senator DOUGLAS. These were not cases. M i n d you, I am not necessarily condemning the policy of the Reconstruction Finance Corporation, but these are not loans to small business'. Here you have over half of the outstanding loans of Reconstruction Finance Corporation made to nine companies, aggregating $256,000,000, of some $450,000,000 outstanding ; so this is obviously not aid to small business. M r . GUNDERSON. There is nothing i n our act which restricts our operation to aid the small business. O f the total of $256,000,000, only $203,000,000 is included in the $433,000,000 outstanding on September 30. Senator DOUGLAS. Pardon me ? M r . GUNDERSON. There is nothing in our act Senator D O U G L A S . I understand, but the argument you started out with, as a justification for direct loans, was that small business did not 152 MONETARY, CREDIT, AND FISCAL POLICIES have access to short-term loans from banks, and now big business is getting in that position. Mr. GUNDERSON. Since the last year, sir. I f the present trend continues, and nothing is done to free equity-investor capital, talking about double taxation of corporate dividends for one thing, it w i l l continue this way. I am not arguing that Kaiser-Frazer is a small business, but it is a small business in the automotive field. Senator DOUGLAS. Well, I seem to remember advertisements by Kaiser-Frazer saying that they were the fourth-largest automobile concern. M r . GUNDERSON. But the larger ones have sold a lot more. KaiserFrazer has about 400,000 automobiles on the road. The first three sell in the millions a year. They do over 95 percent of the business. Kaiser-Frazer does' about 2 percent of the total automotive business. Senator DOUGLAS. Taking the Kaiser-Frazer concern, is it your theory that this was a desirable loan i n order to preserve a greater degree of competition in the automotive business ? M r . G U N D E R S O N . N O , sir. I t does that, but that is not the reason for the loan. The reason is, after it was determined that the money was not available privately, the fact that between 10 and 11 thousand people are employed at W i l l o w Run, and the people employed by the dealers and suppliers, there are the jobs of 4 8 , 0 0 0 people at stake in the continued operation of that business. Senator DOUGLAS. Therefore, to keep those jobs going you felt this further loan should be made? M r . GUNDERSON. A n d they subcontract to about a thousand small businesses. Senator D O U G L A S . The . initial portion of this $ 4 4 , 0 0 0 , 0 0 0 KaiserFrazer loan was $ 1 9 , 0 0 0 , 0 0 0 ; is that true? M r . G U N D E R S O N . N O . The initial part, the first disbursement, was about that amount. Senator D O U G L A S . D O you know how Kaiser-Frazer spent this $19,000,000? M r . GUNDERSON. I don't know what you mean by that $19,000,000. Senator D O U G L A S . Isn't it true that you gave them $ 1 9 , 0 0 0 , 0 0 0 — made available $ 1 9 , 0 0 0 , 0 0 0 ? M r . GUNDERSON. That was the first disbursement. Senator DOUGLAS. That is right. DO you have any information as to the purpose which Kaiser-Fraser put this $19,000,000 to ? M r . GUNDERSON. I think most of it was used as working capital and a part was used to retire an existing bank loan. Senator DOUGLAS. W h a t was that bank loan ? M r . GUNDERSON. I t was a loan from the Bank of America and the Mellon National Bank for working capital during the past year. Senator DOUGLAS. A n d that loan has been repaid? M r . GUNDERSON. I am not informed that it has been repaid. Senator D O U G L A S . Is it true that this loan amounted to $ 1 6 , 0 0 0 , 0 0 0 ? M r . G U N D E R S O N . N O ; the loan amounted to $20,000,000, of which the highest outstanding money taken under it was $16,000,000. Senator DOUGLAS. W h i c h was it, the Bank of America or the Mellon Bank, which got the $16,000,000, that had the $16,000,000? 153 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . GUNDERSON. The credit was by them jointly. I don't know which got which. I t didn't make any difference because each had a half interest. Senator DOUGLAS. Each had $10,000,000 of $20,000,000? M r . GUNDERSON. That is correct. Senator D O U G L A S . I S it true this $ 1 9 , 0 0 0 , 0 0 0 disbursed to Kaiser Fraser has been devoted almost exclusively to reducing or eliminating that loan ? M r . G U N D E R S O N . I don't believe that is a true statement. I think at the time the loan Senator DOUGLAS. When you made the loan didn't you know the purpose for which the $ 1 9 , 0 0 0 , 0 0 0 was to be used? M r . GUNDERSON. Yes; but Senator DOUGLAS. What did they state was the purpose ? M r . GUNDERSON. I don't want to run around, Senator, but at the time we made the loan they had $ 3 5 , 0 0 0 , 0 0 0 i n working capital, and I am sure they didn't use over $8,000,000 of the loan to apply on any back debt. Senator DOUGLAS. They must have stated to you why they wanted the $ 1 9 , 0 0 0 , 0 0 0 cash. M r . GUNDERSON. They stated to us why they wanted it. Senator D O U G L A S . Y O U don't know how they spent the $ 1 9 , 0 0 0 , 0 0 0 ? M r . GUNDERSON. I a m sure we do. Senator DOUGLAS. Could you tell us ? M r . G U N D E R S O N . I would prefer to get that from our loaning agency and provide you with an accurate statement. Senator DOUGLAS. But this is a transaction of such magnitude that it seems strange that it is not known to the men at the top and that it is only known to people in the lower level. M r . GUNDERSON. NO Senator D O U G L A S . $ 1 9 , 0 0 0 , 0 0 0 seems like a large sum of money. M r . G U N D E R S O N . I don't think there is anything strange about it. The loan was approved on the basis that so much of it—and I can give you the exact figures—would be used for working capital and so much for retooling. Senator D O U G L A S . T O the best of your knowledge and belief, was or was not the major portion of the $ 1 9 , 0 0 0 , 0 0 0 which you gave to KaiserFrazer used to retire this outstanding bank loan ? M r . GUNDERSON. Less than 50 percent. I can get the exact figures. Senator D O U G L A S . Y O U think around $ 1 0 , 0 0 0 , 0 0 0 ? M r . G U N D E R S O N . I t was less than $ 8 , 0 0 0 , 0 0 0 . Senator DOUGLAS. I f they had working capital, why did they need to borrow to retire the loan? M r . GUNDERSON. W e w i l l be glad to tell you the reasons they gave us, and the reasons we gave them the loan. One was that when KaiserFrazer began making this automobile—they sold the same automobile for 3 years—they were coming into a more competitive period in the sale of cars. They had attempted to put an automatic transmission on the car last year. Due to certain circumstances, they did not get it. They were faced with sales that were not increasing. They became convinced that it would be necessary to bring the car out on a new basis with some of the competitive characteristics of the other cars, and they had prepared as a part of their operation a car that they 154 MONETARY, CREDIT, AND FISCAL POLICIES believed would do this job. Also, up to the present time, they have only made one automobile, a four-door sedan, wThich restricts them to* 50 percent of the market, because only about 50 percent of the automobiles sold i n this country are four-door sedans. So, they are not competitive across the field. The two banks that agreed to finance them on working-capital requirements would not finance them for tooling, which was necessary i n order to bring out the new car. It was on that basis that they came in and applied to us, believing that, i f they retooled to bring out their new cars, they would be i n a competitive position and would work themselves out of this situation. Senator DOUGLAS. W h a t was the attitude of the Mellon Bank and the Bank of America on continuing to loan Kaiser-Frazer these sums ? Were they calling loans on Kaiser-Frazer ? M r . GUNDERSON. The Kaiser-Frazer people informed me that the banks were entirely willing to continue with those funds, but the $20,000,000 credit was secured by a guarant}7 of two of the Kaiser companies and an agreement that they wouldn't pledge any of the assets, and i n order to give the Reconstruction Finance Corporation a mortgage of the assets as required it was necessary to reduce that loan, which was partially reduced with cash they had on hand and part of the loan proceeds. The bank line was an open account. Senator D O U G L A S . I don't want to use any invidious terms, but isn't the net effect—a large part of the net effect thus far—that you bailed the banks out on this initial disbursement ? M r . GUNDERSON. W e use the term, Senator "bail out," to mean "remove them from a loss." Used in that sense, I do not think we "bailed them out." They were paid off. Senator DOUGLAS. They were paid off out of the proceeds of the loan that you advanced to Kaiser-Frazer ? M r . GUNDERSON. Partially out of the proceeds. Senator DOUGLAS. Well, from where else were they paid ? M r . G U N D E R S O N . The company had $ 3 5 , 0 0 0 , 0 0 0 of working capital. Senator DOUGLAS. I t is just a bookkeeping feat. Y o u say that they had $35,000,000. Y o u gave them $19,000,000 more, making $54,000,000. They paid, let us say $8,000,000 to $10,000,000 out of the $19,000,000 you gave them and paid the rest due out of the $35,000,000. I n practice, you put $19,000,000 in and then they took $16,000,000 out. I would say, on the theory of indistinguishable funds, that you bailed the bank out. M r . BUCHANAN. Were the terms of the loan any better than they were with the bank? M r . GUNDERSON. I think they are more severe. The bank line was unsecured except for a guaranty. W e had a pledge of some $56,000,000 i n machinery and equipment of the company. M r . BUCHANAN. What about interest rate to the company ? M r . GUNDERSON. I don't know what the banks' interest was. I t was probably lower than ours. Senator DOUGLAS. What is the interest rate that you have ? M r . GUNDERSON. Four percent. Senator DOUGLAS. F o r how long a period of time ? M r . G U N D E R S O N . Well, there are two loans. The $ 1 0 , 0 0 0 , 0 0 0 credit is 18 months, and the $ 3 4 , 0 0 0 , 0 0 0 credit, I think, is 3 years. Senator DOUGLAS. What security do you take ? 155 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES M r . GUNDERSON. The company itself, at the time the loan was approved, had $56,000,000 in machinery, equipment, tools, automotive equipment, cash, accounts receivable, and cars. W e have taken a first lien on all that. W e also required a first lien on the plant. There should be no misunderstanding on that plant. The plant was sold by W a r Assets to them for $1,000,000 down payment and a total of $15,000,000. I t had a cost of $42,000,000. A reproduction cost of $47,000,000. The appraiser gave the plant a net value of $58,000,000. W e have a first lien on the plant, on the equipment, and we have a $15,000,000 guaranty by Henry J . Kaiser Co. and Kaiser Engineers, secured by $10,000,000 in marketable value of securities. Senator DOUGLAS. Let me double back for a minute. Is it your understanding that Kaiser-Frazer is now out of debt to Mellon National Bank and Bank of America ? M r . GUNDERSON. That is my understanding. Senator DOUGLAS. A n d that the $20,000,000 loan outstanding has been retired ? M r . GUNDERSON. Y e s , sir. Senator DOUGLAS. A n d your contention is that $8,000,000 of that came from your $19,000,000 ? M r . GUNDERSON. That is the way I would attempt to explain it. I would say, i f we were satisfied we had the collateral, that it was necessary to make this loan in order to keep the business running, we would pay the banks off. W e don't like to pay the banks off, and we do our best to avoid paying banks off; but, when they flatly refuse to go ahead and do what is necessary to help a business, we pay banks off. That is not new. Senator DOUGLAS. I n practice, isn't that what happened? Prior to your loan, the Kaiser-Frazer Co. had $35,000,000 in cash but it owed $20,000,000 in loans to these two banks. M r . GUNDERSON. Never got over $16,000,000. Senator D O U G L A S . $16,000,000, then, in loans to these two banks. Y o u put in $19,000,000. They had a net asset of $19,000,000, let us sav. Y o u put in $19,000,000, building them up to $54,000,000. They retired $16,000,000 worth of indebtedness. So that their net assets were now $38,000,000. So, their net assets were increased by the amount of the loan, $19,000,000, and the banks were really paid off out of the proceeds of your loan. So that, in effect, you did bail out the Mellon National Bank and the Bank of America. M r . GUNDERSON. Senator, paying off is not a bailing out. That is the only point I have made. Senator DOUGLAS. I don't want to use invidious terms, such as "bail out." M r . GUNDERSON. I think that has a definite meaning that does not exist i n this picture. Senator DOUGLAS. Then, let us say that the Mellon National Bank and the Bank of America were paid off out of the proceeds of your loan. M r . GUNDERSON. They were partially paid off. M r . WOLCOTT. Wasn't the indebtedness to the Bank of America endorsed by Kaiser as an individual ? M r . GUNDERSON. Not as an individual. Most of the Kaiser assets are in two companies: Henry J . Kaiser Co. and the Kaiser Engineers. Those two companies had endorsed that line of credit. 156 MONETARY, CREDIT, AND FISCAL POLICIES M r . W O L C O T T . S O the assets of all of those companies were behind the $10,000,000 which was involved? M r . G U N D E R S O N . The line of credit that was arranged was for a maximum of $20,000,000, of which they only used $16,000,000. That was an open line of credit unsecured except for this guaranty. M r . W O L C O T T . T W O loans? M r . G U N D E R S O N . N O ; one loan by the banks jointly. E a c h bank had a half of it. I mean, the banks joined in making that credit available. M r . W O L C O T T . $ 1 0 , 0 0 0 , 0 0 0 ; a line of credit of $ 2 0 , 0 0 0 , 0 0 0 , and the 2 banks split it? M r . G U N D E R S O N . That is right. Senator D O U G L A S . W h y couldn't Kaiser-Frazer Co. have obtained the capital which they needed for retooling, and so forth, by a securities issue? M r . G U N D E R S O N . Their investment brokers, I think it was the F i r s t Boston Corp., advised us that it would not be possible for them to sell their securities. W e went into it very carefully to be sure that the banks—the insurance companies and the investment bankers—could not raise this money for them. That came up when they first came in to discuss this with us last spring. W e were satisfied that they had exhausted the possibilities of either getting the banks to stay i n and participate with us or getting insurance company loans, or of selling their securities. Senator D O U G L A S . D O you see any dangers, i f this Kaiser-Frazer example is blown up into a general practice? M r . G U N D E R S O N . Yes, sir; speaking personally. I don't think the R F C is i n a position to answer that question, but I wouldn't hesitate to say, personally, that you are i n a very dangerous position i f you do not have an adequate supply of equity money for business. There definitely is not an adequate supply of equity capital funds for business today available. Senator D O U G L A S . A n d i n the absence of that equity capital you feel that it is an obligation on the part of R F C to make individual loans ? M r . G U N D E R S O N . I think that Congress, i n writing our act, has written it so that when a borrower has adequate collateral, and is unable to get his money elsewhere, plus the other requirements, we have to do what we can to help them; I think that is the job you have given us to do. Senator D O U G L A S . Y O U didn't take equity i n these companies? M r . G U N D E R S O N . These are capital, working-capital loans; they are capital loans, really. They are well secured, in my opinion; they w i l l be paid off, regardless of what happens to the borrower. Senator D O U G L A S . What you are saying is that the inability of Kaiser-Frazer to get equity capital forced them to turn for intermediate capital to you ? M r . G U N D E R S O N . That is correct. Some of our people, very frankly, have doubts about the future of Kaiser-Frazer Co. and its automobiles. However, i f I did not believe that they had a very good chance of being successful, I wouldn't have, personally, worked so hard to try and help them. I think perhaps, i f the private money market turns around a little bit, they can refinance this whole thing privately in another "7ear or two. 157 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator D O U G L A S . D O you have the same confidence about Lustron Corp. ? M r . G U N D E R S O N . N O , sir. I have never expressed a similar confidence about Lustron. Senator DOUGLAS. D i d you recently make a loan of about $8,000,000 to Lustron ? M r . G U N D E R S O N . N O , sir. They applied for a loan of about $ 1 4 , 000,000 on the first of September; and, as we advised the Banking and Currency Committee, we have been working very hard to try and get the final answer as to whether that business can be made successful, and we have kept them merely on a very small operating basis until we reach that decision. Senator D O U G L A S . H O W much have you advanced in recent months ? M r . G U N D E R S O N . I am sure it wouldn't be over a couple of million dollars. I think we have made three $1,000,000 loans since about August. Senator DOUGLAS. A n d you are keeping them on a month-to-month basis ? M r . GUNDERSON. Yes, sir; until we can reach a decision. We have had an engineering firm, an outside engineering firm, as we told you before, on the original loan. O n two of the second advances, we had Stone & Webster in there. W e employed the firm of Boos, A l l e n & Hamilton, and they are about ready to complete their report on the possibilities of that business and its future. When we get that— and there has been some work we have been doing ourselves—why, we should be i n a position to reach a decision. Senator DOUGLAS. Have you ever wished that you were out of the business of making large loans to companies ? M r . GUNDERSON. Well, I have never wished to be out of the business of trying to be helpful to people who couldn't be helped elsewhere. Senator D O U G L A S . I S there not a danger, when you make loans, that you may not be able to get the funds, when the Government makes large loans, you may not be able to get the funds into the best hands ? M r . GUNDERSON. I don't believe so, Senator. I n the history of the Reconstruction Finance Corporation we have always made, dollarwise, a lot more big loans than we have made small loans. When it was first set up, we used to make hundred-million-dollar loans, as, for instance, to the Central Illinois Bank, to keep it going. I think we are doing the same kind of business today in a different field. I think until something can be done, and I am not saying this in the sense that we feel we know the answers, but I believe that the problem is to ease up investment money sufficiently so that it w i l l go into businesses, and when that is done the R F C w i l l be only making a few business loans. It w i l l be back so that it won't be as large a factor as it is today. O n the other hand, i f investment funds are going to be discouraged from going into business, I think something w i l l have to be done to help business stay open, when they have the collateral and the possibility of paying off a loan. Senator DOUGLAS. I n the field of agriculture, the problem of providi n g credit is largely met, but not wholly, of course, by the creation of intermediate credit banks and by the creation of cooperative banks. I n Germany, beginning about a century ago, they created the so-called Schultze Delitsch banks, which were cooperative banks, to make available credit for small business. 99076—50 11 158 MONETARY, CREDIT, AND FISCAL POLICIES Now, what would you say to the creation of new credit agencies to provide for small business, to meet these needs? M r . GUNDERSON. I don't believe that is the answer, Senator. I think you have got to free equity capital to go into business. Y o u have got to eliminate some of the double taxation on corporate earnings and make it attractive for people who have money to buy something more than municipal tax-free bonds and put it into businesses. A n d when that is done the Reconstruction Finance Corporation business of this nature w i l l sink to a very low volume. I am sure of that, because that was our experience. Senator DOUGLAS. Then, you would say the remedy lies in the abolition of tax on corporate profits and taxing individual income when received ? M r . GUNDERSON. I think some change should be made. I wouldn't say it should be abolished. I think it should be modified so that investing in a corporation is at least as attractive as some other means of investing, because that is the reason for the dearth of capital i n business, and particularly in small business. It is no longer attractive for people to have investments of that character. Senator DOUGLAS. What about noncorporate small business ? M r . GUNDERSON. They should probably have some assistance. I would like to say this, Senator, that during the years I have been with the R F C we are making today a much better type of loan, in my opinion, than we made from 1934 to 1940. The loans we are making now are good loans. Y o u remember our discussions this spring i n the Ranking and Currency Committee about the Northwest Airlines ? I have never understood why we had to make that air-line loan, because that is a fine loan. I t was a good loan at the time the banks made the original commitment. A n d there was no reason at all why it shouldn't have been financed privately. But it was not financed privately. I have every confidence that this loan w i l l be fully repaid on or before its maturity date. O n the basis of operating results for the first 10 months of 1949, the cash available from earnings and depreciation should exceed $6,000,000 for the f u l l year. Over the next 5 years the depreciation account alone w i l l average approximately $6,000,000 per year. I f operations in these years are only at a break-even level, the cash available from depreciation w i l l be more than sufficient to meet the required repayments on the loans. Senator DOUGLAS. D O you see any need for a new type of lending agency to meet the needs of small business ? M r . GUNDERSON. I don't believe so, sir. I think that we may not do as thorough a job as we would like to do, but I think as far as lending money goes, we are supplying the needs of small business for a loan. I don't think an additional source would facilitate it. Senator DOUGLAS. What would you say to giving to the Federal Reserve banks limited power to make direct loans ? M r . GUNDERSON. Well, the Federal Reserve banks have that authority, to make direct loans, have had it for about 11 or 12 years, and they have not done very much business under it. Senator DOUGLAS. H O W limited are their powers ? M r . GUNDERSON. I do not have a record of the loans they have made during the time they have had this authority. I don't know that I can quote the power. It is the authority to make direct industrial 159 M O N E T A R Y , loans—13 (b), I think it is. monetary ? CREDIT, AND FISCAL There is a limitation. POLICIES Is the limitation M r . DOUGHERTY. Y e s ; both. M r . BUCHANAN. F o r working capital purposes only. M r . GUNDERSON. Something like that. There are limitations both as to type and amount of money. Senator DOUGLAS. Would you favor reducing those limitations? M r . GUNDERSON. I don't have any feeling about it. Senator. Senator DOUGLAS. M y general feeling is that it is a very distinct function of the Federal Government to regulate total supply of credit i n order to stabilize business and to maintain an expanding production as well as a stable price level, but that the Government should be very cautious about getting into direct lending activities and insofar as possible it should have these functions performed by middlemen. M r . GUNDERSON. I think that is a sound approach. Senator DOUGLAS. Well, now, following that out, might it not be well to create intermediate institutions which are not governmental agencies, as the R F C necessarily is, to help make loans to small business? M r . (TUNDERSON. I don't see any advantage in it, Senator. I don't think, because something has worked satisfactorily for 17 years, it is a reason for trying to change it. I don't think that as long as you are making loans any agency you could set up would do the job much better than we have tried to do it. Senator D O U G L A S . I am sure you have tried to do well. What we are all holding our breath for, I suppose, is because there is a general fear that the Lustron loan w i l l blow up; and while we wish M r . Kaiser well, we are not at all certain that that is going to come through. I f those two loans should go sour a very heavy blow would be struck at the Reconstruction Finance Corporation. M r . GUNDERSON. I can't agree; i f we were to have a 100 percent loss on Lustron, I don't think it would be any blow to the Reconstruction Finance Corporation. That was done under the Veterans Emergency Housing Act with as near a directive of Congress, short of them appropriating the money, as anything I have ever seen, and i f there is any blow at anybody, it certainly wouldn't be us, because we have done nothing but carry out the assignment the best we could under all of the conditions. I n the case of M r . Kaiser, I am confident that loan w i l l be repaid. Senator DOUGLAS. W E certainly all hope so. M r . GUNDERSON. I feel far more strongly than a hope. I don't think there is any doubt about it. Senator DOUGLAS. M r . Dougherty, did you want to ask something? M r . D O U G H E R T Y . N O ; thank you. Senator DOUGLAS. M r . McCabe, Chairman of the Federal Reserve Board, states, on page 77 of the committee print on monetary, credit, and fiscal policies [reading] : It is my view that both the F e d e r a l Reserve banks and the Reconstruction Finance Corporation may, without inconsistency, operate together to provide financial assistance for business enterprises, provided, however, that there is written into the l a w a provision w h i c h would require the Reconstruction Finance Corporation, before i t extends financial assistance to a business enterprise, to consider whether such assistance is available, not only f r o m commercial banks, but through the Reserve banks. T h i s would be i n the nature of a clarification of the present statutory requirement that the Corporation shall render financial assistance only if it is "not otherwise available on reasonable terms." 160 MONETARY, CREDIT, AND FISCAL POLICIES I wonder i f you have any comment concerning that. M r . GUNDERSON. W e have taken the position, as expressed at some length to the Banking and Currency Committee a year or two ago, and which I might summarize briefly, that i f you want a central bank, perhaps you should give the powers to the Federal Reserve to lend money, but there are two things about the Federal Reserve that lead some people to believe they should not be in the direct lending business or even i n the indirect lending business. That is their banking discounts. I f they were to commit their funds on loans then in times of stress they wouldn't have anything left. Senator DOUGLAS. The discount function of the Federal Reserve bank has virtually disappeared through attrition. The amount of commercial paper which is presented to the Federal Reserve banks for rediscount forms only about 2 percent of the total volume of business. M r . GUNDERSON. I n economic emergency it might be a great deal larger. But the other thing is that they are a supervisory agency of banks, and it is questionable whether they ought to be supervising their own operations. Senator D O U G L A S . I think the second consideration is of much more weight than the first. M r . GUNDERSON. Personally, I don't have any feeling at all as to whether the Federal Reserve should or should not be given authority to make loans. I do not think that people trying to get loans should be put through any more of a devious process than they are now. B y putting in the Federal Reserve, it is just one more place they must go to before they come to us for help. Senator DOUGLAS. What would you say to the creation of banks similar to the agriculture cooperative banks and intermediate credit banks for agriculture, which are fairly well decentralized from government ? M r . GUNDERSON. Well, of course, you know we are fairly well decentralized. Each of our loan agencies has authority to make loans up to $100,000, and handle all that business without recourse to Washington. Senator DOUGLAS. The governing boards of these agencies, as I understand it, are not appointed by the Government but chosen by the groups which are served by the loan. So the shifting is from primarily governmental agencies to primarily voluntary agencies. M r . GUNDERSON. I don't believe that you would get the results with voluntary agencies. It is difficult to get it with an agenc}^ charged with the job of doing it sometimes. I presume you would capitalize such entities, i f you are going to be successful with Government funds. A private pool of bank credit has never been successful in meeting this situation. So I think it is largely a question as to what kind of a job Congress wants done. I f Congress wants a certain job done, as they have i n the last 17 years with R F C , I think R F C is as good an entity to get that result as any. I f it is more desirable to eliminate this function or change it, I don't have any feeling about doing something different, but on the job we are doing I think we can do it as well as anybody else and maybe better. Senator DOUGLAS. M r . Gunderson, would you describe briefly the purposes and functions of the Federal National Mortgage Association, familiarly known as Fanny May. 161 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . GUNDERSON. I n some housing act a long time ago. Congress provided for the creation of a national mortgage association. Pursuant to that, February 10,1938, the Federal National Mortgage Association was set up, I believe, with the primary purpose of creating a secondary market for F H A mortgages. Senator D O U G L A S . Y O U mean it was to be in the real-estate mortgage field what the Federal Reserve was to be in the commercial banking field? M r . GUNDERSON. That is correct. A n d as such its entire function has been in the past and is today purchasing or agreeing to purchase mortgages insured by the Federal Housing Administration, and today that is enlarged because it also purchases loans that are insured by the Veterans' Administration. Back in 1938, at the time when there was a credit stringency, the Federal National Mortgage Association bought a considerable volume of mortgages, which were subsequently sold at premiums, and for a number of years, including the war years, it did very little i f any business. A f t e r the war there was a lot of conjecture that private people who bought mortgages didn't wish to hold them, but I believe probably the best reason is the fact that they believed the interest rate might go up, and there seemed to be a considerable need for an agency to provide a secondary market for F H A and Veterans' Administration insured mortgages, and as a result the Federal National Mortgage Association started in to buy mortgages again. A t the time that Congress indicated to us, by eliminating the R F C Mortgage Company and the other real-estate operations, that they didn't desire to have us make real-estate loans as such Senator DOUGLAS. M a y I interject? A m I correct i n my understanding that the "Fanny M a y " is run by the directors of R F C ? M r . GUNDERSON. Y e s , sir. Senator D O U G L A S . SO that M r . GUNDERSON. I t is for all intents and purposes the same thing. Senator DOUGLAS. I t is the left hand of R F C ? M r . GUNDERSON. I t is just a different account. Senator DOUGLAS. Yes. W h a t is the value of the real estate mortgages which you now hold in your portfolio ? M r . G U N D E R S O N . $637,400,000. Senator D O U G L A S . D O you hold these or do you try to resell them ? M r . GUNDERSON. W e have launched a program, beginning about August, of setting prices on these things. W e are not particularly anxious to make a profit, but we believe there should be some penalty to the people who sell to us; we shouldn't just buy and sell at par. W e have aggressively undertaken the sales, and I would say I think we are progressing satisfactorily. A t the time we started systematically to go about selling them, we believed it would take 6 or 8 months to build these sales up in any great volume. I f my memory is correct we sold about half a million dollars' worth i n August and about a million and a half* in September and about a million and a half in October, and we have tentative commitments for the sale of about $21,000,000. W e have other individual sales of $10,000,000 each under consideration that are not included in the figures I am talking about. I would say that by spring we should be moving at a more rapid and increased rate and i n substantial amounts. 162 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . Well, now, on the mortgages which you hold, w^hat charge do you make for rediscount ? M r . GUNDERSON. Under the F H A and V A acts there are several different kinds of mortgages. I think the highest premium we ask, that is, on old 4%'s, is about 2 points, but we have a schedule of premiums for each type of loan, and I would say that on the bulk of the loans the premium is about a half of 1 percent. Senator D O U G L A S . What do you pay out? M r . GUNDERSON. M r . Dougherty is president of the company. H e might discuss that. M r . DOUGHERTY. F o r those that we buy over the counter we pay par and accrued interest. We pay par and accrued interest for those mortgages we buy over the counter. Senator DOUGLAS. Where do you make your profit then ? M r . DOUGHERTY. Well, we w i l l sell them at a premium after a while. Senator D O U G L A S . Y O U mean the mortgages w i l l sell at a premium ? M r . DOUGHERTY. Yes. Senator DOUGLAS. Isn't that hope rather than realization ? M r . D O U G H E R T Y . Senator, prior to the war we bought $ 2 7 1 , 0 0 0 , 0 0 0 of those mortgages and sold them at premiums of between 5 and 6 million dollars. Senator DOUGLAS. That was prior to the war. M r . D O U G H E R T Y . Yes. Presently Senator D O U G L A S . Y O U bought in a period of low construction cost and sold in a period of high costs, but now you have been buying i n a period of high costs and certainly you cannot sell in a period of still higher costs. M r . D O U G H E R T Y . I hadn't finished the answer, Senator. Senator D O U G L A S . I am sorry. M r . DOUGHERTY. F o r those we buy over the counter we pay par and accrued interest. F o r those for which we issue a commitment to purchase, and those are in the majority, we pay 99%. I f we issue a commitment to purchase a mortgage and it is not sold to us, we charge a quarter of a percent for having issued the commitment, and return the commitment fee except one-quarter of 1 percent. A t the time we issue the commitment, the seller asking us to purchase the mortgage and seeking the commitment pays us 1 percent cash fee, of which we w i l l return him one-half i f he sells the mortgage to us and one-quarter i f he doesn't sell it to us. Senator DOUGLAS. But in practice, don't you make a profit, not from a resale at a higher figure but from the fact that you borrow from the Treasury at a rate of interest which, I assume, is around 2 percent ? M r . D O U G H E R T Y . S O far as income is concerned, that is correct; so far as sale is concerned Senator DOUGLAS. Speaking of income; on income, you borrow from the Treasury at what rate—2 percent? M r . DOUGHERTY. About that, 1% percent is the correct rate. Senator DOUGLAS. Then you collect how much, 4 percent ? M r . DOUGHERTY. Four percent less a half that we pay for servicing the mortgage to the mortgagor. Senator D O U G L A S . Y O U have a iy2 percent credit M r . D O U G H E R T Y . That is right, approximately. Senator D O U G L A S . Out of which you meet your operating costs ? M r . DOUGHERTY. Yes. 163 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Then, in addition, to make any profit on a higher resale figure ? M r . D O U G H E R T Y . I might say that one of the sales to which M r . Gunderson has referred was made at: $500,000 at 1% premium, and for about $7,000,000 of it, 101% is the sale price. Senator DOUGLAS. I f we would have a decline in building costs and in the general price level, you would not have the same confidence, would you, that you would be able to sell at a premium ? M r . DOUGHERTY. Well, they are all the same; regardless of what the cost level may be, your mortgage is insured 100 percent by the Government of the United States and the F H A , and up to 50 percent Senator D O U G L A S . Y O U pass the losses on to someone else ? M r . D O U G H E R T Y . NO. The Government guaranty doesn't change because building costs go up or down. I t remains the same. M r . W O L C O T T . Y O U sell them in bulk also? M r . DOUGHERTY. Yes. Senator DOUGLAS. W h y do the building and loan associations, and so forth, want a rediscount market if they have a hundred-percent guaranty ? M r . DOUGHERTY. That is a mystery we w i l l never be able to solve. We do not know why they do not keep them as investments and why Congress has been obligated to increase the amount of money we spend for them and place limitations upon the kind of mortgages we can buy. Senator DOUGLAS. That is a mystery that is running up into hundreds of millions of dollars, M r . GUNDERSON. I t can be broken down. I believe one of the principal reasons during the past year was the belief by people that the interest rate might be increased of the insured mortgages, which would mean a half percent or more yield. Say F H A would be 4 ^ . Senator DOUGLAS. They want cash to go into new mortgages ? M r . GUNDERSON. Yes. I think when the feeling becomes prevalent that the market is stabilized at 4 percent, they w i l l move back out la rgely where they were. That may not be the only reason, but I think it is one of the important reasons. Senator DOUGLAS. That is all the questions I have. M r . B U C H A N A N . H O W are the lending activities of R F C coordinated with the Federal Reserve in general credit processes? M r . GUNDERSON. Rather loosely. They are coordinated. I n order to explain the position, the type of loan that we make is confined to a rather narrow group of loans when you consider the over-all credit, the types of credit available in the country. F o r example, probably the largest bulk of credit available is consumer credit. Time credit of appliances and purchases at retail stores and that type of credit run into billions of dollars. One of the others, also, which you could probably include in consumer credit, is the short-term bank loans of one type or another, both to individuals and to stores, with which to purchase, carry, and sell merchandise. That field of short-term consumer credit is a very, very vast field. I have seen figures on it which run up into the billions of dollars. Our field, on the other hand, is restricted to a very narrow field where the borrower must have enough collateral. W e cannot lend a fellow, no matter how good he is, if he has marketable securities or Government bonds or money i n the bank; our field of lending is 164 MONETARY, CREDIT, AND FISCAL POLICIES usually on fixed assets. So the typical loan we make is one on a plant or a store, and it is usually for the purpose of either replenishing loss incurred in operating the business or to build an addition to the store, and so forth. Now, the only case that has come up recently was the administration's and Congress' wish to restrain inflation a number of years ago. A t that time the President, i n his message, indicated that the Federal Reserve would take certain steps, and one of the steps the Federal Reserve took was to restrict and curtail in very large measure certain aspects of consumer credit such as monthly payments on automobiles and that kind of thing. Now, at that time we advised all our people to avoid making any loans that were inflationary. A t the same time, the President indicated he wanted every possible aid given to production, with the idea that i f you increase production sufficiently, you w i l l overcome scarcity and decrease inflationary tendencies. Except for the fact that we made a few loans i n the past, maybe to theaters or bowling alleys or something like that, almost every loan the R F C makes is one i n production and distribution. So wTe told our officers' and our people that we did not want to make any loans that were inflationary. A s near as we can define an inflationary loan it was some loan for what I would say would be a nonessential purpose that used up scarce building materials—that type of thing. I t is a very loose thing, but we conscientiously tried to conform to what the Federal Reserve is doing, and in the very small and narrow sphere in which we lend, I think it is adequate. M r . BUCHANAN. What percentage break-down do your loans take i n the form of production and distribution and the other fields ? M r . GUNDERSON. Can you give that, M r . Considine ? M r . CONSIDINE. F o r the quarter ended September 30 of the loans we made, the R F C ' s share of the loans we made, which was $177,600,000, 31.7 percent represented loans for construction purposes, 30.3 percent represented loans for working capital purposes, 27.8 percent for debt payment, and 9.6 percent for machinery and equipment, 0.6 percent for purchase of real estate to be used i n the business, which accounts for the whole 100 percent. M r . B U C H A N A N . H O W much on accounts receivable i n consumer goods ? M r . CONSIDINE. That would be 30.3 percent; inventory loans, accounts receivable. M r . BUCHANAN. Is there a break-down i n that figure ? M r . GUNDERSON. I do not think we can give a break-down on accounts receivable, but I can tell you that our loans on accounts receivable are minute. They are very small. M r . BUCHANAN. W o u l d they be about 15 percent of that figure? M r . GUNDERSON. M y guess is it might even be less than five, might be down around one, because we never make an accounts receivable loan by itself, and usually the only time we take them is' when it is absolutely essential to the business to have a little more money than he can get on his building, equipment, etc., and he has to have it i n order to make a go of it. I f the only source of collateral remaining is a few accounts receivable, we try to do it, but i n almost any business, except up i n 165 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Boston last spring when the banks quit loaning on accounts receivable, they can borrow on accounts receivable. Our lending is largely restricted to term loans on plants and equipment. M r . BUCHANAN. I was thinking of the problem of small business i n regard to contraction by banks on that type of loan and their availability of funds and the only assets left are accounts receivable that they are able to pledge. It is a growing problem with those lines of activities such as furniture and household appliances. M r . GUNDERSON. Unless we have a local bank participating—we have had loans, for example, to dry-cleaning and pressing establishments, which may have thousands of accounts that w i l l run from 75 cents to 3 or 4 dollars. W i t h our set-up, although we can go to any extent to be helpful, i f we do not have a participating bank in that town which can function with the substitution and release of those accounts receivable monthly, you get unwieldy. W e would rather lean over backward and leave them freer on that because, while we do everything we can to help small business, we are not in a position to service things like a vast amount of small accounts receivable loan. I t is difficult for the borrower as well as for us. Mr. BUCHANAN. Even things of a semidurable nature such as household furniture and refrigerators? M r . GUNDERSON. W e have never done much of it. W e did it i n the Kaiser-Frazer loan, that $10,000,000 loan. M r . BUCHANAN. That is where the business units have outgrown the banking facilities ? M r . GUNDERSON. That is where C I T , for instance, does not wish to operate. The bulk of dealers w i l l be financed on the floor plan by credit agencies, and none of that money is available until the regular credit agencies turn one of them down. We have run into more applications in the last 6 or 8 months asking for us to lend them money to assist them in financing certain types of their business, which is accounts receivable, than we have had i n a long time. M r . BUCHANAN. The present moratorium in the strike areas of the steel and coal sections—is that going to lead to a demand for that type of loan ? I have had inquiries. M r . GUNDERSON. W e can certainly help them i f they cannot handle it privately. M r . WOLCOTT. W h a t profits do you show on your loan operations? M r . GUNDERSON. Gross to date about $560,000,000, M r . Wolcott. Have you got it for this year, M r . Considine ? That is after setting up reserve for losses of over a hundred million. So far it has totaled $568,000,000. Senator DOUGLAS. Does that include interest on Government advances to R F C ? Have you deducted interest paid to the Government ? M r . GUNDERSON. Yes; that is correct bookkeeping; net. Senator DOUGLAS. That is profit over and above cost of capital furnished to you by the Government ? M r . GUNDERSON. Y e s , sir. M r . WOLCOTT. Y o u r net would be minus your reserves, so you have made something over $500,000,000 ? M r . GUNDERSON. Yes. 166 MONETARY, CREDIT, AND FISCAL POLICIES M r . C O N S I D I N E . I might add, $ 3 0 7 , 0 0 0 , 0 0 0 of that was paid as a dividend to the Treasury last December, subject to the requirements of a recent act. M r . W O L C O T T . D O you think, M r . Gunderson, i n the operation of R F C i n making investment capital available to small industry, that you perhaps have prevented concentration or helped to prevent concentrations of industrial and commercial power ? M r . G U N D E R S O N . Definitely, M r . Wolcott. W e have certainly done that, and we have done one other thing that is a little difficult to explain, but it interests me. I had a record kept in one of our loan agencies for about 18 months, from J u l y 1946 to about March 1948. I had them keep an individual detailed record of each application from a borrower, the type of business he was in, the amount of money he asked for, and the amount of the loan that the R F C approved. Then we did one other thing: W e broke that list down into the loans that we actually paid out the money on; and the loans thereafter, after we had done all the work, banks and insurance companies took over the commitment and paid it out on our terms. The amount of loans made in which we did all the work and disbursed no money was $ 1 3 , 4 0 0 , 0 0 0 , and during the same period we made and disbursed loans to the amount of $ 3 , 5 0 0 , 0 0 0 . That was just one of our loan agencies. So we have done and continued to do an excellent job i n putting together a situation in businesses that are in difficulty, whereby private sources that were not available to them before we went to work on it come to their assistance after we have put the picture together. M r . W O L C O T T . A f t e r you have made a survey, a study, and a commitment, then a bank takes over the loan, and there is no way of reimbursing you for the service you have performed ? M r . G U N D E R S O N . N O , sir. That is a gratuitous service on our part. M r . W O L C O T T . W h a t is your total borrowing power now? M r . G U N D E R S O N . Three billion five. M r . W O L C O T T . What part of that has been theoretically set aside for capital for "Fanny M a y " [ F N M A ] ? M r . G U N D E R S O N . T W O and one-half billion. M r . W O L C O T T . S O there is a very definite limitation upon your operations ? M r . GUNDERSON. Y e s , sir. M r . W O L C O T T . Y O U have in the neighborhood of a billion and a half of borrowing power with which to compete with our entire economy, and the Congress can or cannot, just as it pleases, expand your authority in that respect as it did during the war; is that right ? M r . G U N D E R S O N . M r . Wolcott, in addition to the monetary limitations, the much more real limitation is the wording of the act and the requirement that credit cannot be privately available and that a loan has to be so secured as to assure repayment. I n my opinion, enforcement of those two conditions is such that it is almost a physical impossibility, no matter what the situation, to find enough loans to use up the money over a very long period of time. M r . W O L C O T T . That language surely prevents you from getting into open competition with private lending institutions. 167 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . GUNDERSON. It means that we have to exhaust every possibility of having a thing financed privately; and we have been, I think, very successful. I know of a case where the fourth largest biscuit-manufacturing company in the country came in to get a loan from us about a year ago, and it already had a loan from one of the insurance companies, and it had embarked upon a program of modernization following the war in which they put i n automatic bake ovens. They had spent about $2,000,000 more than they had expected. They came down because they had exhausted all possibilities of getting credit privately, and I suggested that they go back to the insurance company and offer the insurance company the same rate of interest we would require and the same term of years. After about 6 weeks' negotiating they got the insurance company first to agree to take half of the loan we might make to help them, and finally the company took it all. Those types of our assistance are in carrying out the direction to be sure private capital is not available; and it results in, I would say, on an a verage, two or three loans being made privately that have been turned down by private sources after they have come to us throughout the country. That is why I say that business of exhausting them is a restriction on the amount of work you do. Also, the limitation that it must be so secured as to reasonably secure repayment ties it down to where they must have physical assets, and it eliminates the consideration of all the types of loans that constitute the largest bulk of credit in this country, like a note at the bank for a line of credit. W e cannot do any business like that. Somebody has to have a building or machinery with a market value to it before we can do anything for them, and it is a very real limitation and one that restricts the rate at which we can lend and the number of loan applications, short of some major economic catastrophe. M r . W O L C O T T . W E built you up during the war so that in the spring of 1947 you had a potential borrowing authority of—we never could determine just what it was, but it was between 14 and 18 billion, was it not ? M r . GUNDERSON. That is correct. M r . WOLCOTT. I t is not your impression that we changed the identity of the Corporation in respect to loans to business and banks when we cut you back 2 years ago to the $2,000,000,000 and you became a sort of stand-by organization to meet any emergencies that might arise in the future—it isn't your impression that it was the intent of Congress to give you any more or less power to compete with private enterprise than you had before that ? M r . G U N D E R S O N . N O , sir. The two actual changes in the act, the elimination of loans on purchase of preferred stock, the only change i n this business-loan section M r . WOLCOTT. Preferred stock in banks ? M r . GUNDERSON. Yes. The only change in the wording of the section of the R F C A c t which covers loans to business was the addition of three words: "encourage small business." Mr, W O L C O T T . N O W , I just want to make this statement for what it might be worth. Back in 1940 when we gave you these very broad powers, especially under 5 (d), and then later on increased your borrowing authority to upward of $14,000,000,000, it was very appar- 168 MONETARY, CREDIT, A N D F I S C A L POLICIES ent that the R F C had the authority, the power, i f it had missed it, to socialize our banking structure and to control the flow of credit to agriculture and business and industry. I think it is to the great credit of the Board of the R F C that that power was never abused in that respect. The Congress has always been very cautious not to continue those powers beyond the time when it was found necessary for war purposes, so that any Board in the future that might think otherwise would not have the power to socialize our banking and credit or industry generally. I have always thought that the R F C did a very splendid job during the war in financing our war effort, and especially that it did not at any time misuse its powers to the prejudice of the American system of government. The fundamental and basic issue before the country today appears to be whether we are going to perpetuate the American way of life. Government was set up to encourage and regulate business but not to control it to the point where there would be through Government control or otherwise a too high concentration of financial and industrial power. I think that the R F C has done a very splendid job in contributing to that ambition, which we all should have that America continue strong. I think I should correct a thought I had and I might have expressed to loans made by the Federal Reserve. M r . Buchanan called my attention to that paragraph on page 76 of the preliminary hearings which states that the restrictions on those loans which it says under present law they—that is, the Federal Reserve banks—may make commitments on loans only for working capital purposes, only to "established" business, and only with maturities not exceeding 5 years. These are severe limitations upon the ability of the Reserve banks to render effective assistance in meeting the requirements of smaller businesses. O f course, that does not remove in any manner the basic objection to Federal Reserve banks making direct loans. W e have always successfully fought attempts which have been made to make the Federal Reserve banks banks of deposit and to authorize the Federal Reserve banks to make loans, whether to small business or to big business or anyone, which would put them in direct competition with the members over which they have control. I t is directly contrary to the theory behind the establishment of the Federal Reserve System i n 1913 and the amendments which we have adopted to it. I can readily understand why the Federal Reserve System might think that the only way they can control the volume and velocity of credit is to get control over the issuance of credit ; but, of course, that is to me a rather superficial reason because, of course, i f the Federal Reserve Board is going to do an effective job i n that field, which the Congress itself delegated to it, then the Federal Reserve System would have to be given control over all expenditures in respect to our foreign affairs and E C A and every other expense which the Government has which involves the raising of money. The only other way you could concentrate control of credit would be to transfer the R F C , the Federal home loan banks, the Federal Reserve banks into the Treasury and put them all under the single head; and I do not think anybody is advocating that. 169 M O N E T A R Y , CREDIT, AND FISCAL POLICIES So I think we should proceed rather cautiously in any recommendation we make that the Federal Reserve Board change its identity from that of its present set-up to one in which they are doing a general banking business. We d i d give them the authority at one time, the Federal Reserve Bank of New York, as I recall it, to accept some deposits to the account of foreign countries temporarily. That is the nearest we have come to giving Federal Reserve banks authority to accept deposits. I guess that is about all. Senator DOUGLAS. One final question, M r . Gunderson, which I would like to ask you. W h o owns the profits of the R F C ? The same question has from time to time arisen in connection with the Federal Reserve banks and System, and the Federal Reserve System brought some gifts up to the altar and presented them to the Treasury i n possible anticipation of congressional legislation and possibly with a desire to forestall congressional legislation. Now, i n the case of the R F C , who owns these five-hundred and sixty-odd million dollars ? M r . GUNDERSON. The United States. Senator DOUGLAS. N o t the R F C ? M r . GUNDERSON. Under our act Congress has permitted us to retain $100,000,000 worth of capital and $250,000,000 in surplus, together w i t h the adequate reserves; anything we make over and above that it has to be paid into the Treasury at the end of each year. Senator D O U G L A S . H O W much have you paid into the Treasury ? M r . GUNDERSON. W e have paid $307,000,000. Senator DOUGLAS. Over a period of time ? M r . GUNDERSON. I n the last couple of years, because that provision was just put i n our act about 2 years ago. Senator DOUGLAS. I n addition to that, you have accumulated your capital and surplus ? M r . GUNDERSON. Y e s , sir. Senator DOUGLAS. Y o u have retired the advances ? M r . G U N D E R S O N . A l l but $ 1 0 0 , 0 0 0 , 0 0 0 i n capital stock, but we have surplus and reserves. The best picture on it is that our gross earnings to date are $ 5 6 8 , 0 0 0 , 0 0 0 , of which $ 3 0 7 , 0 0 0 , 0 0 0 have been paid into the Treasury. M r . BUCHANAN. Since the inception of the R F C i n 1932 ? M r . GUNDERSON. That is correct. M r . W O L C O T T . We did write off in legislation about $ 2 , 0 0 0 , 0 0 0 , 0 0 0 of losses in the R F C as a result of extracurricular activities during the war. M r . GUNDERSON. Nine billion. M r . W O L C O T T . Y O U had been mandated to raise money for activities upon which you could get no return. M r . GUNDERSON. That was written off, and on the liquidation of that Ave still, as a liquidation of the war activities, run by direction of Congress the synthetic-rubber program, the tin smelter at Texas City, certain abaca properties i n Central America, and a handful of leases on plants in the process of liquidation; but all proceeds from all that activity goes to the miscellaneous proceeds of the Treasury. Senator D O U G L A S . A S I remember, financial statements on those activities showed a profit, too; is that right ? 170 MONETARY, CREDIT, A N D F I S C A L POLICIES M r . G U N D E R S O N . N O , sir. They did not show a profit, for the reason that much of the money w^e spent during the war was i n the payment of subsidies. Senator DOUGLAS. The operations i n the last fiscal year, I mean. M r . GUNDERSON. Oh, yes. There is profit on most of these operations, M r . WOLCOTT. Y o u paid butter and other food subsidies. M r . GUNDERSON. A l l metal and food subsidies were paid out of those funds during the war. Senator DOUGLAS. W i l l you furnish statistics on various points which we have brought out; that is, the loans outstanding, classified by size, the earnings of the Corporation above costs, and so on ? M r . GUNDERSON. Yes; that w i l l be done. (The following tables were later submitted for the record:) Business loans outstanding, by size, as at Sept. 30,1949 D I R E C T LOANS Number Less than $500,000-$500,000 to $1,000,000 $1,000,000 to $5,000,000 $5,000,000 and over. Total ... .. __ Amount 5,477 41 33 11 $148, 297, 000 26,338, 000 69,320, 000 189,640,000 5,562 433, 595,000 D E F E R R E D PARTICIPATIONS IN B A N K LOANS Number Less than $500,000 $500 000 to $1,000,000 __ $1 000 000 to $5,000,000 _ $5 000 000 and over Total Business - -_ - - _ . -- . loan authorizations, by size, July 1, 1948, through Number 798 591 1,084 $5,000 and under $5,001 to $10,000 $10,001 to $25,000 Total $25,000 and under $25,001 to $50,000 $50,001 to $100,000 - Total $25,001 to $100,000 $100,001 to $200,000 $200,001 to $500,000 Total $100,001 to $500,000 $500,001 to $1,000,000 Over $1,000,000 Total $500,001 or more Total - R F C share 6,453 8 3 1 $127,048, 000 5, 247,000 7, 241,000 9,143,000 6,465 148, 679,000 Sept. Gross amount $2,392, 203 4, 616, 783 19, 508, 780 30, 19^9 R F C amount $2,313,894 4,188,419 16, 962, 959 2, 473 26, 517, 766 23,465, 272 935 759 36, 521,041 60, 306, 969 31, 236, 608 51, 957, 735 1, 694 96, 828,010 83,194, 343 243 224 37, 423,372 71, 929, 355 32, 883, 772 63, 601,195 467 109, 352, 727 96,484,967 71 77 52, 474, 892 308, 461,361 46, 810, 295 276, 568, 313 148 360, 936, 253 323, 378,608 4, 782 593, 634, 756 526, 523,190 171 M O N E T A R Y , Reconstruction lending Finance activities Corporation—Consolidated cumulative from inception T o t a l income Less: A d m i n i s t r a t i v e expense Interest expense A l l other expenses Income before provision for losses P r o v i s i o n for losses Total CREDIT, AND FISCAL POLICIES statement of income from through June 30, 19^9 $1,328,117,141 $193, 767, 680 369, 453, 214 11,780,287 575, 001,181 753,115, 960 188, 039, 575 565, 076, 385 Senator DOUGLAS. IS there anything further, M r . Buchanan ? M r . BUCHANAN. Nothing further. Senator DOUGLAS. M r . Wolcott ? M r . W O L C O T T . N O questions. Senator DOUGLAS. Thank you very much. The committee w i l l stand adjourned. (Whereupon, at 4:10 p. m., a recess was taken until 10 a. m., Friday, November 18, 1949.) MONETAEY, CEEDIT, AND FISCAL POLICIES FRIDAY, NOVEMBER 18, CONGRESS o r T H E U N I T E D 1949 STATES, S U B C O M M I T T E E ON M O N E T A R Y , CREDIT, AND FISCAL POLICIES, J O I N T C O M M I T T E E ON T H E ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to adjournment, at 10:20 a. m., i n the caucus room, Senate Office Building, Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senator Douglas, Representatives Buchanan and Wolcott. Also present: Dr. Grover W . Ensley, acting staff director, and Dr. Lester V . Chandler, economist to the subcommittee. Senator D O U G L A S . M r . Burgess, we are glad to welcome you this morning. I understand that you are chairman of the executive committee of the National City Bank of New York, member of the Federal Advisory Council from the New Y o r k Federal Reserve district, and, I believe, formerly vice president of the New Y o r k Federal Reserve Bank; so you are able to review this situation both from your present position as a private banker and your former position as a public banker or quasi public banker. I understand you have a statement which you have prepared. I w i l l be very glad to have you read it. STATEMENT EXECUTIVE OF W. RANDOLPH COMMITTEE, BURGESS, NATIONAL CITY C H A I R M A N B A N K OF OF N E W T H E YORK M r . B U R G E S S . Senator, I might add that I have been on three sides of this triangle. I have also done some tours of duty with the Treasury from time to time, but I am speaking wholly for myself i n appeari n g before you today. I would like to present a very brief statement as perhaps a quick way of giving you my general philosophy about the place of the Federal Reserve System i n the economy. I n today's search for economic stability we ought to reassess the position and operations of the Federal Reserve System, for I believe it can be the most powerful instrument the Government possesses for avoiding booms and busts. Properly used, it can be more effective than fiscal policy or any of the newer gadgets which have been highly advertised, but have never proved themselves. This and other countries have today committed themselves to the principle that the Government must intervene i n economic life, not only to see that the game is played according to rules that are fair for all, but also to seek to avoid sweeping instabilities which bring with them the excesses of speculation on the one hand, and the distress 99076—50 12 173 174 MONETARY, CREDIT, AND FISCAL POLICIES of unemployment on the other. B y education and the accumulation of experience and wisdom the business and agricultural communities ought by themselves to reduce some of the causes of instability; since the war they have demonstrated their ability to do so. I am not sure it is clear what I mean by that, but it seems to me i n the period since the war that business and agriculture have exercised a great deal of restraint. I n the inflationary period they did not go off the deep end. The farmer paid off his debts instead of acquiring more as he did after W o r l d W a r I. The businessman, when prices went down i n 1948 and 1949, found himself with inventories, which he liquidated, but it did not disclose serious weaknesses, which is an evidence to my mind that the business community has been learning something. Nevertheless, Government has a duty to exert a positive influence for greater economic stability. Too often, alas, Government has been the chief offender i n creating instability. Senator DOUGLAS. Then I take it you do not object to the general thesis that the Government should exercise powers to help create stability, that your objection is to what you believe an improper use of these powers ? M r . BURGESS. Yes; as to the use of the powers we have experimented with—we have not got the final answer yet, but we are committed definitely to the Government's intervention. Senator D O U G L A S . Y O U would not alter that? M r . B U R G E S S . N O ; I would not alter that. Our own and other governments have tried i n recent years three different methods for checking booms and depressions. One of these is establishing direct control—somebody at headquarters makes a plan of fixing prices and wages and rationing goods, general exchange controls, and what not, and compels the people to follow it. Except in a completely totalitarian country like Russia or i n wartime these methods do not work well. Senator D O U G L A S . Y O U would make an exception i n wartime for democratic countries ? M r . BURGESS. That is right, you have to do it i n time of war. Senator DOUGLAS. W h a t about the period immediately following the war ? M r . B U R G E S S . Y O U have to work out of it gradually. Obviously, you cannot simply drop them immediately. O f course, anybody who goes to Europe is impressed with the fact that these controls lose their effectiveness as they go on and people find they way around them and they do not do the job. They grow more and more difficult to enforce, and they gradually choke off the free flow of initiative and enterprise which are the lifeblood of our economic system. They are abhorrent to our democratic notions of the freedom of the individual. The most fashionable recent idea in this country for combating economic instability is the "compensatory spending" theory. A whole metaphysics has been developed on precisely how to manage fiscal policy in a way that w i l l stabilize the economy. The Federal budget is of course an important economic influence, but not always a salutary one. Experience of recent years is discouraging to the belief that the budget can be so subjected to economic control that its fluctuations w i l l become a stabilizing influence i n the business 175 M O N E T A R Y , CREDIT, AND FISCAL POLICIES cycle. According to the theory, spending should be reduced when the economic goose hangs high, and increased in depressions. So far, about all we have succeeded in doing since this theory gained official sanction has been to increase the budget i n both booms and depressions, with the notable exception, of course, of the fiscal year 1948, when we really did have a surplus. Budgets are instruments of politics, and to make them also economic tools is asking much of human nature. That is simply saying in other words what you yourself, M r . Chairman, have said in these hearings: that so many people participate in these decisions that to get the thing agreed on and going one way is very hard to do. The best practice w i l l be to fortify insistently the old tradition that budgets are to be balanced. Circumstances themselves w i l l unbalance them often enough despite all that can be done. Senator DOUGLAS. Would you say budgets should be balanced in a depression period? M r . B U R G E S S . N O ; I think the principle is that you want your budget balanced. Y o u recognize you cannot always do it. Y o u plan out a balance, and your income drops away, and you find yourself with an unbalanced budget. Senator D O U G L A S . Y O U say you should not increase Government expenditures during a depression, and any unbalance would come from shrinkage i n revenues ? M r . B U R G E S S . I would not go that far. There may be occasions wThen you find it necessary to increase expenditures in a depression. Senator D O U G L A S . I think the presumption would be i n favor of increasing expenditures i n a depression to offset the decline of private business. M r . BURGESS. Well, that is one of those difficult questions where we would probably mean the same thing. The thing that, of course, impresses one at this time is the extreme difficulty in getting a democracy to balance the budget, to overbalance it at the right time Senator D O U G L A S . Y O U mean it is difficult to get a government to balance a budget i n a period of prosperity ? M r . BURGESS. Yes; it is difficult at any time. Senator D O U G L A S . N O W , I go with you on the principle that in prosperity the budget should be balanced, and you should have a surplus to retire a portion of the public debt; but I think that there is danger that the advocates of balancing a budget i n a period of prosperity may go too far and say that you should not expand expenditures i n a period of depression. M r . B U R G E S S . I think there is a danger. I do not think I differ fundamentally from you. Senator DOUGLAS. What you are afraid of is that it w i l l get Congressmen and economists i n bad habits i f they embrace the principle of unbalancing budgets i n periods of depression? M r . BURGESS. That is right. Senator DOUGLAS. A n d you are afraid of a relative system of economic ethics lest it destroy the desirability of balancing budgets in periods of prosperity ? M r . B U R G E S S . S O many of us do not determine our immediate actions by long-term objectives, but by rules and by what you call ethics, the ethics of a thing, and the ethics are highly in favor of a budget balance. 176 MONETARY, CREDIT, AND FISCAL POLICIES I f we say that does not mean anything, push that old rule to one side, the danger is we go along year after year with an unbalance. I n the very laudible effort to seek to control our expenditures with an eye on the economic climate, we must not give people the impression that we are just putting aside that old ethic. That is all I am arguing. The third of the traditional methods of affecting business fluctuations is the regulation of money through changes in the supply and cost of money. History records many instances of the successful use of this instrument. F o r years, the Bank of England, by changes in its discount rate, or by its purchase or sale of bank acceptances or Treasury obligations, influenced the flow of funds in and out o f the London market. More important still, it influenced the activity of the investment market. The Federal Reserve System now has a long history of attempts at credit control—some more, some less successful. There are great advantages in trying to influence economic fluctuations through the money supply. I n the first place, it can be done. The central banking system has the power to change the price of money and to influence the volume of money. It can act with the decisions of a relatively small group of men. I t does not have to have the number of people in agreement that you do when you deal with the budget. The second advantage o l using monetary action as a method of influencing business is that this method is consistent with democracy. Y o u don't have to tell the individual borrower or lender what to do, but you create the conditions under which he makes his own decision. I f we must have some form of Government control, the best form in all our experience is control through money, because that involves the least interference with the freedom of the individual to make his own choices in his economic life. A n y skeptic as to the power of money in any economy does well to examine the dramatic illustrations of the results of recent basic changes in money values and credit policies in Belgium, Germany, and Italy. These were extreme cases, but they revealed vividly the improvement that can follow large doses of good old-fashioned monetary medicine. M r . W O L C O T T . I think perhaps, when M r . Burgess uses the term "money" here, we understand that he does not narrow it to hard money; that the term also embraces credit. M r . BURGESS. That is right, bank deposits, and the credit currency we all use. M r . W O L C O T T . I suggest that be in the record. Somebody reading the record might think he is referring to Federal Reserve notes, tens, twenties, and so on—hard money. M r . BURGESS. The Federal Reserve System is our mechanism i n the United States for money management, and I suggest that today it offers a better hope for successful Government influence toward business stability than any of the newer products of the economic laboratories. But, i f the Federal Reserve System is to realize the high purpose for which it was created, it w i l l require from the American people, and more directly from the Congress and from the other arms of Government, better support and cooperation in three special directions. 177 M O N E T A R Y , CREDIT, AND FISCAL POLICIES 1. T H E PRESTIGE TO A T T R A C T A B L E M E N The symbol of the standing of the System is the salaries which are paid the Federal Reserve Board. The salaries recently approved by the Congress would condemn the System to a position as simply one of many Government regulatory agencies. They should be higher. Senator D O U G L A S . M r . Burgess, as I remember it, in the recent topbracket salary bill which Congress passed, we raised the salaries of members of the Board to $16,000. M r . B U R G E S S . That is right, from $ 1 5 , 0 0 0 to $ 1 6 , 0 0 0 . Senator D O U G L A S . N O W , I personally wanted to raise them more than that, but the difficulty that we ran into was that there was quite a demand that the salaries of the members of the Federal Deposit Insurance Corporation should be on a parity with the Federal Reserve Board, and there was a reluctance to raise the salaries of the members of the Federal Deposit Insurance Corporation Board to $22,000; and, therefore, holding the salaries of the Federal Deposit Insurance Corporation Board to $16,000, on the principle of equality, meant keeping the Federal Reserve Board down to $16,000. I wondered i f you would comment on that. M r . B U R G E S S . I think they are all underpaid for the work that they do. Senator D O U G L A S . W o u l d you recommend raising the Federal Deposit Insurance Corporation Board to $22,000? M r . B U R G E S S . I would be inclined to suggest $ 2 0 , 0 0 0 for both the Board of Governors and, let us say, the Comptroller of the Currency and the head of the F D I C . Senator D O U G L A S . I am not a suspicious man, but we received lots of telegrams from banking groups insisting on the F D I C being kept on an equality with the Federal Reserve. I t crossed my mind that that might be a move to keep down the salaries of the Federal Reserve. I wondered i f you were at variance— whether my suspicions were entirely unjust or whether you were at variance with a large proportion of the banking fraternity on this issue. M r . B U R G E S S . I would not be able to read their minds, M r . Senator. Senator D O U G L A S . A t any event, irrespective of what is done in the case of the Federal Deposit Insurance Corporation, you would be in favor of increasing the salaries of the members of the Federal Reserve Board ? M r . B U R G E S S . I would. I think what they do is of enormous importance for the economy of this country. Senator D O U G L A S . I notice you use the term "symbol" rather than "payment." Y o u think that it is not so much the increase in salary but the fact that the gentlemen would have more chips and would, therefore, be indicated to be good poker players in the game of life; is that right ? M r . B U R G E S S . That is a pretty good way to express it. There is a lot of protocol in Washington as well as everywhere else, and what you get is a symbol of your rating. There are some members of the Board to whom the salary does not mean anything of importance. The other point, of course, is that it has been difficult to get members of the Board. I know of a good many cases where people declined membership on the Board, people of the sort you would like to have 178 MONETARY, CREDIT, AND FISCAL POLICIES there. Younger men with other opportunities and a family to educate find it very difficult with those salaries. M r . B U C H A N A N . Y O U do feel, M r . Burgess, that the members of the Federal Reserve Board should be compensated on a higher level than other comparable agencies, such as, for example, the F D I C ? M r . B U R G E S S . I think the work of the F D I C is enormously important and might be critical i n a time of emergency. B u t the work of the Reserve Board in terms of the broad movement of the economy is just out of the class of Government regulatory agencies which deal with special sectors of the economy. They have got the f u l l thing to deal with, and it takes men with breadth of understanding and experience. That is my long way of saying "Yes," M r . Congressman. 2. I N D E P E N D E N C E OF A C T I O N D u r i n g the war the System necessarily became an instrument for enabling the Government to finance the war swiftly, surely, and economically. That role has been continued too long into peacetime. I f the Reserve System is to act vigorously and effectively to check inflation or deflation, it must be free to take action i n controlling credit volume, which w i l l inevitably raise or lower interest rates, and hence the prices of Government securities. There can be no tightening or loosening of credit without affecting interest rates. They are the thermometer of credit. I am one of those people who think there should be flexibility in rates and prices. Senator D O U G L A S . I want to have you finish the next paragraph, and then I w i l l ask some questions. M r . B U R G E S S . Neither can the Federal Reserve System be treated as just one of the political instruments of the administration. The wise Executive w i l l yield to the Reserve System a substantial measure of independence of action so that its judgments can be objective and free from political bias. Only so can it do promptly some of the hard things that have to be done—and politically unpopular things—if inflationary tendencies are to be checked before they blossom into the booms that so often induce depressions. Senator D O U G L A S . M a y I ask you some questions on those two paragraphs, because they hint at a lot of issues. M r . B U R G E S S . I come back to some of that later. Senator D O U G L A S . W o u l d you prefer to finish your statement ? M r . B U R G E S S . Perhaps so, because I think we are wading into some very deep water. The Federal Reserve System needs a certain measure of cooperation from other Government agencies. I n the recent inflation, for example, the Reserve System and the commercial banks were conducting a vigorous campaign to resist inflationary extension of credits. A t the same time other Government lending agencies were pumping out credit vigorously and freely. The activities of these other agencies partly offset restraining action taken by the Reserve System. Some plan of coordination of the activities of lending agencies along the line of the proposed credit council, which Chairman McCabe referred to i n his testimony, warrants thorough examination. 179 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I f we w i l l act to restore the prestige of the Federal Reserve System, to give it greater independence and better cooperation from other Government agencies, I believe it does not need any new powers. It has at its command i n open-market operations and the discount rate instruments of tested worth which have been used i n country after country with success. Senator D O U G L A S . M r . Burgess, isn't the discount rate virtually obsolete as a method of control now due to the fact that the volume of paper presented for rediscount is infinitesimal ? We had testimony on the first day of our hearings that the amount of commercial paper which is rediscounted by the Federal Reserve banks is less than 2 percent of the total transactions at the banks, and I wondered i f this is not just a carry-over from the original purpose of the Federal Reserve System, but which has become obsolete with the passage of time. M r . B U R G E S S . N O , sir. I disagree with that point of view completely and emphatically. That point of view would imply that the importance of the discount rate was that a member bank had to pay a little more when it borrows from the Federal Reserve System. That has very little to do with the use of the discount rate. The discount rate is an indication of what a very responsible group of people in a controlling position think about money; and, when the discount rate changes, all money rates change, not just the rates of that limited amount of paper that they deal with. F o r example, the discount rate was used very effectively by the Reserve System during the past few years. They had a preferential rate of a half of 1 percent in 1945 to encourage the banks to do their job in war and postwar lending. They moved that up until you got a rate of Vy2 percent. Senator D O U G L A S . But, M r . Burgess, the total amount of paper, as I remember it, which has been rediscounted by the Federal Reserve System, now in its vaults, amounts to $ 3 0 0 , 0 0 0 , 0 0 0 . M r . BURGESS. Yes. Senator D O U G L A S . A S compared to $ 1 7 , 0 0 0 , 0 0 0 , 0 0 0 i n Government securities and—well, what is the total volume of commercial loans outstanding by the banks ? That is well over $ 2 0 , 0 0 0 , 0 0 0 , 0 0 0 . So how would $ 3 0 0 , 0 0 0 , 0 0 0 affect $ 2 0 , 0 0 0 , 0 0 0 , 0 0 0 of commercial loans? That is 1 y 2 percent of the commercial loans possessed by the banks not rediscounted. M r . B U R G E S S . Well, it is the marginal difference, it is the marginal straw that makes the difference in the whole thing. A change in the discount rate has frequently, i f not usually, changed the rate that several million borrowers pay at their banks. The rate on some loans is tied to the discount rate, and the rate on all loans is influenced indirectly. A discount-rate change has often changed the rate which the Standard O i l Co. of New Jersey, for example, has to pay when it goes to the market and sells debentures. M y old chief, Ben Strong, used to say that the country's credit pool is one pool. You, drop a rock i n at one point and the ripple runs throughout the pool. Senator D O U G L A S . I f the banks are out of debt to the System, how does this rediscount rate affect the rates they charge ? 180 MONETARY, CREDIT, A N D FISCAL POLICIES M r . BURGESS. The main avenue of contact now between the banks and the Federal Reserve is not the discount window but the Government-security window. Senator DOUGLAS. That is the point. M r . BURGESS. A n d through that window they control the whole money market, both in terms of buying and selling; and the rate at which they buy and sell and the rate of buying and selling moves with the discount rate. Senator DOUGLAS. That seems to me to be the center of attention, the open-market operations. M r . BURGESS. They go together. The open-market operations and rediscount rate are twin instruments used together. Senator D O U G L A S . I would say one twin is of the size of P r i m o Camera and the other twin is like one of Sanger's Midgets. M r . BURGESS. H e has been wounded, but I think you w i l l find he gives a pretty good account of himself over a period. Senator DOUGLAS. What about changes i n reserve requirements ? M r . BURGESS. I refer to that later. Senator DOUGLAS. Excuse me. It is always the tendency of a crossexaminer to anticipate points a witness w i l l later develop. M r . BURGESS. There must be freedom and courage to use them. I am here expressing agreement with the .statement by A l l a n Sproul, on page 156 of the committee print, and I quote just a few sentences, although the whole passage is worth reviewing: * * * for the type of inflationary situation through w h i c h we have just passed, I should think our present powers are adequate, provided they are used to the necessary extent. W i t h respect to the requests which were made for more powers over reserve requirements, M r . Sproul said: A request for more powers was sidestepping the real issue, an issue w h i c h would have remained and reemerged once any new powers have been granted and put i n operation. M r . Sproul further says: So long as the System cannot allow moderate changes i n rates to o c c u r — he means interest rates— as a result of its decisions to ease or tighten credits, then i t cannot i n fact accomplish an easing or tightening of c r e d i t — omitting a few sentences— A resort to special powers to increase reserve requirements would, i n my opinion, only conceal or delay recognition of this central fact. Senator DOUGLAS. Does that complete your statement ? M r . BURGESS. That completes my statement. Senator DOUGLAS. M a y I ask you to turn back to page 3, the bottom paragraph. Y o u speak of the fact that the System during the war helped the Government to finance the operations swiftly, surely, and economically. Would you describe briefly how this was done? M r . BURGESS. Well, the Treasury and the Federal Reserve System, with the concurrence of the banking community—some of us were members of groups that were called in by the Treasury and the System—agreed on a general scale of rates at which the war could be financed, running from three-eights on Treasury bills up through to 2y 2 on bonds. 181 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Then the Federal Reserve by its purchases in the open market stood back of those rates so that, whenever bonds were offered in the market below the prices that these rates indicated, they would buy them i n amounts necessary to maintain it, Senator DOUGLAS. Maintain the price ? M r . BURGESS. Maintain the rates and prices. Senator DOUGLAS. A n d give to the sellers credits on the books of the Federal Reserve banks which would serve as reserves ? M r . BURGESS. They would get a Federal Reserve check which would be deposited in a bank, and that bank presents it to the Federal Reserve, and that creates credit, of course. I t formed the basis for credit expansion which, of course, in some measure you had to have. Senator DOUGLAS. W o u l d it have been possible for the banks to have created some $70,000,000,000 of credit with which they took title to Government bonds without the cooperation of the Federal Reserve System ? M r . BURGESS. NO. Senator D O U G L A S . S O that you think this function was necessary for the prosecution of the war ? M r . BURGESS. I agree. A s a matter of fact, I was chairman of the economic policy commission of the American Bankers Association at that time. W e wrote a pamphlet, which we sent to all banks, explaini n g just exactly the process that was called for and supporting it to the fullest extent of our ability. Senator D O U G L A S . N O W , you say that role has been continued too long into peacetime. M r . BURGESS. Y e s , s i r . Senator D O U G L A S . I wonder i f you would state why you believe that to be true. M r . BURGESS. W e sold savings bonds to the people. Since the war the buying power of those bonds has been reduced very substantially because commodity prices have risen. It is my feeling that a somewhat more vigorous campaign of checking credit expansion could have held back that price increase in some measure. Senator DOUGLAS. We have had the increase i n prices, have we not, because during the war we had this expansion of credit with which to purchase the Government bonds, and while that increase was held back by specific controls during the wartime, when the dam finally burst you had such a quantity of bank credits available that finally it caused prices to rise. M r . BURGESS. I do not think anything could have been done that would have wholly avoided a price increase. There was a shortage of goods and there was a large supply of money. I t is a question of degree. The Federal Reserve System went at the problem; they appreciated what it was; they did raise their discount rate as I have said; and, working with the Treasury, the yields on short-term securities were increased. That led to some further absorptions of these securities by corporations and others. I t was my feeling, however, that more of the debt would be in the hands of others than banks if rates had been raised more rapidly. I think in this I am simply echoing what I gather to be the feeling of many people in the Reserve System. 182 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . I have a chart here which shows that the yields began to rise about the middle of 1947. That is page 30 of this chart book of the Federal Reserve System, October 1949. M r . BURGESS. That is what I have i n mind. They made an adjustment toward the end of 1947. It is known i n the market as the Christmas present by the Federal Reserve System to the banks, when they dropped the support level on Government bonds by one or two points, which I think was very wise. It slowed up the process of new financing, made people who were planning investment programs—I mean business people who were going ahead with accumulating inventory or building new plants or buying machinery—go a little slower. This was an illustration, to my mind, of what can be done, even with only moderate action. Looking at it from the point of view of hindsight, it is my view that they could have acted a little sooner and a little more vigorously. M r . W O L C O T T . D O you not think that perhaps support of the bond market is a very material influence and should be included with the manipulation of the rediscount rate and operation of the Open Market Committee i n respect to economic stabilization ? M r . BURGESS. That is a big question, and, of course, it is the question, because the minute you try to put the heat on credit expansion you inevitably depress the Government market. I have read some of M r . Harl's testimony here yesterday. I n the first place, I want to say that I think the Treasury has no obligation to hold the prices of Government bonds at par. I was the chief salesman for the Treasury i n the third and fourth war loans i n the New Y o r k area, where we sold as many bonds as anybody, and I can assure you that as a salesman for the Treasury we made no such commitment. I can assure you that the banks that I know do not regard themselves as having had a commitment; when you buy a bond you take the risk of decline. I think the facts are evident that the banks do not think they have a firm commitment. I f they felt they had a firm commitment, there is no reason i n the world why they should not buy all longterm bonds and get the benefit of the high yield, but they do not. Their average maturity is down around 3 years. I have the figures here i n a chart from the Federal Reserve chart book. I t shows the figures for a group of banks that report to the Treasury regularly. O f a total of $58,000,000,000 of Government securities held by these banks as of the end of July, $47,000,000,000 are under 5 years' maturity, and only $11,000,000,000 are over 5 years' maturity. The banks are keeping pretty close to the shore, because they know there is always a risk of changes i n prices of bonds. The other conclusion that would be drawn from these figures is, as far as a bank is concerned, a moderate decline i n bond prices is nothing very serious. I f our holdings are reasonably short, we are prepared to have fluctuations i n the market. W e think these are the best securities i n the world. Senator DOUGLAS. W h a t about the general investing public? These bonds are widely distributed. I suppose they are more widely distributed than the bond issues of any previous war. Y o u have virtually everyone in the United States holding Government bonds. M r . BURGESS. Yes. 183 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. N O W , i f you raise the interest rate, you indirectly lower the price; or, i f you lower the price, you raise the interest rate. So your proposal i n effect might well mean an appreciable decline i n the price of Government bonds and, therefore, a capital loss (a) to individuals and (6) to banks. M r . BURGESS. Well, let's look at that one. T h a t raises the real issue, as you suggest. M r . WOLCOTT. M a y I interrupt a moment ? W h e n you use the term "interest rate," does that embrace the yield? The interest rate does not change, does it ? Y i e l d changes. Senator DOUGLAS. I mean, of course, the yield. 184 MONETARY, CREDIT, A N D FISCAL POLICIES M r . BURGESS. That was part of the plan that was worked out at the very beginning of the war. The Secretary of the Treasury at that time was keenly conscious of what happened after W o r l d W a r I when a great many small people bought Liberty bonds and some sold them as low as 82 or 83. H e was resolved that that should not happen again. I think he was right, and there was devised this plan for the sale of savings bonds, which are redeemable by the Treasury at any time at a price above what the man paid for them. I f you hold them a short time, you get less; i f you hold them a long time, you get more interest. So that our great pressure on all these drives which I participated in, was to get people to buy these bonds that were guaranteed by the Government against depression. The small man was sold those bonds. The other bonds, the market issues, were not issued i n denominations of less than $500, it was very carefully planned so there should be two types of bonds sold: One, the bond for the man who is not used to investing, does not want to take a risk; the other, the market type of bonds which are bought by people who could afford to take the risk. The people who bought these market-type bonds were insurance companies, wealthier individuals, who take the risk. Senator DOUGLAS. The price on one goes down, and the price on the other goes down. M r . BURGESS. The price on savings bonds cannot go down, because that is fixed by the Treasury. They are redeemable at any time at fixed prices. Senator DOUGLAS. What about the insurance companies? M r . BURGESS. Well, that is a good point. I n your statement you suggested the possibility of loss. I n the first place, these are the best securities i n the world. I think we w i l l all agree on that. There is nothing better than the bonds of the United States Government. While they may fluctuate i n value, they w i l l be paid off at maturity i n dollars at the face amount. There is no loss i f you hold them. A s far as the banks are concerned, I pointed out their holdings are mainly short. Their holdings of long-term bonds are so modest that they are well within the amount that they can hold to maturity. So, the banks can weather a very considerable change in those bonds, if necessary. So far as insurance companies go, they are holding those bonds against long-term contracts, which mature over a ]ong period of years. They probably w i l l never sell any substantial part of them unless they do it ,as a matter of policy because they can get a higher yield somewhere else. I am on the finance committee of a large insurance company, and we are perfectly comfortable with our Government bonds, even if they fluctuate a little. The individuals who bought the bonds are perfectly able to take some fluctuations. Let's not get our attention focused solely on the dollar price of things. Let's think i n terms of the buying power Now, I say that the responsibility of the United States Government for the buying power of the savings bonds that it sold under high pressure—and I helped to do it—to the people of this country is fully as important as the cash redemption of these bonds at the price you sell them. I do not know any way of controlling credit expansion without really putting on the brakes, and really putting on the brakes means that you are going to get high money rates and feel it i n bond 185 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES prices, but that is part of the responsibility for keeping the purchasing power of these bonds that we have sold. Senator D O U G L A S . H O W would you have the Federal Reserve System raise interest rates? I take it what you are saying is interest rates should be raised i f we move into an inflationary period. M r . BURGESS. There is not much point i n it now. Looking back to the period when prices were going up, I am suggesting that they would not have gone up so far and so fast i f we had not somewhat made a fetish of this matter of maintaining Government bonds at a fixed price. It held back the Federal Reserve System from using the instruments, not just the discount rate, but open-market operations. They could not reduce their holdings. I t made completely ineffective these changes i n reserve requirements. Take the case of a specific bank. When they raise the reserve requirements 2 points, it means the National City Bank has to turn $65 million of its Government securities into cash. So we go out in the market and sell them. W h o buys them? The Federal Reserve System buys them and puts exactly that amount of money back in the banks. So there is no decrease in the amount of money i n the market at all. I t is just an exchange of ownership of those bonds, that is all. So changes i n reserve requirements are ineffective so long as the Federal Reserve System is standing there with a basket to catch all Government bonds that are dropped i n at a given price. M r . WOLCOTT. M a y I follow up i n that respect what I intended to earlier ? M r . H a r l yesterday expressed the opinion that he thought it advisable as a stablizing influence for the Federal Reserve to support the price of Government bonds, notwithstanding the demands upon the Federal Reserve to purchase them from the banks, the point being that in times of depression where there was a need on the part of the banks to get an unusually large amount of cash, which would otherwise affect very materially the price of bonds, notwithstanding the depths to which the bonds might otherwise go, the Federal Reserve should support them—he did not say at par—but substantially. W o u l d you comment on that ? M r . BURGESS. I am glad you asked that. That enables me to clarify it a little more. Here I may say M r . Sproul's statement clarifies this whole thing very much along the lines I am saying. I t happens that lie and I had at different times the responsibility of administering this matter of supporting the market. I had it for some 8 years in the Federal Reserve Bank i n New York, and now it is i n his lap. So, we are giving you the results of our experience in dealing with the market. Now coming to the point that Congressman Wolcott makes, with a debt of $254,000,000,000, or it may have gone beyond that figure since I looked at it, you cannot ignore that as a factor in the economic situation. The Federal Reserve System has got to take account of it. I think it would be foolish to suggest, as the papers reported some of the statements here, that the Federal Reserve should withdraw from the market, withdraw its support. I am not suggesting that. Since Government bonds are such a tremendous factor in the whole monetary economy, there must be responsibility somewhere for their market. I n the Reserve System we developed phrases that are used in distinguishing between "pegging markets" and "maintaining orderly markets." 186 MONETARY, CREDIT, AND FISCAL POLICIES We use those two phrases. One thing is to peg at an absolute fixed price, the other is to make sure there is always somebody there to buy at a price. I n the price economy, there needs to be a buyer at a price. The Federal Reserve System used to try in the old days, when the debt was smaller, to maintain an orderly market, and did exactly that for a good many years; they tried to see that there was a buyer at a suitable price. That way you cushion any serious decline and make sure that you cut off distress selling. I n that way you keep the price declines from getting out of hand. That, of course, ought to be done. But that is very different from standing there and taking everything anybody wants to offer you, whether he is a speculator or dealer or whoever he is, at a fixed price. M u c h of the buying of the Federal Reserve has, in fact, been done way above par to maintain a pattern of rates. M r . WOLCOTT. W o u l d you consider it advisable for the Congress to enact the standards or the limitations upon which the Open Market Committee would be bound in the stabilization of the bond market. M r . BURGESS. N O , sir. I think it would be impossible to phrase any limitation of that sort in such a way that you could work it out. I t is a problem to be worked out within the Federal Reserve System, with the Treasury. There has been very close understanding between the Reserve System and the Treasury in recent years. I think it is a problem of working it out, and nobody can lay down a formula which would govern it, a legal formula. M r . WOLCOTT. I f we were to enact legislation, M r . Chairman, that would provide that the Open Market Committee should never support the Government bond market at less than, say, 95—as an arbitrary figure—there probably would be some danger i n respect to that; would there not? That might become the ceiling or the ceiling the people might expect to be put on the bonds ? M r . BURGESS. It would either be worthless or dangerous, one or the other, because you could not anticipate the events that might occur. Senator D O U G L A S . I S the immediate problem inflation ? M r . BURGESS. Well, I do not know. I notice the President said yesterday that he felt the danger of recession had rather passed. I agree with him. I think that the inventory adjustments that we have been through have passed over; and, very happily, we have done it without any serious difficulty. Where we go from here, of course, nobody ever knows ahead of time. There are both depressing and inflationary elements. I do not think the adjustment is fully completed in the capital-goods area. F a r m income is likely to be a little lower, looking ahead. O n the other hand, there are definite inflationary elements i n the situation, foremost among which is the unbalanced Federal budget, the plan of distributing more than 2y2 billion dollars to the veterans as dividends on their insurance, spending by municipalities and States. I am inclined to think that the inflationary possibilities are now a little stronger than the deflationary. Senator DOUGLAS. Suppose you were a member of the Federal Reserve Board. W o u l d you believe that the support price should be lowered at the moment ? M r . BURGESS. The support price—there isn't any support price at the moment. They have not bought at support price for some time, and I interpret their statement of June 30 as a kind of declaration of 187 M O N E T A R Y , CREDIT, AND FISCAL POLICIES independence, a move in exactly the direction I have been talking about. Senator DOUGLAS. Y o u r proposal to increase interest rates to check bank expansion of credit and, hence, increase i n prices would operate through a lowering of the price at which Government bonds were purchased and, hence, an increase upon their yields; isn't that true ? M r . BURGESS. Yes. Or they would push out some bonds. F o r example, the particular situation i n the market today that is interesting is that the long Government bonds have been rising a bit i n price, and the Federal Reserve has a huge holding of these bonds and is not selling any of them. The statement shows week after week no change. Now, they scooped in all these bonds, and they are holding on to them. I f I were a member of the Federal Reserve today, I would vote to let some of those bonds go as there was demand for them, so that the longer-term rate of interest was a little higher. Now, those bonds are way above par. This does not involve the question of par, but the yield rate now on longer-term Government bonds is so low and the prices are so high that the market is restricted. The market is very restricted. Senator DOUGLAS. Let me see if I follow your train of thought. Y o u would say that the Reserve should sell long-term Government securities in the open market ? M r . BURGESS. That is right. Senator DOUGLAS. A n d that this would diminish, directly and indirectly, the reserves which member banks would have i n the System, and hence reduce their lending capacity; is that true ? M r . Burgess, That is the logic of it, but it isn't exactly what would happen, M r . Senator. Senator DOUGLAS. I was going to ask the further question: W o u l d it not then be possible for banks to present these bonds back again to the Reserve System; and, if the Reserve System had the policy of buying, it would put back in the right-hand pocket deposits for the bank which it had taken away from the left-hand pocket ? M r . BURGESS. They don't have to buy them back. Senator D O U G L A S . N O . They don't have to; but, suppose they didn't, what would happen ? M r . BURGESS. Prices would go down a little. That is what would h appen. A n d the whole investment market Senator DOUGLAS. Yields would go up; interest rates would rise? M r . BURGESS. Yes; interest rates would rise. Senator D O U G L A S . H O W far do you think the prices of bonds would f a l l if the Reserve System stopped buying ? M r . BURGESS. They can decide that almost completely. They can put those bonds down 2 points or down one point. They have almost complete control over that market. Senator D O U G L A S . D O you feel that this is the time for putting such policy into effect ? M r . BURGESS. Well, I don't think the situation is clear enough to pursue the policy vigorously. Senator DOUGLAS. A n d you say "watchful waiting for the moment" ? M r . BURGESS. A n d a little feeling out of the market. Senator DOUGLAS. A n d i f prices should rise by, say, 5 percent M r . B U R G E S S . I would move sooner than that. I think they can tell sooner than that. 188 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . Y O U would say that with any appreciable increase of prices, defining "appreciable" as less than 5 percent, that the Federal Reserve System should temporarily cease buying bonds, until they depreciated i n price sufficiently to raise the interest rate by X amount ? M r . BURGESS. Well, I would have to go back over all those steps and rephrase it, but the effect is the same. I don't think that you can judge the situation completely by the price level. I think they can catch it sooner than that. I f they see the volume of credit rising, due to deficit financing, and see some speculative tendencies, they may move sooner than the wholesale price or retail price reflects that change. But, i n general, I think they ought to start moving a little i n the direction of firmer money and restraint. Senator DOUGLAS. What weight would you give to the presence of unemployment as an index ? M r . B U R G E S S . Well, I think it has very important weight. Senator D O U G L A S . Y O U might have wholesale prices rise slightly, but unemployment i n excess of 5 percent. M r . B U R G E S S . Y O U could and you would have to decide where median judgment lay as to whether the economy was moving too fast or not fast enough. Senator D O U G L A S . D O you have any bench marks i n your own mind ? M r . BURGESS. Yes. Employment is one of them; the movement of wholesale prices is another bench mark; production index; movement of security prices, stocks and bonds; stocks is an indication of the atmosphere, whether speculative or not; the movement of loans of the banks, bank loans, whether they are going up or down. Senator DOUGLAS. When all of the indexes point i n one direction, the decision is fairly clear; but when you get M r . BURGESS. That is a cinch. Senator D O U G L A S (continuing). But when you get contradictions of indexes, that is the difficult problem. I f we found, for example, that unemployment had been reduced to, say, 2 or 3 percent, and production had ceased to increase, and that prices were rising, then I think it would be pretty clear that we were in inflation, and that we should check any further increase in price. M r . BURGESS. That is right. Senator DOUGLAS. Suppose production is rising, prices are rising, and unemployment falling, it is still, let us say, above 3 percent or 5 percent; that is where the difficulty is. M r . BURGESS. That is right. Senator D O U G L A S . Yes. M r . B U R G E S S . That is why you need such competent people i n the Federal Reserve System. Senator D O U G L A S . W e are trying to get A little light on that subject, because the Federal Reserve System, after all, although it dwells i n a handsome building (we hope not in an ivory tower) finds that its decisions are, in part, conditioned by public opinion. M r . B U R G E S S . That is right. Senator D O U G L A S . These hearings perhaps, to some degree, help to build a more informed public opinion. So, we would appreciate very much your judgment on it. 189 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Suppose production were to go up, unemployment were to fall, but would still be above, let us say, 2,000,000, and prices would be rising slightly. M r . BURGESS. Yes. Senator D O U G L A S . N O W M r . BURGESS. A n d the money supply rising. I f the money supply were rising, I would think that was a time Senator DOUGLAS. Because it would be rising faster than production ? M r . BURGESS. Yes. That is the time, I think, to begin to firm things up a little. Senator DOUGLAS. Even though it meant a decrease i n the rate of absorbing the unemployment and the slackening i n production ? M r . BURGESS. Well, I doubt i f it would mean that. I should say, i f your unemployment condition were as at present, the indication would still be for "firming" because you have had a period of high employment and still have. Senator DOUGLAS. H i g h employment, but, i f you can believe the unemployment figures, probably 3,400,000 unemployed, which is about 7 percent of the nonagricultural labor force. M r . BURGESS. B u t still below normal—isn't it ?—for unemployment. Senator DOUGLAS. I t all depends on what you mean by "normal." M r . BURGESS. I w i l l leave that to you; you are the expert i n that field. Senator D O U G L A S . D O you mean average, or what exists at the peak ? M r . BURGESS. Yes. Senator DOUGLAS. I t is certainly less than f u l l employment; let's put it that way. I t is certainly less than f u l l employment. M r . BURGESS. Yes. O f course, there is a tremendous lag i n employment figures. They represent the result of business plans made a long time ahead. So, it isn't a very good immediate index. Senator D O U G L A S . Y O U see, what we would like to do is to get some of these mysterious decisions which the Federal Reserve Board makes i n quiet out in the open, so that they can be appraised. M r . BURGESS. Yes. Well, I think they have a remarkably able research service that turns up the various factors i n the business front. Senator D O U G L A S . I have always believed that the Egyptian priests were extremely able too, but they tried to conceal all their information from the Egyptian public and make it an esoteric secret; and, therefore, I would like to have some of the elements of these decisions made public. M r . BURGESS. Yes. Well, I think that perhaps this chart book by the Federal Reserve Governors shows what they are thinking about. I t is a beautiful job of presenting data. Senator D O U G L A S . D O you have any judgment i n your own mind as to how low the Federal Reserve Board should allow Government bonds to fall? M r . BURGESS. Well, there again, that is dependent on so many factors i n the situation. I have felt that we have been i n a period where very modest changes i n credit policy have substantial effect. Periods are very different that way. There was a period during the middle 1920's when the economic situation was extraordinarily sensitive, when a change of one-half of 1 percent i n the discount rate of the Federal Reserve Bank seemed to make a difference whether speculation or 99076—50 13 190 MONETARY, CREDIT, AND FISCAL POLICIES prices or production moved forward or backward. That is, the economy was very responsive. Y o u take other times, like 1928 and 1929, when you put your foot hard on the brake, nothing happened. M r . W O L C O T T . H O W high was the rediscount rate finally % M r . BURGESS. I t w^ent to 6 percent, I think. M r . WOLCOTT. A b o u t 7 ? M r . BURGESS. I t went to 7 percent i n 1920. M y impression is that 6 is as high as it got in 1929. M r . W O L C O T T . I S there any statutory limitation upon the amount by which they could increase the discount rate ? M r . BURGESS. None. M a y I just finish this thought: I n 1928 and 1929 the situation was very insensitive to Federal Reserve policy. The same was true when you were i n the midst of the depression i n 1932 and 1933. The System bought a billion dollars' worth of Government securities i n the spring of 1932, and it had some effect, but the effect was very slow. L o w money rates had very little effect i n stimulating things i n the early thirties. M y impression is that the present time is one where small changes make quite a difference. The market is watching the Federal Reserve very closely. A t the present time I don't think you have to take any action which would result in putting Government bonds below par i n order to get the effects you want. W e don't have to think i n terms of 95 or 99, or what have you. The situation is very sensitive. B u t I can see other situations where, if you got a very active inflation going, commodity prices were leaping upward, you might really want to put on the brakes. But that is just part of the problem. T h e question is the objective. Is your object to stabilize money rates or is your objective to stabilize the United States economy so that you have i n the long run a period of stability and good employment and sound economic activity, not sowing the seed for difficulty i n the future ? The latter is the objective for the Reserve System. Senator DOUGLAS. I think there is one point that has to be faced: namely, any such move would be criticized as a means of having the effect of increasing the earnings of the banks by giving them higher interest rates. M r . BURGESS. I am prepared to defend that. I think that the banks are earning too little at the moment. They are earning about 7 percent on their capital fund. We are told by the Reserve System and by the Comptroller, and others, that our capital is too small. The only way we can get more capital is by earning it. Bank stocks are now selling at a discount from their book value of 20 to 25 percent, i n many cases more. There are only a few banks i n the country whose stocks sell at their break-up values. I n other words, at the moment the market says we are worth more dead than on the hoof. Senator DOUGLAS. Isn't it also true that the average rate of bank earnings are appreciably higher than virtually every other line of business ? M r . BURGESS. O n the contrary, it is lower than almost any other line of business. I t is 7 percent on its capital. Senator DOUGLAS. Seven percent has always seemed to me to be quite a high rate of return. 191 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . BURGESS. The bank stockholder gets a return of 3% or 4 percent on his money. I f he buys industrial stocks, he gets 7 or 8 or 9 percent. Senator DOUGLAS. But you get also an accumulation of surplus. M r . BURGESS. W e are putting about half away into our surplus, as other businesses are, too. Senator DOUGLAS. Is it not true that over a period of time—I don't knowT how you could make allowances for the losses during the depression, but over a period of time is it not true that bank earnings upon capital have been higher than in most other lines? M r . BURGESS. I think exactly the opposite is true, M r . Senator. The stock market shows it. I would like to show you a chart which shows what has happened to the bank shares in the market as compared with the shares of other companies. Bank shares have gone down steadily in relation to the rest of the market. The test of it is that banks can't sell stock in the market. The buyers don't want them because they have such a low yield. The reasons for that are the very low interest rates and the fact that a large part of our funds are immobilized i n cash because of high reserve requirements. Senator DOUGLAS. That is a very interesting observation. I had not thought that the productivity of capital in other areas was as high as 7 percent; and I have believed that your earnings had averaged well over 10 percent. Mr. BURGESS. The banks of the country are earning 7 percent. Senator D O U G L A S . N O W . But have they not many times gone over 10 percent? I think it is sometimes hard to translate the Federal Reserve figures on earnings on assets into earnings on capital, but I made some computations which indicated that in a number of years it was over 10 percent. M r . BURGESS. Net profits of the member banks i n the year 1 9 4 7 - 4 8 were 7.2 percent; they were 10.9 percent in only one year, 1945, when bond profits were large. F o r the past 10 years bank earnings have averaged 7.9 percent, as compared with over 100 percent for leading business corporations. We are told we ought to have more capital, but the market doesn't want to provide the capital, and we have to earn it. So, we pay smaller dividends. Maybe we should pay larger and push the stock up higher. But the accumulation of capital seems very important. Banks are like other business. I f you are to have a sound banking system that can stand the strains and stresses, they have to earn money and have to put aside reserves and increase their capital. Senator DOUGLAS. I was impressed by the fact that you have not discussed the question of reserve requirements of the Federal Reserve System. I wonder if you would comment upon that. M r . BURGESS. I w i l l be very happy to. Senator DOUGLAS. F o r commercial banks. M r . BURGESS. Yes. The reserve requirements. Senator DOUGLAS. Y e s . M r . BURGESS. M y feeling is that reserve requirements should be changed only when there is a basic change i n the monetary situation. Senator DOUGLAS. I n a period of inflation. Isn't this a direct method of control by increasing reserve requirements. Y o u diminish the amount which banks can lend rather than merely enabling them to get a higher interest rate. 192 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES M r . BURGESS. I have already indicated that I think, as long as your Federal Reserve stands ready to buy Government securities at a price which brings increases i n bank reserves, they are completely ineffective because, as you increase the reserve requirements, the bank simply takes its Government securities to the Federal Reserve bank and gets 193 M O N E T A R Y , CREDIT, AND FISCAL POLICIES the cash to meet them; so, it doesn't make any change i n the lending policy. A l l it does is to decrease the earnings of the member banks and increase the earnings of the Reserve bank. Senator DOUGLAS. Doesn't that tighten the amount of credit which they can extend for other purposes to private lenders ? M r . BURGESS. N O , sir, because they can always get the credit they need from the Federal Reserve bank. They always would prefer to lend to commercial borrowers than to hold Government securities. T h a t is our permanent business. W e want to do business for our customers. So, I would say that the changes in reserve requirements that have been made over the past few years have been almost completely ineffective; made ineffective by the policies with respect to Government securities. Senator DOUGLAS. But is it a question of alternative policies; can you not do both of these at the same time ? M r . BURGESS. Y O U could, of course, and my belief is that the changes i n reserve requirements should be used only rarely and for fundamental changes. One of those took place in 1940,1 think it was. W e had tremendous gold imports over a long period. The excess reserves of the banks were over $6,000,000,000. The Reserve Board, Reserve banks, and the Federal Advisory Council all recommended giving the Federal Open Market Committee power to double the legal reserve requirements. I advocated it myself. That was an appropriate time. B u t as a method of current credit control these changes i n reserve requirements are pretty painful. I f you are trying to operate a bank, you need to know from month to month what money you are going to have to use. These changes i n reserve requirements make it difficult to plan. I f they accomplish the purpose, of course, credit policy has to come ahead of the convenience of the banker. But, since they didn't accomplish the purpose, my belief is that the proper instruments to use were the open market and discount rate, at that time. The Reserve System now has a portfolio of $20,000,000,000 of Government securities to feed the market through open-market operations. Under those circumstances, I see no occasion for any further increase i n their power to change reserve requirements. M r . W O L C O T T . A S an example of that, what happened when the Board did increase their reserve requirements? M r . BURGESS. It simply resulted i n a transfer of Government securities from the commercial banks to the Federal Reserve Bank in the exact amount of the change in reserve requirements. I t didn't change our attitude toward our commercial borrower. W e were already engaged in a very thoroughgoing and careful campaign of scrutinizing our loans and trying to resist the forces of inflation. M r . WOLCOTT. They asked for an increase of 10 points. W e gave an increase of 4 points. W o u l d it have made any difference had the Congress given the increase of 10 points? They didn't use their authority up to 4 points. But would it have had any psychological effect i f we had given them 10 points instead of 4 ? M r . BURGESS. It would have had the psychological effect of creating fear of how these vast powers would be used. I t is my view that any 194 MONETARY, CREDIT, AND FISCAL POLICIES change was entirely unnecessary at that time. A s long as the policy of pegging the prices of governments was maintained, they were completely ineffective on credit and unnecessary. They simply kept things stirred up. M r . BUCHANAN. This was December 1947 or 1948 ? M r . B U R G E S S . N O ; this was last summer. I mean, a year ago. M r . BUCHANAN. 1948 ? M r . B U R G E S S . T h e s u m m e r o f 1948. M r . WOLCOTT. What new legislation might be necessary, in your opinion, or is any new legislation necessary, to give the Federal Reserve adequate controls over the volume and velocity of credit as it affects our economy ? M r . B U R G E S S . I think they have the necessary powers already, if they feel free to use them. M r . W O L C O T T . I S there any statutory restriction on the use of it ? M r . B U R G E S S . N O ; I don't think that is necessary or desirable. M r . WOLCOTT. Y o u r answer indicates that they might not be free to use the powers in some particulars. W h y aren't they ? M r . BURGESS. That is largely a question of their relationship to the Treasury market. I think they have already been facing that, have taken steps to indicate they feel they have more freedom now. H o w far that w i l l actually be the case when the test comes we don't know, but it is a matter of which they are thoroughly aware, where I think they have taken very wise steps. M r . W O L C O T T . I S it reasonable to assume from your statement that you are somewhat i n favor of a higher concentration of credit control i n the Federal Reserve than we have in the Government at the present time ? I perhaps should explain that a little bit and give you a little of the background for iny question. I n the Legislative Reorganization A c t of 1946, although the Banking and Currency Committees of the House and Senate are given the duty and obligation of exercising jurisdiction over credit policies, we find that as a consequence of the Legislative Reorganization A c t the credit policies are distributed over perhaps a half a dozen other legislative committees. Now, I was wondering i f perhaps that didn't prevail in the executive establishment and among the independent agencies to a point where, i f the Federal Reserve is given the obligation to stabilize our economy, perhaps we shouldn't do something to more highly concentrate the control over the issuance of Government credit as it affects our economy i n the Federal Reserve ? M r . BURGESS. Yes. Well, I think I see what you mean. That perhaps is related M r . WOLCOTT. I mean this: W e have the R F C , the F a r m Credit Administration, the Export-Import Bank; there is a coordinating influence, of course, through the National Advisory Council, but that is purely advisory; they have no administrative function M r . BURGESS. Purely with respect to their foreign operations. M r . WOLCOTT. Yes. Y o u might find a situation where, when the Federal Reserve is increasing discount rates or pegging the Government bond market to prevent inflationary tendencies, other agencies of the Government might be expanding their activities and completely offsetting it. 195 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . BURGESS. Yes. I think that there is a need for coordination of some sort at that point. Y o u have the R F C , the Federal Housing A d ministration—it has some new name now M r . WOLCOTT. Housing and Home Finance Agency. M r . BURGESS. A n d the F a r m Credit Administration, all of whom are dispensers of credit. There is no Cabinet officer, I believe, who controls all of those. They are operated with appropriations from Congress directly. What they do greatly influences what the Federal Reserve is trying to do. I think there ought to be some way of pulling that policy together. I think the suggestion for a credit council in the Treasury has a lot to commend it. I think there should be some place of meeting with the Secretary of the Treasury as the appropriate chairman where these various credit-granting agencies review their problems together in the national interest, with the chairman of the Federal Reserve Board there to indicate what the Board's policy is, so that you won't have one group of agencies running off in one direction and the Federal Reserve off in another. Now, how much power such a council should have I am not prepared to say. I think there should be some power so that programs could be slowed down, programs of R F C lending or housing guaranteeing or what have you, could be slowed down in a period where the Federal Reserve was trying to check inflation, and speed it up in a period when you want money put out more freely. M r . BUCHANAN. Wouldn't the recent inflation, the situation relative to easier finance terms for housing, and the housing picture in 1948 and 1949, as the result of these easier terms, have tended to offset the deeper drop i n the curve i f we had followed the recommendations of the Reserve System in the Banking and Currency Committees of both sides and refused to liberalize terms in the face of a concrete shortage in the housing field ? M r . BURGESS. I am not perfectly sure that I understand you, M r . Congressman. M r . BUCHANAN. I n your statement, you refer to the recent inflation. M r . BURGESS. Yes. M r . BUCHANAN. While the Reserve System was conducting a vigorous campaign to resist inflationary extension of credits. M r . BURGESS. Yes. M r . BUCHANAN. A n d one of the resistant proposals w^as, of course, to tighten up on housing financing terms. M r . BURGESS. Yes. M r . B U C H A N A N . A S we look back over the current recession of the past 12 months, it was the housing situation that tended to hold up above all others. M r . BURGESS. That carried through. O f course, you have a difficult problem of timing. I n 1946, 1947, and early 1948, let us say, things were moving too fast. Y o u wanted to hold back a little. There is no question in my mind that the cost of housing was increased for the veteran by reason of the enormous amount of money that was trying to crowd into the housing field in those years. I think the price of housing for the veteran is higher today because of the amount of money that was poured in, partly through Government channels. Senator DOUGLAS. But the veterans are getting more houses than they otherwise would have obtained. I think that is the Congressman's point. 196 MONETARY, CREDIT, A N D FISCAL POLICIES M r . BURGESS. That is always the problem, to try to assess the weight both ways. That is all the more reason why there should be current consultations on this matter. Y o u have to change policy with some rapidity from time to time. That is hard to do i n a housing campaign, I realize. M r . WOLCOTT. M r . Chairman, I wish that some witness—and perhaps M r . Burgess could do it—for the record could discuss the influence of deficit financing on the value of our currency, on inflation, depression, and so forth. Senator D O U G L A S . I think that is a very good question. I hope that M r . Burgess i n making his reply w i l l distinguish between a period of depression in which you have idle capital and idle labor, and a period of prosperity in which capital and labor are relatively fully employed, because I think it makes a great deal of difference which period one is talking about. M r . W O L C O T T . I think that is true. But I don't think he should be restricted. Senator D O U G L A S . N O . M r . BURGESS. M r . Chairman, I was a member of the Committee on Public Debt Policy, which spent the better part of 3 years studying that question. W e have written a booklet on the subject which is now published and, I think, i n your hands. O f course, deficit financing long continued is inflationary. A s it goes to the point where you lose complete confidence, then it becomes deflationary, perhaps. O f course, we recognize the effect of deficit financing in every country that the E C A is working with. Our representatives i n E n g l a n d and i n France and i n Italy have applied the greatest pressure on all those countries to bring their budgets into balance. Senator DOUGLAS. That is because they have f u l l employment, isn't it? M r . BURGESS. It is because they are creating money faster than they are creating goods. Senator DOUGLAS. The British are not operating on deficit financing. M r . BURGESS. The British budget is, apparently, balanced. Senator DOUGLAS. That is right. M r . BURGESS. They are going to have difficulty the coming year. They are cutting their expenses somewhat, Some of the other budgets are balanced for current operations but in deficit for special operations. Those countries illustrate very clearly the principle that deficit financing is one of the fastest and most vigorous ways to inflate your economy and to destroy economic soundness and the prosperity of the workingman. Our problem is that we are so rich and prosperous and productive that we can violate some of these rules for a time and get away with it. But i n the long run the economic laws usually work out. So that i n the long run, i f we continue deficit financing over a period, I think we will pay the penalty. Senator DOUGLAS. I f we continue it i n periods of prosperity as well as i n periods of depression. M r . BURGESS. That is right. M r . WOLCOTT. W e have been told that inflation is sometimes 90 percent psychological. I f we indulge i n deficit financing, there is a 197 M O N E T A R Y , CREDIT, AND FISCAL POLICIES psychological reaction on the value of our currency before the time when it actually affects it. M r . BURGESS. I t is very hard to untangle those two things. There are always plenty of people who are trying to anticipate what is going to happen next and move ahead. M r . W O L C O T T . I S it reasonable to assume that it follows as an actual consequence of deficit financing that prices and values go up and the value of the dollar goes down; in anticipation of that people start converting their savings into goods, and they create a demand which, i f it becomes unusually large in proportion to the supply of goods, causes the prices to go up or the value of the dollar to go down before the deficit financing would itself cause it? M r . BURGESS. That, of course, is the logic of it. That is what happens. Y o u could run into cases of people who say, "Well, the money isn't worth anything; let's spend it; let's build that house we were talking about," and so forth; but I think the figures show that for the American people as a whole they haven't taken that step; they still have sufficient faith in the dollar so they are saving a great deal of dollars; our savings accounts are going up i n the banks; the people are putting money into savings bonds, building and loan associations, insurance policies, and so on; they are still saving. M r . WOLCOTT. When it was announced some time ago that the anticipated deficit for fiscal year 1951 might be something over 5 billion, and especially since that has been confirmed by the President's statement the other day, that we might expect a deficit of 51/2 billion—which some of us believe is conservative, that it might go up to 7 billion—since that time, I think, all of the Members of Congress, although I only speak for myself, have experienced an increase in mail on that issue daily; and I think i n the last week I have been asked the question at least a dozen times by people as to whether we are going to have inflation; and, i f so, they are going to use some of their savings. I have a newly rich friend who has a home that I think perhaps he paid five or six thousand dollars for, and he wants to know whether he should build a house which is going to cost him about $32,000. I explained that he was newly rich. H e thinks that we are going to have inflation and that he can afford now to buy the $32,000 house with a reasonable assurance that when he gets ready to turn it over in the market he can get at least $32,000 out of it. So there is undoubtedly some influence being brought to bear; people generally are affiliating deficit financing with inflation, although we haven't commenced to see it in volume yet; but I think perhaps after 60 days we might see much more of it and much more demand for goods. Is that a reasonable assumption ? M r . BURGESS. That is really what I had i n mind, M r . Congressman, i n suggesting that I thought in the current situation the inflationary forces looked a little stronger than the deflationary ones. Senator DOUGLAS. Then do I understand that you say for the fiscal year 1951, assuming that we do not move into a depression, and assuming that we get reasonably f u l l employment, that we should strive to reduce the deficit, and, i f it is possible, to balance the budget ? M r . BURGESS. Exactly. I am sure that is right. Senator DOUGLAS. That happens to be my own view too. 198 MONETARY, M r . BURGESS. CREDIT, AND FISCAL POLICIES Yes. Senator DOUGLAS. M r . Burgess, you were reported i n the press the other day as advocating the adoption of what was termed the goldcoin standard for this country, by which I suppose was meant that the Federal Reserve notes should be made convertible into gold, redeemable in gold ? M r . BURGESS. M r . Senator, I didn't say gold-coin standard. I said that as an objective of monetary policy I think we should work toward convertibility into gold. S e n a t o r DOUGLAS. Yes. M r . BURGESS. I didn't say whether I felt that should be gold bullion or gold coin. I also said emphatically that I saw no occasion to change the price of gold and that it was foolish to even think about it. The dollar is the anchor of world commerce and should be held at a fixed price. Senator DOUGLAS. The President and the Secretary of the Treasury made the same statement. M r . BURGESS. Yes, sir. I agree with that. I also said that it was premature to talk about domestic convertibility, that with so many of the countries of the world still i n economic uncertainty, and with our own picture not fully settled down after the w a r ? this is not the time to restore convertibility. I did say that as a long term objective I thought we should work toward it; I thought there w^ere some things that might well be done toward that end, particularly reconsideration of the Gold Reserve A c t of 1934, which appears to some people, at least, to be a little ambiguous as to the Treasury's authority with respect to the buying or selling of gold. Senator DOUGLAS. W o u l d you expand on that point ? M r . BURGESS. Yes. A section of that act appears to give the Secretary of the Treasury power to buy or sell gold at any price. That has been interpreted by some people to mean that the Secretary simply by his purchases or sales of gold could change the gold content of the dollar. There is legal opinion that the Bretton Woods A c t supersedes that, when it provided that nobody can change the gold content of the dollar without act of Congress. I f there is an ambiguity there, after carefully examining it, it ought to be cleared up, because that is one of the surest of these insidious rumors about changing the price of gold. M r . WOLCOTT. I f I may interject, for what it may be wTorth: That provision of the Bretton Woods Enabling A c t was put i n there definitely and with deliberation i n an attempt on the part of the Congress to prevent any further increase or change i n the dollar value of gold without congressional assent. I think, and I am sure I am not speaking only for myself, that i f it wasn't clearly stated i n the committee report, it was intended by the members of the House Banking and Currency Committee, and I believe I can speak for them as a whole, that we could not otherwise have stability i n world currencies. A s M r . Burgess has said they were anchored to the dollar, with the danger of fluctuations i n the dollar value of gold. F o r that reason it was clearly our intent when we wrote that provision that there should not be any changes i n the dollar value of gold unless the Congress approved it. Senator DOUGLAS. M r . Burgess was raising the question as to whether the original act did not give the power. 199 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WOLCOTT. No. The trouble comes from the ambiguity i n the Gold Act, which I think is corrected, or explained, i n the Bretton Woods Agreement Act. I think it is section 3 of the Gold Act, isn't it ? M r . BURGESS. Sections 8 and 9 of the Gold Reserve A c t of 1934. M r . WOLCOTT. Yes; whatever it is. But the Bretton Woods A c t explains and is, perhaps, i n clarification of the ambiguity which appeared in the Gold Act. Senator D O U G L A S . Y O U think the Bretton Woods A c t w i l l make it impossible to alter the price of gold without consent of Congress % M r . WOLCOTT. That was clearly our intent in writing that law. Now, how the lawyers would interpret it, I don't know, but i f they interpret it as I know was the intent of Congress, whether it is expressed in such language that they would get the same interpretation or not, I don't know, but I do know that w^as our intent, and, from my indirect contact with the Treasury, I think the General Counsel of the Treasury has taken that attitude recently, and I think the President has made the same statement. I don't know as he made the statement, but I think the General Counsel of the Treasury has given an opinion, formal or not I don't know, that the dollar value of gold could not be changed without the consent of Congress. So it is very apparent Jthat they are not going to change it, notwithstanding the ambiguity and the possibility of authority. Senator DOUGLAS. One final question which I should like to ask: F r o m time to time the responsible officials of the Federal Reserve System imply or state that their power to control credit is restricted by the some 50 percent of the banks which are outside the Federal Reserve System and which create about 15 percent of the total volume of outstanding commercial credit, and that as long as you have this residual, with the power of State banks to secede at any time, that the Federal Reserve Board goes into the battle of stabilization with one hand tied behind its back. What do you think of that contention ? M r . BURGESS. I don't agree with it. I think they are overemphasizing that difficulty. When I used to be with the Reserve System and made speeches about it I used to say there were i n the System a third of the banks with two-thirds of the banking resources. The proportion of resources in the System has steadily increased. There hasn't at any time been any substantial defection from the System, in spite of the very large rise of reserve requirements that took place. There again we come back to the question that you and I discussed a little, about how the policies of the Federal Reserve become effective, do they become effective because this particular member bank has to borrow at the Reserve System and finds the rate of interest a little higher, or because the Reserve System tells it to do something ? M y whole belief, based on my experience, is that that isn't the way credit controls work. I quoted Ben Strong in saying that the country's pool of credit is one pool, and if you just stick your toe in at one side and start the ripples going they go right across. A credit policy is effective primarily, not so much on the loans that banks make, but in the investment markets, where people get capital, and where they make their decisions as to whether to do something a year from now or 2 years from now i n the way of building a new plant and employing people. 200 MONETARY, CREDIT, A N D FISCAL POLICIES It is the climate that you create i n your money markets and your investment markets that has much more to do with changing the swings of business than your relationship with any single member bank. Senator D O U G L A S . I think it is logical that you take this position, because you seem to minimize the effect of alterations i n reserve requirements. M r . BURGESS. Yes. Senator DOUGLAS. B u t i f reserve requirements were to be an appreciable factor i n controlling the supply of credit, then the fact that State banks can secede at any time and go under State laws, with perhaps less stringent reserve requirements, and therefore give them greater earning power upon a given set of assets, that might exercise a restraining influence upon the Board to use this instrument which they have i n their possession, and which, i f escape by member banks were impossible, they could and would use. M r . BURGESS. Well, of course, you can't just say there is nothing at all i n that argument. I don't think there is very much. I think a little restraint on the Board i n using those powers might have some merit. I don't think very much of changes i n reserve requirements as a means of handling current credit problems. They are rather for meeting substantial alterations i n the gold supply or similar basic changes. W e advocated a change in requirement, and a very substantial one i n 1940; so our record is reasonably good on that. Senator DOUGLAS. A t that time did you recommend that they be made applicable to nonmember as well as members ? M r . BURGESS. A S a matter of fact we did. Senator DOUGLAS. W h y are you opposed to it now ? M r . BURGESS. Because of the fear of encroachments of centralized Government power. There also is a change in the situation which is that i n the States the nonmember banks have been decreasing, relatively, i n their assets, the members have gradually been coming into the System, and the State banking laws are becoming more adequate. I think this committee has not had called to its attention the efforts of the American Bankers Association i n this respect. W e have had for a good many years a group of people, a committee, and some staff members, who have been examining the provisions of the State bank legislation and the instruments that the States have for controlling the banks that are under their supervision. W e have suggested to the States a model banking code that has been adopted i n many States and that provides that a State banking board, or the supervisor of banks, would have the power to apply to the State banks the same requirements, or substantially the same requirements, i n terms of percentages, that the Reserve System can impose on the member banks. I n my own State, in New Y o r k State, when the Reserve System acts the State banking board gets together and they have, without exception adopted a similar change in reserve requirements for their State banks. I would like to place i n the record a resolution adopted by unanimous consent of the administrative committee of American Bankers Association on September 28, 1942, proposed by the committee on State legislation, which makes this recommendation to the States. I don't need to read it. I w i l l put it in the record. 201 M O N E T A R Y , CREDIT, AND FISCAL POLICIES (The resolution referred to is as follows:) RESOLUTION PROPOSED B Y TIIE COMMITTEE ON STATE LEGISLATION Whereas i n the determination of the adequacy, the control and the composition of nonmember bank reserves, it is considered preferable that the power of such determination be vested w i t h the proper State supervisory authority; and Whereas it is deemed further advisable that the m i n i m u m and maximum reserve requirement of nonmember banks be clearly defined by statute, and made, insofar as may be consistent, to conform w i t h regulations of the F e d e r a l Reserve System, and that such reserves be limited to cash on hand or on deposit w i t h reserve depositaries approved by the supervisory authority, w h i c h depositaries may include, i n addition to other nonmember banks subjected to additional reserve requirements, F e d e r a l Reserve Banks or member banks of the Federal Reserve System : Therefore be i t Resolved, T h a t the administrative committee approve i n substance the report and recommendations of the committee on State legislation, and authorize the d r a f t i n g of appropriate legislation to accomplish the purposes therein expressed, w h i c h legislation when approved by the legal department, shall become a part of the A B A program of approved State legislation. Adopted by unanimous vote. ADMINISTRATIVE WALDORF-ASTORIA, NEW COMMITTEE YORK OF A M E R I C A N C I T Y , September 28, BANKERS ASSOCIATION. 1942. Senator D O U G L A S . Y O U say a number of the States have adopted this? M r . BURGESS. There are 21 States. Senator DOUGLAS. That have adopted this standard ? M r . BURGESS. Yes, or substantially that, which grants discretion respecting reserves to their State banking authorities, so that they can follow the Federal Reserve System. When you take account of this action it narrows down this nonmember problem to very small proportions. Senator DOUGLAS. A r e these States with large numbers of private bankers ? M r . BURGESS. Arkansas, Connecticut, Delaware, Illinois, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New York, Ohio, Pennsylvania. That is the list. Senator D O U G L A S . N O minimum or maximum requirement, it is purely optional upon the State board as to whether or not it is followed? M r . BURGESS. Optional on the State board. They have minimum requirements. They can be raised optionally by the banking authorities, I understand. So that this type of cooperation I think is growing. I think this is a method that can appropriately be used and carried further so that this whole question of nonmember banks boils down to one of very small proportions. M r . BUCHANAN. California or Texas are not i n the list ? M r . BURGESS. I think not. Senator DOUGLAS. Thank you very much, M r . Burgess. (Whereupon, at 12:15 p. m., a recess was taken until 2 p. m., of the same day.) A F T E R N O O N SESSION Senator DOUGLAS. M r . Foley, w i l l you come forward and bring with you anyone you wish to have with you ? 202 MONETARY, CREDIT, AND FISCAL POLICIES M r . FOLEY. I w i l l have the Deputy Administrator, M r . Fitzpatrick, at the table with me, and others from the agency w i l l be available. Senator DOUGLAS. M r . Fitzpatrick is an old friend. M r . FOLEY. I have also Dr. Husband from the Federal Savings and L o a n Insurance Corporation, Commissioner Richards of the Federal Housing Administration, and M r . Hardy, Assistant Administrator of the Housing and Home Finance Agency, and others here whom you may want to call upon for details. STATEMENT OF RAYMOND M. FOLEY, ADMINISTRATOR; ACCOMPANIED BY B. T. FITZPATRICK, DEPUTY ADMINISTRATOR AND GENERAL COUNSEL, HOUSING AND HOME FINANCE AGENCY; FRANKLIN D. RICHARDS, COMMISSIONER, FEDERAL HOUSING ADMINISTRATION; DR. WILLIAM H. HUSBAND, GENERAL MANAGER, FEDERAL SAVINGS AND LOAN INSURANCE CORPORATION ; AND NEAL J. HARDY, ASSISTANT ADMINISTRATOR, HOUSING AND HOME FINANCE AGENCY Senator D O U G L A S . Y O U have already submitted a statement for this committee, and unless you have additions which you would like to make, there are a few questions I should like to ask. I do not think it need take us too long. M r . FOLEY. W e submitted answers at some length to the questions that had been sent to us, and I do not feel I have anything to add. I would be glad to try to answer any further questions. Senator DOUGLAS. This is the question I would like to start off with. I personally believe that one of the fine features i n the Public Housing A c t was the provision that the number of housing units started would vary i n a countercyclical manner with the business depression; that while the average was, I believe, 162,000 a y e a r ? it could f a l l as low as 50,000 starts i n a year of acute prosperity and rise to 200,000 in a year of acute depression. I may say that i n the b i l l as originally introduced, we provided a variation between 50,000 and 250,000, and it was on the motion of Senator T a f t that we reduced the peak from 250,000 to 200,000. T h i s makes it possible, i f the act is so administered, to build approximately the same number of houses over a 5-year period, which would otherwise be done, but to vary the rate of building between years so that i n years of prosperity there would not be as much inflationary pressure upon the economy as a whole as there otherwise would be and that, on the other hand, during a period of depression you would have a larger volume of construction to throw into the breach, and to that degree, therefore, you would be able to check the cumulative forces of depression. I personally believe that is a very wise provision. The question I should now like to ask is whether some similar provision should not be introduced into the F H A insurance field. A t present F H A insurance is written i n boom times as well as i n depression times. There are those who have contended—I personally do not take too great stock i n it—that the high volume of residential construction i n 1948 may have contributed to the booms of that year and similarly i n 1947. 203 M O N E T A R Y , CREDIT, AND FISCAL POLICIES I f we adopt as a policy that F H A should be geared to help produce stability as well as be an end i n itself, could we not approach this i n two ways: First, by having F H A write insurance only i n periods of depression and then to suspend its taking on new business during prosperous periods or, second, to have F H A insurance mortgages continuously but to liberalize its terms when housing activity needs to be encouraged and to tighten its terms when an inflationary boom develops or threatens. Among the terms which could be thus varied would be: (a) the amount of down payment required; (b) the length of the period of repayment; (c) the amount of the insurance charge; (d) the basis for appraisal; and, possibly (e) the height of permitted interest rates. I n other words, so manipulate these terms as to encourage F H A insurance and, hence, construction i n periods of depression and dampen it down somewhat in periods of prosperity and inflation. I wonder i f you would be willing to comment on that or i f you want to ask any members of your staff to comment on it, we would be grateful for that, too. M r . FOLEY. I would like to comment on it, but I think my remarks would havei to be general, without considerable study of the implications of both those suggestions. A s between the two, I think the second suggestion would be the more practicable, i f either were to be adopted. A s a matter of fact, much of the effect that your question contemplates has already been inherent in the System as applied, both in the terms of legislation as passed by Congress and in the activities of the agency in the past. I think you would have first to look at the situation we are trying to meet at a given time. Since the war—and it has been since the war and particularly in the last 2 or maybe 3 years—discussions of this kind have arisen and we have been contending with the basic and urgent necessity for producing a very large supply of housing, as against a variety of difficulties and changing conditions. The original difficulties after the war were chiefly material and labor shortages. That necessity has not yet passed. One, at least, of the chief causes for inflation in the price of housing after the war was the drastic shortage of housing and the tremendous and suddenly effective demand for it. So that the task we had to do was not only to build as many units as possible, but to build them insofar as possible in certain price ranges for sale and^for rent, and underlying all of that to build an industry organization sufficient to carry that kind of volume through a long period of time without the various strains of competition that add to inflation. Now, i f the contemplation i n either of these proposals were as against the condition of the kind that we met immediately after the war, I think you would have to give an entirely different consideration to it than you would i f you were contemplating when we get into a fairly stabilized situation as a safeguard against the future. Senator DOUGLAS. This is an important qualification. I n the year 1948 we built something over 900,000 housing units, and I am informed the record this year looks as though we are going to have approximately that number. Suppose that over a period of the next 2 or 3 years we build 900,000 units, and while I know new families 204 MONETARY, CREDIT, AND FISCAL POLICIES are forming at a rapid rate, we get this housing development, the housing shortage may ease; is that not true ? M r . F O L E Y . T h e acute edge of need from the standpoint of supplying an absolute lack of shelter, yes. I think the studies made by the committees of Congress i n the past several years, Senator, have been pretty thorough and have pretty well demonstrated that we need from a million to a million and a half added units per year for perhaps 10 years. Assuming no other situations that would cause inflation, I am of the opinion that production of a million and gradually i n excess of a million houses a year, i f they are properly distributed into types and price brackets and as to geographical locations, would not necessarily be an inflationary factor. I n other words, I think we have developed the capacity to produce materials and have developed and are developing the techniques, and the skills so that kind of production need not put a strain on the supply of either materials or men to the point that would cause inflation. Senator D O U G L A S . A leading public figure made a speech a day or two ago setting the goal as between a million and a half and tw^o million dwelling units a year for 10 years. M r . F O L E Y . I would not attempt to make an exact statement any more than I think the committees of Congress in their studies would. I t depends on what you are approaching as a goal i n the way of total betterment or improvement i n the housing situation. Senator D O U G L A S . I n other words, what you are saying is that as long as housing construction does not exceed a million units a year, you do not believe that should be dampened off even i n periods of prosperity ? M r . F O L E Y . A S against the further assumption I made of no other factors creating an inflationary boom, which would cause inflation i n housing other than for reasons of that production. Senator D O U G L A S . I f you got to a million and a half units a year, do you think that might possibly be dampened down i n periods of prosperity and accelerated in periods of depression ? M r . F O L E Y . Taking the million and a half as a figure that could be assumed to make the degree of speed i n improvement of the over-all housing situation that, for instance, was contemplated i n the reports of Congress, I think I might say yes. I was going on to add that actually the operation of the insured mortgage system at present has anti-inflationary effects. Senator D O U G L A S . I would be very glad to have you develop that. M r . F O L E Y . That, as we pointed out at some length i n our answer to your question, has been applied chiefly through the valuation and appraisal system. I do not believe it is necessary to repeat the detail we had there as to how that actually operates. I w i l l not recite the successive stages of application, imperfect I grant you, but pointing to the possibilities and the trends of thought i n application of the insuredmortgage system. The fundamental philosophy i n the whole insured-mortgage system, except the emergency types of title V I , has been i n itself an effort to apply the financing aids involved i n insured mortgages in an antiinflationary way in a sense that the more liberal types of insurance have been made available i n the lower price fields, so that the incentive 205 M O N E T A R Y , CREDIT, AND FISCAL POLICIES furnished through the financing aids to the industry has been downward, away from an inflationary increase in prices. Again, of course, it has not worked perfectly, but that has been the philosophy under which it was set in title I I and section 203 and originally i n section 207 in the rental field, although not nearly so closely applied there. The emergency type of financing, beginning in the defense period, carried on through the war, lapsed and then renewed for the veterans' program after the war, got away from the valuation theory to the current cost, first a reasonable current cost and then a necessary current cost; so that that philosophy was only imperfectly applied. I think the general effect of the basic philosophy of the permanent phases of the mortgage-insurance system is in the direction of an antiinflationary influence upon the market. Senator D O U G L A S . Y O U mean because the appraisals are based not on present cost but upon what the expected normal sales value w i l l be ? M r . FOLEY. Yes; and in normal times the amount of mortgage funds available in a large-volume market is an important factor in determini n g sales price and controlling sales price. Senator D O U G L A S . H O W much under cost have you been insuring houses? M r . FOLEY. I am not sure I understand your question, Senator. Senator D O U G L A S . Y O U say you have been making your appraisals on the basis of expected normal sales value, which is lower than current costs in a period of inflation. What I was trying to find out is how much under has it been on the average. M r . FOLEY. That would depend on the scale. F o r instance, i f the insurance is under title II, the possible maximum mortgage would range from 95 percent of appraised value down to a maximum of 80 i n certain types. Senator DOUGLAS. But what is the relationship of appraised value to cost ? M r . FOLEY. That is what I was coming to. The distinction between title I I and title V I , in which necessary current cost was recognized on the for-sale side until, I think, 2 years ago and on the for-rent side until now, with certain qualifications, is that you did not have an appraisal of value but rather a determination of necessary current cost. Now, the sale price of housing on which insured mortgages are placed is not fixed by the Government. I t is fixed by the seller. I n times of a strong seller's market, there may be a wide variance, a very large down-payment required. I n times of what becomes more a buyer's market, your sales price is more likely to approximate the appraisal fixed by the F H A . A s of now, I am not sure I could give you any close idea. Perhaps M r . Richards could tell you what the current experience on sales prices against our valuation is. Do you have any such information, M r . Richards ? M r . RICHARDS. D u r i n g the period that was referred to the variations would range, I would say, from 5 to possibly 30 percent or more, according to the area. D u r i n g the last year, of course, the line or difference between current cost and appraised value has been coming closer and closer together, due to these many factors; and I would say 99076—50 14 206 MONETARY, CREDIT, A N D FISCAL POLICIES in the majority of instances today, all other things being equal, such as your not trying to build a larger house in an area than the area w i l l absorb, and that sort of thing, that the difference between long-term value and reproduction cost is very little or approximately the same i n a great number of areas throughout the country. M r . FOLEY. But the Senator, I think, wants to know if you can give some estimate of what it is currently. M r . RICHARDS. That is what I say. Senator DOUGLAS. Y O U think the two are identical ? M r . RICHARDS. Virtually so, all other factors being equal insofar as the house being a suitable house for the area, and so forth. Senator DOUGLAS. Y O U expect present costs to reflect almost precisely future values ? M r . RICHARDS. Virtually so. There is very little difference between what we construe now to be current costs and long-term mortgage value. M r . FOLEY. That is assuming you would allow estimated replacement costs. M r . RICHARDS. Yes. M r . FOLEY. Costs vary with different buildings on the same house. The cost estimation has to be made typical. Senator DOUGLAS. I n other words, do I take it that you think this suggestion should not be seriously considered until we get a much larger volume of building than we now have ? M r . FOLEY. I think the suggestion is well worthy of study. I do not think it is susceptible of a simple answer of " Y e s " or " N o " at this time. I think we can and do apply the F H A - i n s u r e d mortgage system generally i n the direction of trying to hold down an undue inflation of prices, but there are so many factors i n the consideration such, for instance, as the suggestion for varying the amortization terms. That becomes a very complicated question, and I do not think a yes-or-no answer on the question of whether it should be varied for anti-inflationary purposes—in fact, shortening it might have the effect, perhaps would have the effect, of reducing the amount of construction. It might, however, have the effect of reducing the amount of construction i n the very fields where you want to focus your limited amount of construction at that period; so it is a complicated question, I think an important question and a significant one, but I think it would require much more study than would be possible to answer " Y e s " or " N o " now. Senator DOUGLAS. I n our questionnaire, which you were kind enough to reply to, we asked as one of the queries: What legislation would you recommend for the purpose of increasing F H A ' s contribution to general economic stability? Y o u responded, as I remember it, with two recommendations. The first recommendation was to place on a permanent basis the program for home improvement. The second of your recommendations I shall read in f u l l : T o provide the President w i t h authority to terminate or reinstate emergency insurance program on an economically sound basis, depending on the economic conditions prevailing i n the Nation. Such authority w o u l d provide a degree of flexibility i n the administration of the insurance programs w h i c h w o u l d increase the F H A ' s contribution to general economic stability. T h e success of the emergency insurance program during the defense period, war, a n d postwar periods 207 M O N E T A R Y , CREDIT, AND FISCAL POLICIES testifies to their effectiveness i n meeting the housing needs of the Nation. By meeting the housing needs of the N a t i o n a significant contribution can be made to general economic stability. I found that interesting but somewhat general, and I wondered i f you could describe more fully the kind of authority you believe should be given to the President. M r . FOLEY. The suggestion was made as against the background of title V I , which we mentioned there as having served a very useful purpose i n defense, wartime, and postwar. The history is very interesting in that the number of times that it had to come before Congress for renewal, consideration, amendment, change to meet changing conditions. current conditions; for instance, it had expired and then was renewed or reestablished to take care of the veterans' emergency housing program after the war. During the past year, I forget how many extensions there have been, but it has been a stop-and-go proposition all the time. It had to be brought up and considered by Congress as to whether it should go on, and Congress has determined each time that this was a need and that it should go on. Then it would be extended perhaps for a few months, 6 months, or 1 month, depending again on the Congress. That has made an extremely difficult situation, not only for the administrative agency but for the building industry as to making plans for even a single building season. What was contemplated in that suggestion and limited rather to that one consideration, since that is the only emergency program that we have had to deal with, was that such an authority, i f it were coupled with an authority for the President to say it shall go on or it shall stop or it shall stop and be revived within an over-all period that Congress had originally determined Senator DOUGLAS. I n other words, Congress would authorize for a longer period of time, with the President given discretionary powers to start or terminate within that period. M r . FOLEY. Perhaps within other maxima and minima broadly set forth, so that it could be applied flexibly by the President. Senator DOUGLAS. Could your suggestion not be combined with the suggestion I have just previously made, that administrative officials be given power to vary the terms according to the state of business conditions ? Could not the two suggestions be combined ? M r . FOLEY. I f the first suggestion were to be adopted, I think the variants of it suggested here would be desirable. Senator DOUGLAS. President Truman recently stated that the Federal National Mortgage Association has been accumulating insured mortgages at a rapid rate, I think around a hundred million dollars a month. I wonder i f you would explain the purposes of F N M A , the reason why its mortgage purchases are so large at the present time and the types of mortgages which have been acquired. M r . FOLEY. The Federal National Mortgage Association was originally established i n pursuit of the program for a national mortgage association set-up in title I I I of the National Housing A c t originally back in 1934,1 think, the original contemplation being they would be financed privately to deal i n insured mortgages, particularly as a secondary market to furnish an avenue of liquidity when needed by the initiators thereof. 208 MONETARY, CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. I n other words, it was designed to play the same part for building and loan associations which the Federal Reserve banks had been designed to play for the commercial banks ? M r . F O L E Y . N O ; I think that is hardly the parallel, since it was designed to serve all approved mortgages of the system, which might be building and loan associations, banks, mortgage companies, insurance companies, etc. Senator D O U G L A S . T O do for real-estate financing what the Federal Reserve banks were supposed to do for commercial banking ? M r . FOLEY. It was part of the declared plan or purpose in the act for the establishment of a national home mortgage market, seeking to make that security, a mortgage on a loan, a standard security, the insurance being one of the factors in making it that. I t was furnished that avenue of liquidity for lenders that needed it from time to time as perhaps their portfolio filled up and they had demands for home loans and no funds; so they could dispose of the mortgages they had made, i f insured. I t also was designed to be and did operate successfully as a sort of way-station for the gathering, packaging, and disposing of mortgages to private investors in the secondary mortgage field. It worked very successfully on that basis all through the thirties and during the war and early postwar period. I t works very successfully on that basis now. I should add that subsequently this market was broadened to include the guaranteed mortgages of the Veterans' Administration as well as the insured mortgage of the F H A . There is, of course, a definite difference and distinction between insured mortgages of the F H A and the common tyr>e of Y A guaranteed mortgage, which is under section 501. Senator D O U G L A S . H O W do you account for the recent transfer of so many mortgages from the building and loan associations to the "Fanny May'' [ F N M A ] ? M r . F O L E Y . T O start with, Senator, at the time that I am talking about, when the Federal National Mortgage Association market was used more sparingly than it is now, it was never on a perfectly level basis, it changed in its volume as conditions changed, the availability of funds, and so on, but at that period and during the war period the demand for mortgage funds was much less. W e had a total production far below what we now have, perhaps as low as a quarter during the war of what we now have. So that the opportunities for investment of mortgage funds were much more limited, and there was stronger competition for getting them and premiums actually were paid for them, even by the originating mortgagee as well as the secondary mortgagee. Now, you have a volume calling for readily available, current, rapid flow of mortgage funds to sustain upward of a million-house production. Y o u consequently have local situations frequently i n which a portfolio of a bank or a savings and loan company gets too f u l l 0$ mortgages, cannot continue to meet the need locally; so they have the necessity to dispose of some. The private secondary market does not absorb them sufficiently rapidly, and so they go to the Federal National Mortgage Association. Y o u have also in that picture a greater activity on the part of a nonportfolio type of mortgagee than you used to have. That is the mort- 209 M O N E T A R Y , CREDIT, AND FISCAL POLICIES gage company as distinguished from the bank or savings and loan association. They have served a very useful purpose, but they must have a rapid turn-over of their portfolio i f they are going to continue to loan; so they seek more frequently the Federal National Mortgage Association as a quick and assured outlet. There are other factors of the relative desirability of mortgages. Senator DOUGLAS. O n page 222 of the committee print, M r . Hise stated that as of the present, "Fanny M a y " held 55,000 F H A insured mortgages totaling approximately $390,000,000; 41,500—and I am giving this to the nearest rough figure—VA guaranteed mortgages, total amount of $247,000,000; and i n addition had outstanding contracts to acquire additional mortgages—namely, a little over 18,000 F H A mortgages, amounting to $346,000,000; 52,000 of V A mortgages, amounting to $376,000,000. So, if vou add those totals together, you get approximately $735,000,000 of F H A mortgages and about $650,000,000 of V A mortgages, or a total of $1,400,000,000. Now, apparently that has been growing Very rapidly. M r . FOLEY. That is right. Senator DOUGLAS. Have you ever awakened i n the middle of the night and wondered whether possibly sour mortgages were being unloaded upon you ? M r . FOLEY. I think one would never be in the situation of the Federal National Mortgage Association or any other purchaser of mortgages without being aware of the necessity of wondering whether you are going to have mortgages go down. Senator DOUGLAS. Perhaps I used the wrong pronoun, because of course "Fanny M a y " is not under your direction. M r . FOLEY. That is right. I knew you meant in the broad sense, but I do not think it is to be deduced from the fact that this volume of mortgages is being offered that it i n any way implies that the mortgages might be called sour in the sense that they would be unsafe and go bad more than others. There are other factors. Interest rates are one, the matter of the application of standards in the construction of the houses is another, as to why at one or another time a given type of mortgage may not be attractive to private lenders in the secondary market i n the volume necessary to sustain this over-all production. Senator D O U G L A S . I am told that I am very indiscreet i n the way I ask questions. I hope you w i l l forgive me. I asked M r . Gunderson, who represents the R F C yesterday i f he could explain why such large quantities were being sold to "Fanny M a y " [ F N M A ] or R F C . A t first he said he could give no explanation, and then he thought that possibly the real estate lending agencies thought the interest rate was going to rise and that they wanted to divest themselves of this type of security i n order to have liquid funds to invest at a higher rate of interest. That seemed acceptable to me at the time, and then during the night I got to thinking it over, and I wondered i f possibly they were not sorting out their mortgages and taking those mortgages which they thought were perhaps a bit overinsured and turning them over to "Fanny May." 210 MONETARY, CREDIT, A N D FISCAL POLICIES M r . FOLEY. O f course, I am not familiar with all details of the portfolio nor the current handling or offerings made to the Federal National Mortgage Association. I t would be interesting to examine a list of the exact offerings for a current period. I think you would find, Senator, that they are not being presented that way. I think you would find, for instance, that from certain types of institutions a very considerable percentage of their current loans are offered not on a selective basis but as made and without the idea of selecting this one as better than that one or that one being a little worse than the others. I think that has been the experience during the past 2 years, and I think you w i l l find it so now. The increase of offerings very lately is probably due i n considerable part to the expansion of the mortgage authority of "Fanny M a y " [ F N M A ] to 100 percent as against the 50 percent limitation that existed before. I would not believe from any information that we have that it is a selective offering of what they consider poorer mortgages from the standpoint of risk. They may be poorer mortgages from the standpoint of Senator DOUGLAS. They are insured by F H A and, therefore, the holder would have no chance of losing. M r . FOLEY. I think a little more exactly than that. F r o m the standpoint of the risk of there being a foreclosure likely to take place, they may be less desirable from the standpoint of yield or some other reason to the particular institution involved. I think it is a little bit early to draw conclusions as to what the present flow of mortgages into the "Fanny M a y " may really mean. I t may well be that their sales plan or effort to dispose, which is now under way and beginning to acquire some momentum, I understand Senator DOUGLAS. Not too much momentum. M r . FOLEY. Not at present, but it may well be that within six months the situation in the investment market w i l l be such that sales w i l l develop rapidly. I think it is too soon to come to a final conclusion as to the meaning. The question of yield is involved. Senator DOUGLAS. Suppose they were to turn out sour. Then "Fanny May," one Government agency, would have claims against the F H A , another Government agency. M r . FOLEY. A n d against V A . I t would make no difference as f a r as the claim is concerned, however, since i f they had not been sold to the Federal National Mortgage Association and resulted i n a foreclosure, the claim would come from a private holder rather than f rom the Federal National Mortgage Association. M r . WOLCOTT. M a y I ask a question ? S e n a t o r DOUGLAS. Y e s , sir. M r . WOLCOTT. The bank or savings and loan association or mortgage association wilich sells the mortgage to "Fanny May"—what do they get as a service charge ? Is it 1 percent ? M r . FOLEY. The original mortgagee who keeps it and services it, I think their present rate is a half percent allowance. M r . WOLCOTT. Then let's work this out i n a case. I gave a bank a mortgage on my house, which is F H A , which I agreed to amortize over a period of time. That bank sells the mortgage to "Fanny M a y " ; I continue making my payments to the bank; the bank reimburses 211 M O N E T A R Y , CREDIT, AND FISCAL POLICIES "Fanny M a y " ; there is a servicing charge there that they make, isn't there, representing "Fanny May? Is that the one-half of 1 percent? M r . F O L E Y . "Fanny M a y " pays them a service charge. Y o u do not pay that. M r . W O L C O T T . That is right. They get one-half of 1 percent service charge. M r . FOLEY. Yes. M r . W O L C O T T . N O W , the reason why there was an adjustment i n "Fanny M a y " operations was perhaps not primarily due to but was influenced by the fact that there were a few—and I know of a very few—mortgage-investment concerns which sprang up and organized on a shoestring and were selling their mortgages without recourse to "Fanny May," and in that way there was direct financing by the Federal Government of a good many builders, some of them had perhaps controlling shares in these mortgage associations. Now, I am making this as a statement, but I hope it w i l l be interpreted as a question, because I am seeking information. Perhaps there is another or a third reason why there has been this increase in sales of mortgages to "Fanny May." That is, that when the mortgagee sells a great enough volume of mortgages to "Fanny May," which he services and is getting one-half of 1 percent on, it becomes quite a profitable business to him. That is my question i n the form of a statement. M r . F O L E Y . The question, as I get it, is whether or not he is making the mortgages with a view simply to establishing a servicing business which w i l l be profitable in itself and using the existence of the publicly financed secondary market as an easy avenue to do that. I doubt that many mortgage institutions have engaged in the mortgage business with sales to the Federal National Mortgage Association primarily to establish a servicing account, although the servicing ascount, i f it gets large enough, can be a profitable business. Unless they continue in operation, it w i l l gradually decline. I think it has probably been an incidental cause in an unknown number of cases, that type of lending institution. Senator D O U G L A S . The Hoover Commission recommended that "Fanny M a y " be transferred from the R F C to your agency. Is it an unnecessary question to ask you if you favor that ? M r . F O L E Y . I n the sense that i f it were unnecessary I would have said "Yes," or that you would assume I would say "Yes" ? A s a matter of fact, the matter has been discussed many times i n the course of various recommendations for reorganization; and actually i n some legislative proposals of 2 years ago—S. 866, I believe—it was proposed; and we testified in favor of the establishment of the Federal National Mortgage Association i n the housing agency. I am familiar with the answer of the R F C to that question. Senator D O U G L A S . W h i c h was "No." M r . F O L E Y . A n d from the standpoint of the reasons they advanced, i f those were the only factors under consideration, I would probably agree with them. A s a matter of fact, I do not think it is possible to separate the operation so entirely from the character of an agency concerned with housing as to describe it solely as a financing and investing firm. 212 MONETARY, CREDIT, AND FISCAL POLICIES So that, i n the face of the type of conditions we confront and may continue to confront, while I am not at this time recommending a transfer, I would not give an unqualified " N o " to it, such as has been given. Senator D O U G L A S . D O you remember Dickens' novel, David Copperfield? M r . FOLEY. Barkis is willing ? Senator D O U G L A S . D O you have any such implications ? M r . FOLEY. I would not say " Y e s " to all the implications. H i s explanation of it, as I recall it, was that when he said that he was really very anxious. Senator DOUGLAS. I t amounted to a marriage proposal. I was not quite certain what this diplomatic reply of yours boiled down to. M r . FOLEY. A t this point what I am saying is that I would not go along with the answer of the R F C to the extent of saying " N o ; it should not be considered," because at this point I think the operation is one that cannot be considered strictly and solely as a financial operation. Senator D O U G L A S . Y O U do not say "No,'' but do you say " Y e s " ? M r . F O L E Y . I say that, i f present conditions continue and we have to continue to rely as heavily upon a secondary mortgage market as we apparently now do, I think we should give serious consideration to incorporating it i n the agency. Senator DOUGLAS. Those are all the questions that I had. M r . Wolcott? M r . W O L C O T T . I do not think I have any. M r . F O L E Y . I have tried to be as responsive as I could. I hope it has been helpful. Senator DOUGLAS. Thank you very much. Gentlemen, I should announce for the benefit of the press that we open our hearings again on Tuesday, and i n the morning at 10 o'clock M r . Marriner Eccles, now member and former Chairman of the Board of Governors of the Federal Reserve System, w i l l testify; at 2 o'clock in the afternoon M r . E . E . Brown, chairman of the board of the F i r s t National Bank of Chicago, w i l l testify. (Whereupon, the committee adjourned at 3 p. m., to reconvene at 10 a. m., Tuesday, November 22,1949.) MONETARY, CREDIT, AND FISCAL POLICIES TUESDAY, NOVEMBER 2 2 , 1949 CONGRESS OF T H E U N I T E D S T A T E S , S U B C O M M I T T E E OF M O N E T A R Y , CREDIT, AND FISCAL POLICIES, J O I N T C O M M I T T E E ON T H E ECONOMIC REPORT, Washington,, I). C. The subcommittee met, pursuant to adjournment, at 10: 00 a. m. i n the caucus room, Senate Office Building, Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senator Douglas (chairman of the subcommittee) and Representative Wolcott. Also present: Dr. Grover W . Ensley, acting staff director, and Dr. Lester V . Chandler, economist to the subcommittee. Senator DOUGLAS. M r . Eccles, we are very happy indeed to have you with us this morning. W e were glad to get the expanded statement of Chairman McCabe, which I suppose represented official Federal Reserve policy on the matters which we raised i n our questionnaire, and I assume that may have been one of reasons why you as an individual did not submit a reply to our questionnaire. B u t we are happy to welcome you here this morning, and I understand that you have a statement which you would like to give first. I think perhaps I should say for the record that you are here on our invitation and not on your solicitation. STATEMENT OF MARRINER S. ECCLES, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM M r . ECCLES. I would like to comment on your observation. The reason I did not reply to the questionnaire is that I understood, as did the rest of the Board members, that it w^as submitted to Chairman McCabe as a personal matter, and I did not see the questionnaire, nor have I seen the replies. The replies to the questionnaire, as Chairman McCabe indicated, were his views and not necessarily those of the Board. I would not say, however, that there may not be a lot of agreement on the Chairman's replies, but at the same time there may be some different points of view and some disagreement. I appreciate this opportunity, Chairman Douglas, to appear before your committee. M r . Chairman, I am here, as you know, i n response to the invitation i n your letter of October 31, 1949, to discuss issues that have been raised during the study initiated by your subcommittee i n the field of monetary, credit, and fiscal policies. I shall be glad to try to answer such questions as may be uppermost i n your mind, but I should like first to present for your consideration a short statement 213 214 MONETARY, CREDIT, AND FISCAL POLICIES which I hope may anticipate and answer some of your questions. M y views are the cumulative results of 15 years of participation i n developing and carrying out policies of the Federal Reserve System, preceded by long experience in private banking under State as well as National authority and membership i n the Federal Reserve System. I therefore could not f a i l to be aware of the vigorous opposition that has so often been voiced against new proposals with respect to Federal authority over banking. I n recent years it has seemed that nearly every recommendation emanating from the Federal Reserve Board has been assailed as a threat to destroy the dual banking system. A s one who has spent his business life in that system, I have been unable to see the justification for such agitation. Our commercial banking system is composed of banks that receive deposits subject to withdrawal upon demand, make loans, and perform other services. About half of the total dollar amount of bank deposits are insured up to $ 5 , 0 0 0 for each depositor by a Federal agency, the Federal Deposit Insurance Corporation. Banks holding 85 percent of the resources of the banking system are i n the Federal Reserve System, another Federal agency. Approximately 5 , 0 0 0 of these banks operate under Federal charters, issued by the Comptroller of the Currency, and about 9,100 operate under charters from the 48 States. T h i s is the dual-banking system. Senator D O U G L A S . M a y I interrupt a minute? And, of the 9 , 1 0 0 State banks, about 2,000 are i n the Federal Reserve System ? M r . E C C L E S . That is correct. Senator D O U G L A S . About 7 , 1 0 0 outside ? M r . E C C L E S . I do not know the exact figure, but I think it is less than 7 , 0 0 0 that are outside, between 6 , 0 0 0 and 7 , 0 0 0 . While I am sure that those who are its most vociferous supporters would not seriously contend for the abolition of the Federal Reserve System, with the consequent restoration of the intolerable conditions that prevailed before its establishment, they nevertheless constantly oppose measures that would enable the Reserve System to be far more effective i n carrying out its intended functions—functions that help to protect not only all banking but the entire economy. T w o proposals, more than any others, stir up this agitation. One is the proposal for the equal application of a fair and adequate system of reserve requirements to all insured commercial banks. T h e other proposal is that the Federal Government apply the principles and objectives of the Hoover Commission to the Federal agencies concern©^, with banking, monetary, and credit policy. Bankers believe i n the objectives of the Hoover Commission, at least as applied to all other activities of the Government—why not the banking activities ? The red herring of the dual banking system is always brought up to obscure the real merits of the fundamental questions involved i n the proper administration of fiscal monetary, and credit policy, which concerns commerce, agriculture, industry, and the public as a whole; it is by no means the sole concern of bankers. The major responsibility of the Federal Reserve System is that of formulating and administering national monetary policy. I t does this chiefly through the exercise of such influence as it may bring to bear upon the volume, availability, and cost of commercial bank reserves. I t must operate through the commercial banks of the country, 215 M O N E T A R Y , CREDIT, AND FISCAL POLICIES because they, together with the Federal Reserve banks, are the institutions through which the money supply is increased or decreased. I t is of paramount importance to the entire country that someone have the means as well as the ability to discharge this responsibility. I t cannot be left to the voluntary choice of some 14,000 individual and competing banking institutions. I t cannot be split up among the various agencies of the Federal and State Governments. The framers of the Federal Reserve A c t undoubtedly intended that it should be i n the Federal Reserve Board under the direct control of Congress. Others have pointed out that existing bank reserve requirements are inequitable, unfair, and ineffective at the very time when they are most urgently needed to restrain excessive expansion of bank credit. They should not depend as they do now on whether a bank is located in a central Reserve city or in a Reserve city or whether it is outside of one of these cities or away from its downtown area, nor should they depend on whether a bank is a member or a nonmember. There is no good reason for such distinctions from the standpoint of effectuating monetary policy. Senator DOUGLAS. May I interrupt a minute? A r e you suggesting, therefore, that you should have one set of reserve requirements and abolish the present distinction between central Reserve cities and country banks ? M r . ECCLES. That is right. Senator DOUGLAS. That is one set across the board ? M r . ECCLES. That is right. Senator DOUGLAS. F o r banks wherever located ? M r . ECCLES. The next paragraph w i l l cover that, I think. I n addition to other handicaps of membership, members of the Federal Reserve System are subject to much more onerous reserve requirements than nonmember banks. Member banks are required to carry certain percentages of their demand and time deposits i n non-interestbearing cash balances with the Federal Reserve banks. A p a r t from these required reserve balances, member banks necessarily carry some vault cash to meet deposit withdrawals, and in addition they carry balances with correspondent banks, none of which can be counted toward statutory reserve requirements. O n the other hand, nonmember bank reserve requirements not only are generally lower in amount but may also consist entirely of vault cash and balances carried with city correspondents. I n some instances reserves of nonmember banks may be invested in United States Government and other specified securities. Thus to a considerable extent nonmember banks may receive direct or indirect compensation for a substantial part of their reserves. These discrepancies are most obvious and difficult to explain when two banks, one a member and the other not, are doing the same kind of business as competitors on opposite corners of the same town. Member banks therefore bear an undue and unfair share of the responsibility for the execution of national credit policy. There should be a plan under which the responsibility for holding reserves to promote monetary and general economic stability would be as fairly distributed as possible. This would require a fundamental revision of the existing basis for bank reserve requirements. They should be based on the nature of depoits rather than mere location; they should be somewhat higher upon interbank deposits than upon 216 MONETARY, CREDIT, A N D F I S C A L POLICIES other demand deposits. Vault cash should be given consideration because it has much the same effect as deposits at reserve banks. I n any such revision of reserve requirements, it is of primary importance to take into account the fact that they are a means of contracting or expanding the liquidity position of the banking system and of making other credit instruments more effective. Reserve funds of banks may expand through large gold inflows or silver purchases, or return of currency from circulation, or borrowing from Reserve banks, or Federal Reserve purchases of Government securities through necessary open-market operations. There should be sufficient authority over reserve requirements to permit taking such developments into consideration when necessary. There is widespread misunderstanding even among bankers of the function of reserve requirements as a means of expanding or contracting the supply of bank credit. I n sharp contrast with State reserve requirements, those applied to member banks under the Federal Reserve A c t are primarily designed to affect the availability of credit; that is to say, the money supply. The Federal requirements are not primarily applied for the purpose of providing a cushion to protect the individual bank. They are not basically reserves i n that sense at all, and incidentally the Reserve banks do not and cannot use them to buy Government securities, as most of the bankers seem to think. The Federal Reserve System is a creature of the Congress. Y o u can make it weak or you can make it strong. W e have recited to the Congress over and over again the dilemma that we face. It is perfectly simple. So long as the Reserve System is expected to support the Government bond market and to the extent that such support requires the System to purchase marketable issues, whether sold by banks or others, this means that the System is deprived of its only really effective instrument for curbing overexpansion of credit. I t means that the initiative in the creation of reserves which form a basis on which credit can be pyramided rests with banks or others and not with those responsible for carrying out national monetary policy. T o the extent that banks or others can at w i l l obtain reserves, they are thus able to monetize the public debt. I n view of this situation, i f the Congress intends to have the Reserve System perform its functions, then you should by all means arm it with alternative means of applying restraints. The only effective way to do that is through revision and modernization of the mechanism of reserve requirements. The Congress w i l l not have done the job at all i f it fails to include all insured banks. Reserve requirements that are limited only to member banks of the Federal Reserve System impose upon them a wholly unfair and inequitable burden which becomes the more intolerable as the need arises to increase reserve requirements as a means of curbing overexpansion of bank credit. O f course, organized banking and its spokesmen, chiefly large city banks, do not want any change. They never do. Throughout the long history of banking reform i n this country— and it is still very far from complete—the same bankers or their prototypes have been for the status quo. Beginning with the National Banking Act, they have fought every progressive step, including the Federal Reserve A c t and creation of the Federal Deposit Insurance Corporation. I f you abide by their counsels or wait for their leader 217 M O N E T A R Y , C R E D I T , A N D FISCAL POLICIES ship, you w i l l never do anything i n time to safeguard and protect private banking and meet the changing needs of the economy i n such a way as to avoid still further intrusion of the Government into the field of private credit, to which I am really very much opposed—an intrusion which the public has demanded i n the past because private banki n g leadership failed. I may add that whenever Congress sees fit to enact into legislation the principle of equitable reserve requirements applied uniformly without regard to membership i n the Federal Reserve System, there might well be changes in other relations of the Federal Reserve System which would be of benefit to all commercial banking, as, for example, to offer the credit facilities of the Reserve banks on equal terms to all banks which maintain their reserves with the Reserve banks, together with further improvements i n the check-collection system. These and other beneficial changes could well be brought about with great advantage to banks and to the public i n general. The role of the Reserve System i n relation to Government lending to business also should be clarified. This is particularly important to the functions exercised in that field by the Reconstruction Finance Corporation and with respect to the authority of the Reserve banks to extend credit to industrial enterprises under section 13b of the Federal Reserve Act. The latter should be modified as proposed in S. 408, the bill favorably reported by the Senate Banking and Currency Committee in 1947, and the enactment of which was again recommended by the Board i n 1948. There is unquestionably a need for such an agency as the Reconstruction Finance Corporation i n emergency periods for direct Government lending for projects outside the fieid of private credit, but I have always taken the position that the Government should not compete with or invade the domain of private banking and credit institutions. When aid is necessary to facilitate the functioning of private credit, then such aid should take the form of guaranteeing i n part the loans made by private institutions, just as was done i n the V-loan program of the Federal Reserve for financing war production. That is what S. 408 proposes. The profound difference i n the principle at stake here ought to be obvious. I n relation to the second question, that of organization, which I mentioned at the outset, I feel that students of government, and particularly those who endorsed the objectives of the Hoover Commission, ought to be more interested than they appear to have been in the problems of organization of the agencies of Federal Government concerned with bank supervision. Some, however, may have been misled into thinking that there is no problem i n this field because the expenses of these agencies are not paid from governmental appropriations. The establishment of a system of insurance of deposits by the Federal Government was one of the great accomplishments of the Congress in the direction of fostering public confidence in the banking system. I favored Federal deposit-insurance legislation at a time when most of my fellow bankers were denouncing it. But I never expected, and I am certain Congress never intended, that this protection for depositors would be used either to hamper effective national monetary policy or to give any class of banks special advantages over others. I regret to say that the Federal Deposit Insurance Cor 218 MONETARY, CREDIT, AND FISCAL POLICIES poration has been used to discourage membership in the Federal Reserve System and to weaken effective monetary policy. There is no logic whatever in the present provisions of law, which say, in effect, to a bank, " Y o u can't joint the Federal Reserve System unless you also join the Federal Deposit Insurance Corporation, but you can join the Federal Deposit Insurance Corporation without joining the Federal Reserve System." The law compels a national bank to join both, but a State bank has the option of joining one or the other or neither. I should like most earnestly to urge upon you the importance of making this a two-way street by providing that a bank can be a member of the Federal Reserve System without joining the Federal Deposit Insurance Corporation, in the same way that a State bank is now privileged to be a member of the Federal Deposit Insurance Corporation without being obliged to join the Federal Reserve System. Senator DOUGLAS. M r . Eccles, may I ask a question there ? Is this a counterattack which you are proposing that the Federal Reserve System make M r . ECCLES. It is a logical answer to some of the comments. Senator DOUGLAS. Are you serious about this ? M r . E C C L E S . I have proposed a uniform system of reserves. Certainly, i f there is not to be a uniform system of reserves, the Federal Reserve System is weakened, and its position can only be maintained by having a two-way street as proposed. I n other words, it seems to me that, unless you have uniform reserve requirements, then certainly this proposal here is an alternative that should be taken into account, not as a counterattack for the purpose of any destructive effects, but merely, as it seems to me, a necessary piece of legislation so that the Federal Reserve is in a position at least to protect itself or to defend itself. Senator DOUGLAS. This might be a very effective means of bringing the Federal Deposit Insurance Corporation and some of its supporters into line with your proposal for uniform reserve requirements. M r . ECCLES. I would hope that would be the result. Senator DOUGLAS. But i f it were not the case, do you think this proposal of yours would strengthen the banking system as a whole ? M r . ECCLES. I do not think it would hurt it. M r . WOLCOTT. W o u l d it strengthen it ? M r . ECCLES. No; I do not know that it would strengthen it. I think there may be some member banks that would decide they would not need Federal deposit insurance just as there are many State banks now that have decided they do not need the Federal Reserve as long as they have Federal deposit insurance. I think some of the bigger banks may well say that as members of the Federal Reserve they do not need F D I C . Senator DOUGLAS. D O you think that Federal deposit insurance has lowered the value of a bank belonging to the Federal Reserve System ? M r . E C C L E S . N O ; I do not think so. I favored F D I C . Neither do I think that membership in the Federal Reserve System would lower the standards of a bank which is a member of the F D I C . The Federal Deposit Insurance Corporation was designed i n the public interest, and it should be maintained for that purpose; but this is not to say that the continued existence of three Federal agencies performing similar or allied functions i n the field of bank supervision, 219 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES regulation, statistical, and other services is justifiable. There is unnecessary duplication and triplication of offices, personnel, effort, time, and expense. While the maintenance of separate and often conflicting viewpoints may serve selfish interests, on the old principle of "divide and conquer," it seems to me that this should not prevent improvements wherever possible in the organization of a Government already overburdened with complexity and bureaucracy. I n this connection various suggestions as to where responsibility should be lodged for the examination of banks subject to Federal supervision have been offered, ranging from the setting up of a new agency with no other responsibility to maintaining the status quo. The Reserve System must have currently accurate information, procured through examination, bank condition reports, special investigations, constant correspondence, and contacts with the banks. The System must have examiners and other personnel responsible to it, specially trained and directed for the purpose of procuring such information. The Reserve System is in position to determine policies to be pursued by examiners, to coordinate them with credit policies, and at the same time decentralizes the actual administration by utilizing the facilities of the 12 Reserve Banks and their 24 branches. They examine all State member banks, receive copies of examination of all national banks, are in close touch in this and i n other ways with all member banks, as well as the State and National supervisory authorities. Through their daily activities of furnishing currency, collecting checks, seeing that member banks maintain their reserves, and extending credit to them, the Reserve banks obtain current information about banks which is invaluable for purposes of bank supervision. The Federal Reserve is and must be at least as vitally concerned with the soundness of the individual bank as anyone i n the organization of the Comptroller or the Federal Deposit Insurance Corporation. The Federal Reserve Act places i n the Federal Reserve a specific responsibility for effective supervision over banking in the United States. Soundness of the individual bank and soundness of the economy must go hand in hand. Therefore, Federal Reserve concern with the maintenance of stable economic conditions should be and is i n the interest of sound banking as well as the public welfare. I t has not destroyed the effectiveness of Federal Reserve supervision over State member banks, and it is absurd to think, as I understand has been suggested to you, that it would destroy the effectiveness of supervision or examination of other banks. Moreover, is it reasonable to believe that the intelligence of the officials of the Federal Reserve banks, combined with the judgment of a seven-man board appointed by the President, confirmed by the Senate, responsible to the Congress, should be regarded as less independent than a bureau i n the Treasury under one official whose deputies are appointed by the Secretary of the Treasury ? No single individual in the Federal Reserve System determines its policies. Since examination supplies information essential to the right conduct of the business of the Reserve System and since the Reserve authorities must review reports of examination of all member banks, it is illogical to argue that they should be deprived of all examination authority. Examination procedure is a tool of bank supervision and regulation which should be integrated with and responsive to 220 MONETARY, CREDIT, A N D F I S C A L POLICIES monetary and credit policy. I f directed as though it were not concerned with such policy it could nullify what otherwise could be effective monetary and credit policy. I n fact, too often i n the past, bank examination policy became tighter when conditions grew worse, thus intensifying deflation, and conversely examination policy has gone along with inflationary forces when caution was needed. Only one of the three Federal supervisory agencies, the Federal Eeserve System, is charged by Congress with responsibility over the supply and cost of credit, which is directly affected by reserve requirements, discount policy, and open-market operations. The Eeserve System views the economic scene principally from the standpoint of national credit conditions as effected by monetary, fiscal, and related governmental policy. Other agencies do not have these responsibilities. Their differences of interest often lead to prolonged discussions which delay or prevent agreements. Let me turn now to the question of the composition and responsibilities of the Board of Governors and the Open Market Committee, which committee is composed of the seven members of the Board plus five Reserve bank presidents. The New Y o r k bank has one of those five, and the position is continuous. The other banks rotate i n their membership on the committee. I do not suggest that the present system has not worked. I t was a compromise and your committee is interested, and properly so, in the question whether the present structure could be improved. I feel that I should point out its defects and how they could be remedied. W h i l e the Board of Governors has final responsibility and authority for determining, within statutory limitations, the amount of reserves that shall be carried by member banks at the Federal Reserve banks, for discount rates charged by the Federal Reserve bank for advances to member banks, and for general regulation and supervision of the lending operations of the Reserve banks, the responsibility and authority under existing law for policy with respect to the Government security market, known as open-market operations, is vested in the Open Market Committee. These operations have become an increasingly vital part of Federal Reserve policy. I n practice they are the principal means through which debt-management policies of the Government are effectuated. They are the means by which an orderly market for Government securities is maintained. W i t h the rapid growth of the public debt, chiefly as a result of wartime financing, with the continuance of a budget of extraordinary size, with major refunding operations in view and the prospect of deficit financing, there can be no doubt of the responsibility that w i l l continue to rest with the Federal Reserve System for open-market policy . Suggestions have been made and I believe w i l l appear in answers to your questionnaire, with a certain degree of logic in their support, that the interrelations between the considerations of policy governing open-market operations and those governing reserve requirements, discount rates, and perhaps other functions, are such as to justify transferring these major instruments of policy to the Federal Open Market Committee, leaving to the Federal Reserve Board as such only matters of secondary importance. T h i s would not justify the continued existence of a seven-man Board of Governors. T o the extent, however, that such suggestions recognize the principle that responsibility for over-all credit and monetary policy should be fixed i n one 221 M O N E T A R Y , CREDIT, A N D F I S C A L POLICIES place, I would agree. O n the other hand, they accentuate the major inconsistency in the present set-up. I t should be noted i n this connection that the president of a Federal Reserve bank is not a director of that bank but is its chief executive officer. H e is elected for a 5-year term by a local board of nine directors, three of whom are appointed by the Board of Governors and the other six by the member banks of the district. I n addition to making the appointment, the directors fix his salary. Both of these decisions are subject to approval by the Board of Governors. Neither he nor the directors of the bank have any direct responsibility to the Congress, or the administration, for that matter. When a Reserve bank president sits as a member of the Federal Open Market Committee, however, he participates i n vital policy decisions with full-time members of the Board of Governors, who are appointed by the President of the United States and confirmed by the Senate and whose salaries are fixed by Congress. Those decisions, which must be obeyed by his bank as well as by the other Federal Reserve banks, affect all banking. So far as I know, there is no other major governmental power entrusted to a Federal agency composed i n part of representatives of the organizations which are the subject of regulation by that agency. President Woodrow Wilson expressed himself very vigorously on this subject when the original Federal Reserve Act was under consideration. I f this principle is not to be discarded, it follows that further inroads should not be made into the functions of the Federal Reserve Board and on the other hand that responsibility for open-market policy should be concentrated i n the Board. I am convinced i n this connection that there is no need for more than five members, instead of seven as at present, and that the Congress should recognize by more appropriate salaries the great importance of the public responsibilities entrusted to the Federal Reserve System, of which the Federal Reserve Board is the governing body. Such recognition would be more likely to attract to the membership of the Board men fully qualified for the position. I f , however, it is believed preferable for national credit and monetary policy to be determined in part by some of the presidents of the Reserve banks, then the presidents of all 12 Reserve banks should be constituted the monetary and credit authority, and they should take over the functions of the Board of Governors, which body should be abolished. The governmental responsibility of such a body should be recognized by requiring their appointment by the President of the United States and their confirmation by the Senate; their salaries should be fixed by Congress, to whom they should report. M a y I point out that i f the presidents of the Reserve banks can, in addition to performing their manifold duties as chief executive officers of these very important institutions, take on i n addition the principal functions of the Federal Reserve Board, it must be that these functions do not justify a full-time seven-man Board, and this would be another reason for abolishing it, and substituting a part-time Board composed of the 12 presidents. Y o u would have to add, of course, an administrator and a proper staff i n Washington, and you would possibly have to add committees made up from the 12. 99076—50 15 222 MONETARY, CREDIT, A N D FISCAL POLICIES I am offering this seriously. This is not a counter-proposal. T h i s is a serious proposal based upon the experience that I have had in Washington over a long period of time. Senator D O U G L A S . I S this your first choice or is your first choice the abolition of the Open Market Committee and the lodging of powers of the Open Market Committee in the Federal Reserve Board ? M r . ECCLES. Well, I would be pretty neutral on that. I think either would work. I think it is largely a question of placing responsibility i n a governmental body, whether it be the President's or whether it be another board. I think either would work. I would be neutral. Senator DOUGLAS. But you would prefer either to the present set-up ? M r . E C C L E S . I would. The views I have expressed have developed out of a long experience i n and out of Government and they have not been altered by the fact that I have ceased to be Chairman of the Board after serving i n that capacity for more than 12 years or by the fact that I expect sometime to return to the field of private banking. I n the foregoing I have not attempted to include some other important matters which may be of interest to the committee i n its deliberations and might well be considered by a national monetary commission, such as that proposed in S. 1559 which I strongly support. Accordingly, I would appreciate it i f you would permit me to file a supplemental memorandum for the record in the even that it appears to be desirable to do so in order to complete my statement. Senator DOUGLAS. Thank you very much, M r . Eccles. O f course we w i l l be glad to have you file a supplementary statement. I want to thank you for your very interesting testimony. (The following supplementary statement was later furnished by M r . Eccles:) BOARD OF G O V E R N O R S OF T H E F E D E R A L RESERVE SYSTEM, December Hon. PAUL H. 1, 19^9. DOUGLAS, United States Senate, Washington, D. G. DEAR SENATOR DOUGLAS : I n connection w i t h my testimony presented on November 22 before your committee, I indicated that I had not attempted to include i n my statement some important matters w h i c h may be helpful to the committee. Y o u granted me the privilege of filing a supplementary statement should that appear desirable. I n the course of my testimony you asked i f it w o u l d serve a useful purpose i f Congress were to instruct the Treasury further as to the policies to be f o l l o w e d i n debt management where they are dependent upon the monetary policies of the F e d e r a l Reserve System. Y o u also stated that you w o u l d appreciate it i f y o u could get some suggested standards of an instruction that might be given to the Treasury by Congress w i t h reference to Treasury relations w i t h the F e d e r a l Reserve. Since presenting my testimony I have given a great deal of thought to t h i s subject. I n reading over the record of my remarks, it was apparent to me that I had not responded as f u l l y as I could have to some of your questions. Therefore, I should like to take advantage of the privilege of making a supplementary statement. A very fundamental dilemma confronts the F e d e r a l Reserve System i n the discharge of the responsibilities placed on it by Congress. T h e System has by statute the task of influencing the supply, availability, and cost of money and credit. I n peacetime, the objective is to do this i n such a w a y that monetary and credit policy w i l l make the maximum possible contribution to sustained progress t o w a r d goals of high employment and rising standards of living. Federal Reserve System powers for c a r r y i n g out this responsibility are at present basically 223 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES adequate. B u t the System has not, i n fact, been free to use its powers under circumstances when a restrictive monetary policy was highly essential i n the public interest. It has been precluded from doing so in the earlier postwar period in part because of the large volume of Government securities held by banks, insurance companies, and others who did not view them as permanent investments. Reasons for supporting the market under these conditions I have already presented before your committee. T h i s policy of rigid support of Government securities should not be continued indefinitely. T h e circumstances that made it necessary are no longer compelling. B u t the Federal Reserve would not be able to change these policies as long as i t felt bound to support debt-management decisions made by the Treasury, unless these were i n conformity with the same objectives that guide the Federal Reserve. The Treasury, however, is not responsible to Congress for monetary and credit policy and has had for a long time general easy-money bias under almost any and a l l circumstances. A s long as the Federal Reserve policy must be based upon this criterion, it could not pursue a restrictive money policy to combat inflationary pressures. Decisions regarding management of the public debt set the framework w i t h i n which monetary and credit action can be taken. A s the size of the debt grew through the period of deficit finance i n the thirties and particularly over the w a r period, Treasury needs came to overshadow and finally to dominate completely Federal Reserve monetary and credit policy. When the Treasury announces the issue of securities at a very low rate pattern during a period of credit expansion, as it did last Wednesday, the Federal Reserve is forced to defend these terms unless the System is prepared to let the financing fail, which it could not very well do. T o maintain a very low rate pattern when there is a strong demand for credit, the System cannot avoid supplying Federal Reserve credit at the w i l l of the market. Under these conditions it can hardly be said that the Federal Reserve System retains any effective influence in its own right over the supply of money i n the country or over the availability and cost of credit, although these are the major duties for which the System has statutory responsibility. Nor can i t be said that the discount rate and open-market operations of the System are determined by Federal Reserve authorities, except in form. They are predetermined by debt-management decisions made,by the Treasury. T h i s w i l l be true as long as the System is not i n a position to pursue an independent policy but must support i n the market any program of financing adopted by the Treasury even though the program may be inconsistent with the monetary and credit policies the System considers appropriate i n the public interest. The Federal Reserve System was established by Congress primarily for the purpose of determining and carrying out credit and monetary policy in the interest of economic stability and is responsible to Congress for that task. There is a seven-man Board of Governors, appointed for 14-year terms w i t h approval of the Senate. The B o a r d is assisted by an experienced and highly qualified staff of experts. There are 12 presidents of the Federal Reserve banks, each w i t h a staff of specialists, and each Federal Reserve bank has a board of directors composed of leading citizens in its district drawn from professional, business, farming, banking, and other activities. There is also the Federal Advisory Council, composed of a leading banker from each of the 12 districts, established by Congress to advise the Board. A l l of these supply information and advice and many participate i n formulation of monetary policies appropriate to the needs of the economy. Under present circumstances the talents and efforts of these men are largely wasted. Views of the Federal Reserve B o a r d and Open Market Committee regarding debt-management polices are seldom sought by the Treasury before decisions are reached. T h e System, however, has made suggestions on its own initiative to the Treasury i n connection w i t h each financing, but very often these have not been accepted. Decisions are apparently made by the Treasury largely on the basis of its general desire to get money as cheaply as possible. In a war period or a depression, there is reason for financing a deficit through commercial bank credit—that is, by creating new money. The Federal Reserve System has supported such financing at very low rates by purchasing Government securities i n the market at such rates, thus pumping the needed reserves into the banking system. I n the early postwar period some support was desirable, especially for the 2%-percent long-term bonds, but it should not have been as inflexible as it was for short-term rates. 224 MONETARY, CREDIT, AND FISCAL POLICIES T h e outlook at the present time i s for a n expanding economic activity w i t h high employment. W e also n o w anticipate a Government cash deficit of over $6,000,000,000 i n the calendar year 1950. It w o u l d be inexcusable to finance this deficit at very l o w rates of interest by creating new money should inflationary pressures resurge. B u t i f the Treasury, under these conditions, insists on cont i n u a t i o n of the present very l o w rates, the F e d e r a l Reserve w i l l have to pump new money out into the economy even though i t may be i n the interest of economic stability to take the opposite action. I n m a k i n g a cheap money market f o r the T r e a s u r y , w e cannot avoid m a k i n g i t f o r everybody. A l l monetary a n d credit restraints are gone under such conditions; the F e d e r a l Reserve becomes simply a n engine of inflation. W i t h respect to the problem of h o w future monetary and credit policies are to be established, i t seems to me Congress must choose f r o m the f o l l o w i n g three general alternatives i f the present dilemma confronting the F e d e r a l Reserve System is to be resolved: (1) Congress can permit the present arrangement to continue. T h e T r e a s u r y w o u l d control i n effect the open market and other credit policy as i t does n o w by establishing such rates a n d terms on its securities as i t pleases, w i t h the reQuirement that the F e d e r a l Reserve support them. I t should be recognized t h a t under this course, limitations over the volume of bank credit available both to p r i v a t e and public borrowers, a n d accordingly l i m i t a t i o n over the t o t a l volume of money i n the country, w o u l d be largely given up. Such credit a n d monetary restraint as might be required f r o m time to time to promote economic stability w o u l d be entirely dependent upon the willingness of the T r e a s u r y to finance at higher interest rates, and i n the past the T r e a s u r y has been resistant to doing this. I f this alternative is followed, w h i c h is the present arangement, Congress should recognize that the responsibilities for monetary and credit policies are w i t h the T r e a s u r y and not w i t h the F e d e r a l Reserve System a n d that the p r i n c i p a l purpose of the F e d e r a l Reserve System is then to supply a d d i t i o n a l bank reserves on the demand of any holder of Government securities at rates of interest i n effect established by the Treasury. (2) T h e Congress could provide the F e d e r a l Reserve System w i t h a p a r t i a l substitute f o r the open market and discount powers w h i c h debt-management decisions of the T r e a s u r y have rendered and can continue to render largely useless f o r purposes of credit restraint. Soin§ measure of control over the availa b i l i t y of credit under inflationary circumstances could be regained i f the System were given substantial a d d i t i o n a l authority over basic reserve requirements of the entire commercial b a n k i n g system. W i t h such authority, the System could, i f necessary, immobilize new bank reserves a r i s i n g f r o m a return of currency f r o m circulation, gold inflows, and System purchases of securities f r o m nonbank investors and thereby prevent the multiple expansion of the money supply. In addition, the System w o u l d need authority to require banks to h o l d a special reserve i n Government bills and certificates. T h i s w o u l d be necessary i n case banks entered upon an inflationary credit expansion through the sale of Government securities to the F e d e r a l Reserve or i n the event i t was necessary to assist the Government to finance large deficits w i t h o u t creating a d d i t i o n a l bank reserves w h i c h serve as a basis for multiple credit expansion. (3) Congress, i f i t wishes credit a n d monetary policy to be made by the Fede r a l Reserve System i n accordance w i t h the objectives of the F e d e r a l Reserve A c t a n d the Employment A c t of 1946, could direct the T r e a s u r y to consult w i t h the System i n the f o r m u l a t i o n of its debt-management decisions i n order t h a t these decisions may be compatible w i t h the general f r a m e w o r k of credit and monetary policy being followed by the System i n the interest of general economic stability. I t is obvious, of course, that Government financing needs must be met a n d the responsibility of the F e d e r a l Reserve to insure successful T r e a s u r y financing must continue to be f u l l y recognized. B u t T r e a s u r y financing can be c a r r i e d out successfully w i t h i n the framework of a restrictive credit policy, provided the terms of the securities offered are i n accordance w i t h t h a t policy. T o sum up briefly my views, I believe that Congress should fix clearly the responsibility for n a t i o n a l monetary and credit policy. A l t h o u g h the F e d e r a l Reserve System w a s established as a n agency of Congress for determination of monetary a n d credit policy, as it must function now i t is responsible both to Congress and to the T r e a s u r y f o r that policy. These two responsibilities are often conflcting, and both cannot be satisfactorily discharged. T h e responsibilities a n d authority of the System need clarification and for that purpose one of three alternative actions might be taken by Congress: 225 M O N E T A R Y , CREDIT, AND FISCAL POLICIES (1) Recognize i n the statute that responsibility f o r monetary and credit policy is w i t h the T r e a s u r y and recognize the F e d e r a l Reserve for w h a t i t is t o d a y — a n agent f o r advising the Treasury and c a r r y i n g out monetary and credit policy determined by the Treasury. (2) Give the F e d e r a l Reserve System such additional authority over bank reserve requirements as would adequately serve as a p a r t i a l substitute for discount and open-market powers. (3) Give the System a mandate to determine monetary and credit policies on the basis of guide posts stated i n terms of the language of the F u l l Employment A c t of 1946, w i t h the Treasury required to advise and consult w i t h the F e d e r a l Reserve and take into account the mandate of Congress i n connection w i t h its debt-management decisions. I recognize that monetary or credit policy by itself cannot assure economic stability. I t should be accompanied by a fiscal policy, as w e l l as a bank supervisory policy, i n harmony w i t h it. I appreciate very much having the opportunity to express my views on this matter. Sincerely yours, M. S. ECCLES Senator D O U G L A S . N O W , M r . Eccles, I take it that the three main methods by which the Federal Reserve System attempts to control the general supply of money and credit are first, rediscount; second, open-market operations; and third, the reserve requirements which the Board can impose on member banks; and I would like to ask you whether you think the rediscount powers under the present conditions of banking furnish any appreciable strength to the Reserve System. M r . ECCLES. B y themselves, practically none. Senator DOUGLAS. W e had testimony last week which indicated that the total amount of commercial paper rediscounted by the System and held by the Federal Reserve banks amounted to less than 2 percent of the assets of the System. M r . E C C L E S . S O long as the banking system owns such a large amount of Government securities, and there is an immediate market for those securities, banks have little or no use for the rediscount facilities, and therefore the discount rate by itself is not effective. The discount rate may have some psychological effect, but it must closely adhere to the Open Market Committee s buying rate on shortterm Government securities. Otherwise, it would be considered a penalty rate, and would not be used at all to the extent that the buying rate on short-term securities is very close to or below the discount rate. The banks, i n order to meet their, reserve requirements, which in the Reserve city and central Reserve city banks are figured on a weekly basis, w i l l sometimes borrow over-night funds, perhaps for 2 or 3 days, rather than go through the market. The sale and the repurchase of securities contains an element of cost in the commissions that they have to pay i n the buying and the selling. If, however, the discount rate is substantially higher than the buying rate, of course, banks w i l l buy and sell bills and certificates to adjust with their reserve position. Senator D O U G L A S . N O W may I ask some questions about the openmarket operations which imply not merely the purchase of Government securities by the System, i n order to build up the reserves and therefore to expand credit, but I take it also it was at least originally intended to imply the sale of Government securities in order to reduce the member bank reserves and therefore curtail expansion. That is true, is it not? That is a preliminary question. Then I was going to follow that up. Is that statement correct? 226 MONETARY, CREDIT, A N D FISCAL POLICIES M r . E C C L E S . I f the banks have excess reserves, and the System does not sell its Government securities, that is, the Open Market Committee does not sell out of its portfolio of Government securities, then the banks would bid up the prices of Government securities; interest rates drop, and an exceedingly easy-money situation develops. A n example of that occurred when the emergency authority of the Board to increase reserve requirements was permitted to lapse on the 1st of July. The banking system immediately received very substantial excess reserves. The Open Market Committee did not sell securities in the market, and as banks endeavored to invest their funds the b i l l rate, which was approximately one and an eighth, went down to three-quarters within a week's time or less. Certificate rates dropped accordingly and bond prices went up. I n order to keep the short-term rate from practically going to the vanishing point, the System then permitted the sale of sufficient securities to absorb the excess reserves. Let me put it this way: The money market banks as well as most of the Reserve city banks generally maintain practically 110 excess reserves with the Reserve System. They immediately invest any excess reserves that they have in short-term Government paper, almost irrespective of the rate. I t has been definitely demonstrated that it is impossible to maintain more than about three-quarers of a billion of excess reserves, which are maintained largely by what are known as the country banks—smaller banks throughout the country. Reserves are supplied through gold imports, the return of currency and Treasury operations which put funds into the market. The Treasury may also take funds out of the market, as would an increase i n currency or a loss of gold. N Variations i n reserves through all of these immediately affect the short-term rate. Senator D O U G L A S . Well, I take it that you believe that during the period of expanding prices, and a period i n which there is a tendency toward inflation, one way of checking this would be, i f it could be made effective, for the System to sell Governments in the open market and thus draw down the M r . E C C L E S . I t cannot be made effective. Senator D O U G L A S . That is the next point I was coming to. B u t i f it could be made effective, that is what you would like to have done ? M r . E C C L E S . Oh, yes; i f the banks or the public would buy securities out of the portfolio of the System, that would be fine. Senator D O U G L A S . That would draw down the reserves and therefore diminish the lending power ? M r . E C C L E S . Yes; but there are not any reserves during those periods. W h a t really happens is that not only the banking system but nonbank holders, such as insurance companies and investors, generally may sell Government securities. The only market for the securities during those periods is the Federal Reserve, and System purchases, of course, monetize the public debt. Every dollar's worth of securities that the Federal Reserve buys, whether from banks or otherwise, adds to the total deposits of the banking system and the reserves of the banking system upon which a multiple expansion of credit can be created. W h a t would be required under the conditions which you have indicated would be not that the Federal Reserve, the Open Market Committee, sell securities in the market, but that it withdraw from the market and refuse to buy. 227 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Well, now, that was the next point. A r e you saying that the weapon of the open-market operations has been virtually made inoperative to check inflation because of the readiness of the System to buy unlimited quantities of Governments at relatively pegged prices ? M r . ECCLES. That is correct. Senator DOUGLAS. A n d that as long as the banks can take bonds, go to the Federal Reserve System, sell them and get reserves, that the process of selling to them is taking money out of one pocket, which they promptly proceed to put in the other ? M r . ECCLES. W h e n the System buys securities it creates new reserves upon which the banking system can loan six times that amount of money on the basis of the present reserve requirements. Senator DOUGLAS. Now who decides whether or not the Federal Reserve System shall buy Governments ? M r . ECCLES. T h a t is a decision that is made by the Open Market Committee in conjunction with the Treasury. Senator DOUGLAS. Well, do they determine the amount or do they determine the rate ? M r . ECCLES. Well, they do not determine the amount. Y o u cannot determine the amount not knowing what the supply of securities is going to be. The support price is really what is determined, and i f you have a support price, then whatever amount is offered is what we take. The best example of that was last year when there was very heavy selling of the long-term -percent Treasury bonds. They were mostly the 2y2 marketable bonds not eligible for purchase by banks. The insurance companies particularly were very, very heavy sellers, and the System over a period of a few months purchased over $3,000,000,000 of these securites i n the market and within a year such purchases were nearly $7,000,000,000. I n the same period over 2y2 billion of bonds—eligible bonds—were purchased by the System. Senator DOUGLAS. M r . Eccles, I have never believed that congressional hearings were designed to exploit administrative differences, but you have been a member of this Open Market Committee, a very influential member, and yet now you are saying that this policy that the commitee has followed is i n your judgment incorrect ? M r . ECCLES. I did not say it was* incorrect. I merely outlined the effect of it. When I appeared before this committee November 25, 1947, this same committe of which Senator T a f t was then chairman and again before this committee on A p r i l 13, 1948, I discussed very fully this whole question of monetary policy. Y o u may recall that there were some very important inflationary pressures i n existence i n the f a l l of 1947 and i n the spring of 1948. O n those occasions I requested for the Board certain powers. I made this statement i n A p r i l of last year. I t is very short: So f a r as the monetary and credit yield is concerned, we have t r i e d to make clear the action on these fronts alone cannot guarantee stability. Nevertheless we believe that the Reserve System should be armed w i t h requisite powers, first to increase basic reserve requirements of a l l commercial banks, and, later on, i f the situation requires it, to provide that a l l such banks hold a n a d d i t i o n a l special reserve. That was i n the form of short-term Governments. 228 MONETARY, CREDIT, AND FISCAL POLICIES B o t h of these w o u l d be protective measures. T h e first could be used to offset gold acquisitions and purchases of Government securities by the F e d e r a l Reserve— That is, from insurance companies and others. lock up the effect of such an operation— I t would neutralize, and thereby restrict continued expansion and the already excessive money supply. T h e second w o u l d be essential i n case banks embark upon an inflationary credit expansion through the sale of Government securities to the F e d e r a l Reserve, or to assist the Government i n case of large-scale deficit financing. Now that was the gist of what was recommended at that time. I supported a policy of maintaining a 2% percent rate for the longest term Government securities at the time when that policy was being pursued. That policy likewise had the support of the Reserve bank presidents including M r . Sproul, who was vice chairman of the Open Market Committee, and also of M r . Brown, who was the chairman of the Federal Advisory Council of the Board, and of the great majority of the bankers of the country. Last October, before the Iowa bankers, i n answer to M r . Parkinson, the insurance company executive who criticized that policy, M r . L e f fingwell of J . P . Morgan & Co., and M r . Burgess of the National City Bank—the three leaders opposed to the support policy—I presented a statement i n justification of the support of the long-term 2y 2 percent rate, at that time, and gave the reasons for it. I w i l l read this later. Senator DOUGLAS. Then you wanted the short-time interest rate on Government notes, certificates, and so forth, to go up and not the longtime rate ? M r . ECCLES. Over the last several years the Open Market Committee was, I believe, i n almost unanimous agreement on the question of raising the short-term rate. W e advocated a much freer shortterm rate than was in effect. W e ran into resistance always with the Treasury. D u r i n g the war period we had a pattern of rates for the purpose of carrying out the war financing which seemed very necessary and desirable. W e assured the Treasury that we would see to it that whatever deficit financing was required would be carried out at a fixed pattern of rates. W e did that because it seemed to us, with the very large amount of deficit, financing that the war required, and not knowing, of course, just how large it would be or when it would end, that we could not have a speculative Government bond market. I don't mean to say there wasn't considerable speculation on the "up side." There was too much speculative bidding up of prices which was not our fault—but we realized that it would be exceedingly difficult to finance the Government with increasing interest rates, which would mean declining prices for securities after issuance. W h e n the war ended we tried to get out of what we called a straitjacket by raising the short-term rates. W e had difficulty with the Treasury, commencing with Secretary Vinson—Secretary Morganthau, of course, left the Treasury prior to the end of the war. W e continued to have difficulty with the Treasury i n getting them to agree to freeing the short-term rate. That couid have been a flexible rate, i f it could have been permitted to go wherever it would go, i n relation to the %y2 percent long-term rate. I t may well have gone as high as the long-term rate—short-term rates i n the past have gone 229 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES as high or even higher than long-term rates—and we would have then followed up that change i n the short-term rate with an increase i n the discount rate. Senator DOUGLAS. M a y I ask: When did the Federal Reserve first suggest raising the short-term rate Treasury bills ? M r . E C C L E S . I n 1946. Senator DOUGLAS. B u t it was not carried into effect until the middle of 1947? M r . ECCLES. Yes. I think that is true. W e had a buying rate of bills of three-eighths. Senator DOUGLAS. Was there a disagreement i n Government circles ? M r . ECCLES. T h e r e was. Senator D O U G L A S . Y O U felt the short-time rate should go up ? M r . ECCLES. The Open Market Committee felt it should go up. Senator DOUGLAS. The Treasury did not think it should go up ? M r . ECCLES. That is correct. Senator DOUGLAS. W h y did you think it should go up ? M r . ECCLES. Well, I felt that you had no flexibility i n the market at all. Y o u could, as many of the banks were doing, sell the shorter securities to us and buy the longer-term securities. This practice, which wTe call playing the pattern of rates, tends to force the longterm rate down as long as short-term rates are not permitted to rise. I n other words, we had a spread between short-term rates and longterm rates that didn't make sense, i n view of the support policy. W h y should anyone want to handle any short-term securities at seveneighths i f you could get 2y2 percent for a demand liability i n long-term securities ? Senator D O U G L A S . Y O U were in favor of the pegging of the longterm rate? M r . ECCLES. I couldn't figure out any alternative. I didn't like it but it seemed to me that we were confronted with a dilemma, that the size of the public debt was so great, the amounts of E . F . <& G. bonds outstanding, which were demand liabilities, were likewise very great and—I am going to read this from the Iowa statement, to which I previously referred, because really it is the heart of the problem, and I might just as well cover this point here. [Reading:] Now, just what does this type of program actually contemplate ? That is pegging. It seems to involve a continued willingness on the part of the F e d e r a l Reserve System to take Government bonds and to supply Reserve bank credit, but at yields higher than 2% percent. That is the policy that some were talking about. Apparently, however, the System should f o l l o w a policy of gradually easing bond prices down and yields up, but buying aggressively, i f necessary, to maintain orderliness i n the market. W h a t would be the position of a Government bond owner or a potential bond buyer under such circumstances? W o u l d they have any confidence i n the market? Holders w o u l d tend to sell and potential buyers to hold back, creating increasing d o w n w a r d pressure on bond prices, u n t i l substantially lower prices were reached. I f yields should rise only % percent on the longest 2% percent bonds, their price w o u l d f a l l to less than 93. B u t i n a f a l l i n g bond market, w i t h general credit demand strong, rates on other securities and loans w o u l d tend to rise at least proportionately as much. Under these conditions, can i t be expected that insurance companies or savings and loan associations or other institutional investors would act materially differently w i t h the yield on Governments at 3 percent than they do now at 2% percent? 230 MONETARY, CREDIT, A N D FISCAL POLICIES W e have had tax-free Governments, entirely tax free, selling at almost 6 percent i n the past with a small public debt. L o a n s or investment, other than Government securities, w o u l d have as much, i f not more, relative attractivenes to lenders and investors. Few, if any, borrowers w o u l d be priced out of the market for funds by rate increases of the size contemplated by advocates of this "flexibility" policy. The long-term rate. A n y moderate rise i n long-term interest rates w o u l d not, i n itself, reduce significantly the demand for money. Investing institutions, w h i c h are now switching f r o m long-term Government bonds to private credit forms, w o u l d s t i l l be motivated to do so by a continuing margin of return between the two kinds of investment. Thus, under the "flexible" policy, the F e d e r a l Reserve System w o u l d s t i l l be called upon to support the bond market and w o u l d thereby continue to create bank reserves. It is possible that the amount of support required under these conditions would be much greater than is now the case. Investors generally w o u l d lose confidence i n the market and w o u l d rush to sell their securities before prices declined further. Money and reserves created by F e d e r a l Reserve purchases below present support prices w o u l d be just as high-powered as those created by support at existing prices, and the reserves thus made available could support nearly six times as much i n bank loans. Senator DOUGLAS. M r . Eccles, may I interrupt for a minute. Y o u r program was not, therefore, to raise the yield on long-time securities ? M r . ECCLES. That is right. Senator DOUGLAS. But to raise the yield on short-time securities nearer to the 2y2 percent on long-time ? M r . ECCLES. That is right; that is correct. Senator DOUGLAS. A n d this was opposed by the Treasury ? M r . ECCLES. Well, the Open Market Committee and executive committee of the Open Market Committee meet regularly and discuss the question of the open-market operations i n relation to the constant and current problem of debt management. A s you know, with the billion dollars of bills falling due every week, and with the 25 billion of certificates, something of that sort, outstanding, falling due, with several billions of bonds falling due periodically, debt management is a current and constant problem. I t is important that the Federal Reserve policy be coordinated with the refunding operations, or the "rolling off" operations of the Treasury with reference to short-term debt. I n other w^ords, we couldn't let the short-term rates go completely free. W e never proposed that it go free. But what we d i d propose is that the b i l l rates and the certificate rates be permitted to go up. T h e Treasury was unwilling to permit our buing rate to go up as far as we recommended it, and thus permit the rates on short-term Government securities to rise. Senator DOUGLAS. They didn't want the short-term rate to go up because it meant a greater interest charge on the short-term debt; is that right? M r . ECCLES. That was one of the reasons, I suppose. Senator DOUGLAS. A n d they, also, did not want fluctuating prices? M r . ECCLES. D u r i n g this period of time, over a period of 2 or 3 years, the rate did go up on the certificates from % to 114. There were three raises of an eighth i n a period of a little over a year. Senator DOUGLAS. Well, this is something that puzzles me a bit: A s I remember it, the Federal Reserve System was supposed to be an independent agency; the Treasury, another independent agency. Yet, 231 M O N E T A R Y , CREDIT, AND FISCAL POLICIES it is inevitable that the views of one be taken into consideration by the other, and highly desirable. W h a t is the machinery for coordinating the policies of the Eeserve System with the policies of the Treasury ? Here was a case i n which the Federal Reserve Board, or rather the Open Market Committee, wanted a higher rate on short-time Government securities; the Treasury did not. Now, what is the process of osmosis by which the views of one becomes communicated to the other ? M r . ECCLES. Well, our staff of people are constantly i n contact w i t h the Treasury staff people, giving them the point of view of the Federal Eeserve; and the Chairman of the Board was in close touch with the Treasury. M r . Sproul and I met with the Secretary of the Treasury periodically to discuss with him the recommendations of the Open Market Committee with reference to this question. W e were successf u l in persuading the Treasury to permit some modest changes. That is how we got the changes that we did, but we were never able to get the short-term rate as free as we desired to get it, and there has been Senator DOUGLAS. Suppose you had gone ahead and raised the short-term rate; what would have happened ? M r . ECCLES. Well, I suppose that the System could have done that, in defiance of the wishes of the Treasury. M y views of the independence of a central bank are these: That the Congress appropriate the money; they levy the taxes; they determine whether or not there shall be deficit financing. The Treasury then is charged with the responsibility of raising whatever funds the Government needs to meet its requirements. They have the responsibility not only for raising new funds and determining the types of issues and the rates that should be paid, but they also have the responsibility for the refunding of the debt. The mechanism, however, for establishing money-market rates is in the hands of the Open Market Committee. I do not believe it is consistent to have an agent so independent that it can undertake, i f it chooses, to defeat the financing of a large deficit, which is a policy of the Congress. I n other words, it seems to me that it is up to the Federal Eeserve, the Open Market Committee, to advise, to recommend, to the Treasury and to the Congress. But it is not the position, I believe, of the Federal Eeserve Board, or the Open Market Committee, to enforce its will. I t has its day i n court. I t has its opportunity to make its views known. It has an opportunity to persuade and to influence, to whatever extent it can. I feel, however, that the final responsibility for making the decisions with reference to public financing is up to the Congress and the Treasury. A n y open-market committee, or any central banking system, that for any length of time did not go along with that conception would not survive. Now, I do think, when the policies pursued by the Government are sufficiently displeasing to the central banking authorities, their redress is to resign, but not to undertake to enforce their will. Senator DOUGLAS. M r . Eccles, I can quite understand that during the period of the war, when the amounts collected i n taxes and subscribed for bond purchase out of current income were not sufficient to meet the total cost of the war, we had to create credit by banks. B u t i n the period of 1946 and the first part of 1947, of which you speak, 232 MONETARY, CREDIT, A N D FISCAL POLICIES the Government d i d not have a deficit; it had a surplus, so that the policy of low rates on short-time securities was not necessary f o r current financing. Y o u can say that it was desirable for refunding, but not for current financing. M r . ECCLES. There was no current financing. I t was a l l a problem o f refunding. Senator DOUGLAS. T h e n the question comes, F o r how long w i l l the refunding needs of the Treasury dictate reserve policy ? Is this going to continue forever? M r . ECCLES. I think so. I f Congress would, as a result of hearings of this sort, make it apparent that this support policy on the part of the Open Market Committee was not desirable, I think you w o u l d find, maybe, a greater independence on the part of the Open Market Committee. B u t i n the hearings that have been held up here d u r i n g the past 2 or 3 years we were unable, though the agent of Congress, to get any indication f r o m any of the committees of Congress as to whether or not this support program should be discontinued. I don't think the System expected to get an opinion, but it only indicated that they had to do the best they could under the circumstances that existed. Senator DOUGLAS. A n d i n default of such a mandate you felt that, while you should advise and conciliate and attempt to persuade the Treasury, you should not act i n opposition to its wishes? M r . ECCLES. T h a t is correct. W e felt that increasing the short-term rates or permitting a long-term rate to go up would not necessarily stop an inflationary development unless we went so f a r as to withdraw f r o m the market. T o buy Government's, whether you buy Government's i n the market at par or at 75 cents on the dollar, you still create reserves. T o stop the growth of bank credit, it would have been necessary to deny banks Federal funds, either through rediscounting or through the support of the Government bond market. That, of course, would have stopped the growth of bank credit and the supply of money. A n increase i n rates of 1 percent or 2 percent, or even more, is not going to stop, i n a period of inflationary development, the borrower f r o m desiring to borrow i f he needs that credit i n order to do what he considers necessary to do business. T h e psychological effect on borrowers and lenders of such rate increases is, of course, h a r d to judge. I t would depend upon the degree of inflation, and the amount of confidence or lack of confidence i n the Government security market. Senator DOUGLAS. I n order to get an appreciable increase i n yields and i n interest rates, you would have to let the price of Government bonds depreciate markedly ? M r . ECCLES. A half of 1 percent i n interest rate would put the longterm Government bonds to 93. Now, you must consider what w o u l d then happen to the fifty-some-odd b i l l i o n of E , F , and G savings bonds that are outstanding. Senator D O U G L A S . I understand those are to be redeemed at par. M r . ECCLES. No, but they could be redeemed for cash. Those bonds, first, are demand liabilities on the Treasury, and i f Senator DOUGLAS. T h e Treasury w i l l redeem at par ? M r . ECCLES. I t w i l l redeem them for cash at stated prices. B u t , i f the Treasury has to redeem those bonds, then the Treasury has got to raise money i n the market, i n order to pay them off, and the Federal Reserve would have to see to it that the Treasury could raise the money. Therefore, you have a process of monetization there. 233 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. I n other words, what you are saying is that, for the stability of the banking system, perhaps the stability of the finances of the country, you can only permit minor changes i n the price of government; and, therefore, i n yields—very minor changes? M r . E C C L E S . I think so. Senator DOUGLAS. A n d that these minor changes w i l l not have very much effect i n damping down inflation ? M r . ECCLES. Well, if the demand for credit is great, or if the lack of confidence i n the long-term rates is greatly weakened, i f confidence i n the purchasing power of the dollar, which usually takes place i n a rapid and continuing inflationary condition, developed, then certainly merely a change of a few points i n the interest rate is not going to stop your inflationary development. A s was pointed out, there are two ways that inflation must be stopped. One is through fiscal policy, budgetary surpluses. But budgetary surpluses, i n and of themselves, w i l l not stop inflationary development, i f the effect of budgetary surplus, which is anti-inflationary, is neutralized or nullified by the banking system expanding credit of an amount equal to the budgetary surplus. That is what took place i n 1946 and 1947. Senator DOUGLAS. B u t couldn't the budgetary surplus be used to purchase a portion of the bank-held public debt ? M r . ECCLES. I t was used entirely for that purpose. Senator DOUGLAS. That should have diminished the reserves. M r . ECCLES. I t diminished the amount of deposits and reserves, but the banking system expanded bank credit, for housing particularly under a Government-sponsored program, for consumer credit through commercial loans, and various types of credit, which were encouraged. The banking system expanded credit and created money by an amount i n excess of the budgetary surplus which the Government created through a sound fiscal policy. Senator DOUGLAS. B u t they expanded by less than would have been the case had there not been a budgetary surplus. M r . ECCLES. One largely neutralized the other, or you would have had a much more serious inflationary development. Now, the principal reason why the Board proposed what was known as the special reserve was i n recognition of what I am saying. I t was desirable to put the banks under pressure not to loan, not to expand credit. Merely changing the interest rate further encouraged the banks to want to loan. T o increase the rates wouldn't discourage bank lending. The small increase in the rates would not discourage borrowers from borrowing. So, what seemed to us to be required was to put pressure on the banks by requiring that a substantial part of their deposits be locked up against the short-term Government securities which i n their purchase created the deposits. A n d I would like to read, in that connection, what I said on November 25,1947, to the Joint Committee on the Economic Report, i n hearings that were held for the purpose of considering inflationary problems, just a paragraph on this very point. [Reading:] It is unfortunate, I think, that banking leaders oppose protective measures against inflationary forces arising i n the credit field. T h e y seem to forget that, i n order to assist i n w a r financing, the Government provided the banking system w i t h additional reserves w h i c h enabled the banks to buy Government securities; that this created new deposits i n the banks; and that banks have also had the benefit of interest received on the Government securities they have held and w i l l 234 MONETARY, CREDIT, A N D FISCAL POLICIES continue to hold for an indefinite period. They object even to a temporary limitation on the further use of these funds as a basis for loans to private borrowers, w h i c h w o u l d i n t u r n create more and more deposits. T h e Government has an obligation and a duty to step i n at this time of national danger to say to! the banks, " W e are not proposing to deprive you of benefits you have already derived and w i l l continue to derive from the vast increase i n bank deposits resulting f r o m your purchases of Government securities, but we do say that you should be w i l l i n g to accept a reasonable limitation on using a war-created situation to multiply private loans i n peacetime when they serve to intensify inflationary pressures." Senator DOUGLAS. That was to be a limitation on the purchase of short-time securities ? M r . ECCLES. That was to require a reserve to be held i n short-term securities. M r . WOLCOTT. M a y we identify what he is reading from, M r . Chairman ? M r . ECCLES. Hearings before the Joint Committee on the Economic Report entitled "Anti-Inflation Program as Recommended i n the President's Message of November 17,1947," page 145. M r . WOLCOTT. Testimony which you gave before this committee or the House Banking and Currency Committee ? M r . ECCLES. Before this committee. M r . WOLCOTT. What was the other one you read from; was that testimony before this committee? M r . ECCLES, They were both before this committee. M r . WOLCOTT. O n what dates? M r . ECCLES. November 25, 1947, the one that I have just read; and the other was A p r i l 13,1948. Extensive hearings were held before your committee, M r . Wolcott, i n the House at that time. I appeared for two f u l l days before your committee in connection with this entire subject. M r . W O L C O T T . I remember you did. I thought there was something nostalgic about what you were reading. M r . ECCLES. That is right. There w i l l always be, of course, nostalgia, I think, about this subject of inflation and monetary and credit control. There is nothing new about it, and there is not likely to be over the ages. Senator DOUGLAS. M r . Eccles, when M r . Burgess testified last week, he contended that an increase i n the member-bank reserves ordered by the System could not restrict the growth of credit extended by the banks so long as the Federal Reserve follows the policy of pegging the prices of governments and is therefore committed to purchasing all securities offered to it. D o you agree with that ? M r . E C C L E S . I agree w i t h it. Senator D O U G L A S . S O that, i n effect, you are saying that the openmarket operations of the Reserve System and the reserve requirements of the System are relatively inoperative as a means of checking inflation because of the debt-management policy ? M r . ECCLES. Well, I think the debt-management policy is, of course, the most important factor i n this whole situation. W h a t M r . Burgess said, of course, is, like a great many statements, true as far as it goes; but more could be said upon the subject of how to exercise more effective credit controls through increasing reserve requirements to offset the effect i n reserves of Federal Reserve purchases of securities sold by nonbank investors. When insurance companies or other longterm investors decide to sell, so long as the Federal Reserve is support- 235 M O N E T A R Y , CREDIT, AND FISCAL POLICIES ing the long-term 2%-percent rate, reserves are created in the banking system. The banks themselves don't create those reserves. They get reserves and are under pressure then to use the money. Gold imports or silver purchases, or a reduction of currency i n circulation, all of those factors add to the excess reserves of the banking system; and the banks themselves, either individually or collectively, have nothing to do with the creating of those reserves. Y e t when reserves are available, the banks are under pressure to expend credit, to use those funds to drive interest rates down and to drive prices of securities up. Now, an increase in reserve requirements sterilizes the effect of reserves going into the banking system from these sources. But to increase reserve requirements very materially and not include nonmember banks would drive member banks out of the System. The Reserve banks would be, in effect, holding an umbrella over the banking system as a whole, and that is why we argue strongly that reserve requirements should be applied to all banks, so as to help the System get new members and to help the System hold the members we have. Now, there is one other point on that that I want to make. The banker v/ho chooses to sell securities doesn't see how or why he is necessarily creating more money. H e only sees that he has a good customer who gets the credit. Even though that customer gets the credit and uses it to compete for goods in short supply, the individual bank doesn't see that you must stop the growth of bank loans and investment i n order to stop the growth of bank credit. The special reserve requirement that would require the banks to hold a substantial part of their demand deposits in short-term Governments would put the banks under pressure to restrict loan expansion, because they wouldn't be able to sell their short-term securities. They would have much more hesitancy to sell the longer-term securities which give a higher yield, and they would want to maintain such liquidity as was left to them i f a reserve of short-term securities was applied. Now, I merely mention that as reviewing the proposal made, because we saw this situation fully at the time. W e saw the dilemma, and we tried to point out to the committees what we could do as an alternative to withdrawing support from the Government security market, which may have been necessary to prevent monetization of the public debt. W e hesitated to withdraw support for the reasons which I have indicated to you: Because of the effect upon the entire problem of management of the public debt, the problem of refunding, and particularly the effect that might be had upon the demand liability i n the form of E , F , and G bonds. Senator DOUGLAS. M r . Eccles, earlier you said that i n default of a congressional mandate you felt that you should not disregard the considered judgment of the Treasury on the question of yield of Government securities. M r . ECCLES. T h a t is correct. Senator D O U G L A S . I would like to ask: W o u l d it serve a useful purpose i f Congress were to instruct the Treasury further as to the policies to be followed in debt management and the procedures of cooperating with the Federal Reserve System ? M r . E C C L E S . I think it would be of great assistance. Senator D O U G L A S . D O you have any suggestions as to the policies which Congress might instruct the Treasury to follow ? 236 MONETARY, CREDIT, AND FISCAL POLICIES M r . ECCLES. Well, I hadn't thought of the subject, but I w i l l be glad to do so. I can't think of the practical language of a resolution or b i l l that would be required. I t would require action on the part of Congress. I t would certainly be debated plenty within the Congress. Senator DOUGLAS. B u t you are saying, i f properly constructed, it would be helpful. I take that i f such an instruction were unwise it could cause great damage. Therefore, we would appreciate it very much i f wTe might get some suggested standards, standards of instruction. M r . ECCLES. O f course, the Federal Eeserve System—that is, the Board in particular, more than the Open Market Committee—is i n a particularly difficult situation. The Members of the Congress and the public blame the Federal Eeserve for not restricting credit expansion and not preventing inflationary developments on the one hand, while on the other hand the Board would, of course, be condemned by many who would be opposed to such action. Certainly the Eeserve Board is no place for a person who does not have the courage to take unpopular action. I t would be of great assistance, of course, to the Board i f that were made perfectly clear, that this responsibility for credit and monetary control is theirs and not the Treasury's. I don't know that it would be practical to work out an arrangement, for the reasons I stated a while ago, to create an independent Eeserve Board, independent to the extent that it was expected to enforce its will. I t is now independent and should continue to be independent to the extent that it has an opportunity to recommend and to advise. That is, of course, desirable, and is a better situation than would be the case i f the Federal Eeserve authority and power were vested in the Treasury itself. Senator DOUGLAS. Well, would you favor a national monetary counc i l composed of the chief officers of the Gocernment who deal with fiscal and credit policies, so that there might be a formal opportunity for them to meet and try to arrive at common decisions rather than have these matters discussed at informal conferences on a staff level? M r . ECCLES. I don't think that would improve the situation. I t may be desirable to have an interdepartmental statutory council, such as the N A C i n the foreign field, for the purpose of coordination of certain credit activities. Y o u have the F a r m Credit Administration, and you have the Housing Administration, you have the E F C , and you do have a great many Government agencies whose activities affect the field of money and credit. I t might be desirable to have such an interdepartmental committee; but it would seem to me that, whatever the policy of the administration was at the time, it would prevail i n such a council; and it would, i f anything, reduce the independence of the Board and not increase it. Senator DOUGLAS. W e asked Secretary Snyder a question as to how we could get better coordination of fiscal policies; also, among other questions we asked him, whether he believed that the Secretary of the Treasury should be made a member of the Board of Governors of the Federal Eeserve System; and he replied [reading] : T h e Secretary of the Treasury is the seems to me that any proposal to make of the F e d e r a l Reserve System for the coordination of F e d e r a l Reserve and chief fiscal officer of the Government. I t h i m a member of the B o a r d of Governors express purpose of bringing about better Treasury policies w o u l d appear to sub- 237 M O N E T A R Y , CREDIT, AND FISCAL ordinate the responsibility of the Treasury ters. I n the final analysis, the p r i n c i p a l area must rest w i t h the President and his the electorate f o r their actions (p. 11 of the and F i s c a l Policies). POLICIES Department i n fiscal-monetary matresponsibility i n the fiscal-monetary fiscal officers who are accountable to committee print on Monetary, Credit, Now, i f what you have been saying amounts to this, that on these vital matters the Federal Reserve Board defers in its credit policies ultimately to the Secretary of the Treasury, that means that the Secretary of the Treasury ultimately has responsibility both for the fiscal and for credit policies ? M r . ECCLES. Well, there is no difference between money and credit. They are one and the same thing. W e say "money and credit," but credit is merely the basis for creating money. Senator DOUGLAS. Debt management, perhaps. M r . ECCLES. That is right. There is a distinction, of course, between what we call fiscal policy and monetary and credit policy. Now, I have advocated that the Federal Reserve Board or some organization should have the sole responsibility i n the field of monetary and credit policy; and, as I have indicated here, examinations are closely related to that question of monetary and credit policy. Senator DOUGLAS. Including the management of the public debt? M r . E C C L E S . N O ; when it comes to the question of management of the public debt, the Treasury is the huge borrower; and I don't know wThether you can, as a practical matter, improve a situation that merely gives to an independent Federal Reserve agency the opportunity to advise—the opportunity to recommend. I t is difficult for me to see how you can go further than that. When the administration in power at any given time is put there by the electorate and is responsible to the electorate, to have an independent agency deprive them of the most important tool i n the economic kit doesn't seem to me to be very practical. I t has never operated that way i n any other country. I n Canada, i n England, France, and every other country i n the world, so far as I know, the central bank has never successfully used its authority to enforce its w i l l over any administration i n power. Senator DOUGLAS. M r . Eccles, i n connection with the responsibilities of the Treasury for debt management, which you now say you do not propose to change, does not that necessarily carry w i t h it, i n the final analysis, control over credit policy and therefore over money policy? M r . ECCLES. Well, you could make A good argument for that. Senator DOUGLAS. Isn't that just a statement of fact under the present situation ? M r . E C C L E S . I would question that. Certainly the desirability of it. Senator D O U G L A S . I am not speaking about the desirability of it. I am just saying, isn't that a statement of the situation? M r . ECCLES. Well, I must admit that that is where the logic of the situation leads you; I must admit that. A n d yet we all know, I think, as a practical matter, that to increase the direct authority of the Treasury over the whole field of money and credit—in other words, set up within the Treasury itself a division or a department of monetary and credit control—may well lead, i n time, to a socialization of the credit structure, w^hich, I think, would be very undesirable and very dangerous. 99076- -50 16 238 MONETARY, CREDIT, A N D FISCAL POLICIES Senator DOUGLAS. I want to make it clear that I am not advocating that. ^ I am merely raising the question as to whether, in the present situation, the power of the Treasury to manage the debt, which you do not question, does not, as a matter of fact, also carry with it the virtual control over credit and monetary policy. That is all. I am not saying this should be permanent. M r . ECCLES. I wouldn't say that it carried the complete control. Senator D O U G L A S . N O ; predominant control. M r . ECCLES. I would say that it exercised a tremendous influence. I would say that it possibly carries a much greater control than is generally recognized and understood. That control, of course, can be extremely dangerous if the Treasury would be, for political reasons, enforcing a monetary and credit policy i n connection with its debtmanagement responsibility that was contrary to the best interests of the country at a given time. They could do that and it could be dangerous. Senator DOUGLAS. M r . Eccles, I am aware of the fact that I have probably asked more questions than I should, i n justice to my colleague, Congressman Wolcott, but I do have one or two more questions, and then I w i l l defer to him. I n hearings last week I asked a number of witnesses whether the Federal Reserve Board, in their judgment, should not be given powers to impose uniform reserve requirements on all banks, whether members or nonmembers, and their reply was almost uniformly "No." The chief argument which they brought forward was that already 85 percent of the deposits of the country are i n the Federal Reserve banks, and that the dog in the System was a big dog, and that the tail outside of the System was a relatively small tail, and that in practice the Federal Reserve Board did not need this control on reserve requirements to control the total amount of credit. Now, I replied to this argument of theirs by saying "Yes," but i f the Reserve Board raises requirements to check inflation there is always the danger that State banks w i l l resign from the System. They replied, "Have any ever done so," and their implication was, in practice, that the advantages of being in the System are such that even i f reserve requirements are raised that State banks, members of the System, holding 35 percent of the total deposits, w i l l not get out. What is your judgment on that? M r . ECCLES. I don't agree with that at all. I think i f reserve requirements were substantially increased that you would not only find a substantial number of State banks getting out, but you would find national banks converting to State banks. Y o u would weaken the entire structure of Federal control over the banking system. Not only would that happen but the State banks which are now out of the System would certainly not come into the System. Senator DOUGLAS, They only have 15 percent of the deposits. M r . ECCLES. That is right; but that is a pretty good size hole i n the dike. There is always a terrific opposition to an increase i n reserve requirements by member banks and national banks because of the discrimination. That is one of the great arguments against further increasing reserve requirements. Now, as a banker with a good many years of practical experience I can say that I cannot see any good reason why a bank would remain i n the Reserve System under conditions of an expanding increase i n reserve requirements. The advantages of the System are very minor aside from the use of its credit facilities. 239 M O N E T A R Y , CREDIT, AND FISCAL POLICIES Senator DOUGLAS. What about the clearance of checks ? M r . ECCLES. Well, you can clear checks through the banks which are members. That is no problem. They are delighted to have your balances. I n other words, most nonmember banks might get by on 15 percent of their demand deposits held as reserves—in cash and correspondent balances; whereas a member bank today cannot get by on less than 25 or 30 percent. Now, that is already a great penalty. Senator DOUGLAS. That includes vault cash ? M r . ECCLES. That is vault cash and correspondent bank balances that member banks must carry, i n addition to required balances with the Federal Reserve, in order to get the services that the Reserve System is unable to give them. Nonmember banks can count their vault cash and balances with correspondents to meet any reserve requirements the}7 are subject to. There would be no good reason why banks should stay in the Federal Reserve System so long as they have a large portfolio of Government securities which they are able to sell in order to get funds to meet their situation. Senator DOUGLAS. M a y I ask this, Has the fear that the raising of reserve requirements might cause State banks to get out of the Federal Reserve System ever operated to make the Federal Reserve Board abstain from putting into effect an increase i n reserve requirements which otherwise it would have thought desirable ? M r . ECCLES. W e didn't have authority to increase reserve requirements any further than we did. Senator DOUGLAS. Then has this fear operated to restrain you in the past ? M r . ECCLES. The fear hasn't operated to restrain the Reserve Board, no; but had we gotten the authority that was requested it may well have. I appeared before the committee and said that, unless authority to increase reserve requirements applied to nonmember banks, the Board did not want that authority, because they would be under pressure not to use it, because of the discrimination. Senator D O U G L A S . H O W much more did you want to raise it ? M r . ECCLES. W e asked for authority, as I recall, of 10 percent. I think that was i n A p r i l 1948. I n December of 1947 we had suggested authority to impose a special reserve requirement of up to 25 percent of demand deposits i n short-term Governments, which would have permitted the banks, of course, to hold their reserves i n the form of Governments, which are earning assets. What I have said here this morning, of course, with reference to this subject, had application in an inflationary situation that existed i n 1947 and 1948, and does not have the same application today. This is now an academic discussion, which does not necessarily have application to the present economic situation. I see no urgency at the present time for increased authority. I f the System had increased authority I can't see any use that they would have for it at the present time. That does not mean, however, looking to the future, that whatever authority may be necessary to deal with inflationary situations, should not be available. Senator DOUGLAS. I think those are all of the questions I have. Congressman Wolcott. M r . WOLCOTT. M r . Eccles, I don't know as you intended, and I surely am not going to interpret your remarks as critical of the con 240 MONETARY, CREDIT, A N D FISCAL POLICIES gressional action, but, of course, you have known for some time of the difficulty which Congress has had in trying to reconcile the policy as it was announced by the Treasury and the Federal Reserve Board—and sometimes, as I recall it, you haven't been in hearty agreement with other members of the Board in respect to these problems M r . ECCLES. I do not think that statement is correct. M r . WOLCOTT. Perhaps not on these problems, but on others. M r . ECCLES. I think that the statements I have presented are the statements of the Board. M r . WOLCOTT. A t that time ? M r . ECCLES. A t this time. M r . WOLCOTT. What I was leading up to is the statements you are making today and the suggestions and recommendations which you have made—are they your own, or are they the Board's ? M r . ECCLES. They are my statements. I am not Chairman of the Board, and I was asked to come up here and express my own views. M r . WOLCOTT. Do you believe that they substantially conform to the thinking of the other members of the Board ? M r . ECCLES. Well, it would be my judgment that they do conform y i n general, with certainly the majority of the Board. That is my judgment. I may be wrong. M r . W O L C O T T . Y O U have been dealing principally here in the past tense as to what our attitude should have been in previous inflations. Do you believe that the Government should, either through the Federal Reserve or the Treasury, continue to support the Government bond market? M r . ECCLES. Well, the Open Market Committee is not supporting the Government bond market at this time. M r . WOLCOTT. I f there should be a case where the Government bond market has to be supported, do you believe they should? They are surely influencing it to a point where it is supported i n some measure today. M r . ECCLES. Yes; as a matter of fact the Federal Reserve has reduced its holdings of Government securities during this year; it has sold into the market something over $4,000,000,000 of securities; including $3,000,000,000 of bonds. M r . WOLCOTT. W h y have they sold them? M r . ECCLES. Well, they have sold them to meet the demand. W e have let the market have securities; otherwise prices would have gone sky high, interest rates would have gone exceedingly low. M r . WOLCOTT. A l l of the operations of the Open Market Committee are predicated upon the desirability of maintaining a stable market, are they not; that is, since 1935, when you were given this authority, these mandatory powers? Before that the Open Market Committee was purely advisory. M r . E C C L E S . Y O U mean the Board was advisory. The Open Market Committee was composed of the governors of the 12 banks. M r . WOLCOTT. Yes. M r . ECCLES. The Board was advisory. power. M r . WOLCOTT. The Board had the veto Yes. M r . ECCLES. B u t they had no initiative; the initiative was i n the hands of the governors of the 12 banks. 241 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . WOLCOTT. The Open Market Committee had no initiatory powers previous to 1935 ? M r . ECCLES. The Open Market Committee had initiative before 1935.. The Open Market Committee was set up i n 1933. P r i o r to that they acted informally. F r o m about 1922 they acted informally, largely under the leadership of New York. B u t it wasn't until the Banking A c t of 1935 that there was an Open Market Committee that had the authority to force the Reserve banks to buy and sell. P r i o r to that time all the Open Market Committee could do was to adopt a policy over which the Board had a veto power. But whatever policy they adopted, any Reserve bank could refuse to participate. It was, of course, a very impractical and unsuccessful operation. That is why the Banking A c t of 1935 changed that entire open-market structure. A t the time of the Banking A c t of 1935, and I sponsored that legislation and carried it through Congress, it was recommended that the authority of the Open Market Committee be put in the Board, and the b i l l passed the House i n that form. It was the Senate that set up the present form, and that compromise was accepted in the conference committee. M r . WOLCOTT. M r . Eccles, can you give us some idea as to where you think the bond market should be pegged, w^here the Government bonds should be pegged ? M r . ECCLES. I t seems to me asked me the question, D i d I feel the Government bond market should be supported ? M r . WOLCOTT. Yes. M r . E C C L E S . A n d I answered by saying that the Government bond market w^as not requiring support, but the System was selling securities in the market, M r . WOLCOTT. Let me put it this way: W h a t we are trying to get at is whether the Congress should enact legislation to help i n the stabilization effort. I gather from what you have said that you believe the authority to peg the Government bond market should be continued ? M r . E C C L E S . Well, there is no direct requirement that the Government bond market be pegged. I am not saying, looking to the future that the 2!/2 rate should be maintained. I t seems to me that nothing could be worse than that the Reserve system be given a mandate, or that it be indicated, either by the Congress or by the Open Market Committee, that it should peg the Government bond market at a 2%-percent rate indefinitely, as M r . H a r l suggested the other day. Nothing could be worse. I t would be perfectly stupid then to have more than one rate. W h y on earth, i f the Open Market Committee, or the Congress, were to publicly announce that from here on out the long-term rate of 2% percent on Government securities was going to be maintained on market securities would anyone want a b i l l or a certificate that yields 1% or 1% ? A l l the Government would need to have is just one security, which would be a demand liability of 2y 2 percent. W h y have obligations maturing in 20 years ? M r . W O L C O T T . That brings up the question of the standards under which you should be given the authority. M y point is, Should the Congress just say that either the Treasury or the Federal Reserve, through the Open Market Committee, shall have the authority to support the Government-bond market, and stop there? W h a t more authority would that get you over what you have at the present time ? 242 MONETARY, CREDIT, AND FISCAL POLICIES M r . ECCLES. I t wouldn't give us any. W e have got that authority now. M r . WOLCOTT. Then it becomes a question of standards. W h a t standards, as Senator Douglas has suggested, could the Congress enact into law that would clarify your position i n respect to supporting the Government-bond market any more than has been done by giving the Open Market Committee initiatory powers under the Banki n g A c t of 1935 ? M r . ECCLES. I don't know. M r . WOLCOTT. W e don't know. That is what we have been t r y i n g to find out here ever since 1935. Surely we should make it flexible enough so that you wouldn't create a situation where you would destroy your market for the short-term stuff. M r . ECCLES. What the Board suggested was that the authority that the Open Market Committee has was not i n itself sufficient and that further powers were needed; namely, the authority to increase reserve requirements or to apply special reserve requirements, as supplemental to the other authority. M r . WOLCOTT. A l l r i g h t . M r . ECCLES. The authority of the Open Market Committee was adequate only to the extent that you denied the market Federal Reserve funds by withdrawing. M r . WOLCOTT. W e did give you authority i n respect to reserve requirements, and you say they weren't operative and you couldn't effect your purpose because we did not give you authority over reserves of nonmember banks ? M r . E C C L E S . N O ; we got authority about a year ago to increase requirements by 4 percent, but it was temporary and lapsed last June. M r . WOLCOTT. Yes. M r . ECCLES. I t applied to member banks only. I f you recall, that authority was not given until a year after it was asked, and then we were heading into a recession. M r . WOLCOTT. Y o u asked for a 10 percent authority ? M r . ECCLES. Yes. M r . WOLCOTT. The reason that the Congress did not give you the 10 percent was because it was self-evident, it was thought, that i f you exerted that authority up to the limit you could have put almost every bank i n the United States out of business; we thought it was too broad an authority. W e eventually compromised on your 4 percent, and you did not use all of that, did you ? M r . ECCLES. W e pointed out that the 10 percent at the time would still leave the banking system with enough Governments. They had about 50 percent of their deposits i n Governments; and a 10 percent increase, we pointed out, would leave them with nearly 50 percent of their deposits i n Government securities, and therefore it was not as drastic as you have indicated. M r . WOLCOTT. Well, we were told, as I recall, that you would never use that much authority. M r . ECCLES. Well, the very fact that we had the authority to use M r . WOLCOTT. Because there was no other alternative given to the Congress, we had to use our own good judgment as to what we considered equitable and what we considered sufficient authority to do the job at the time, so we compromised on 4 percent. M r . ECCLES. W e got no authority at that time. 243 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . W O L C O T T . Y O U didn't get the authority, M r . Eccles, because you asked for this unwarranted amount, in the opinion of the majority of the Congress. Mr. E C C L E S . N O ; they didn't even give us 4 percent; they gave us nothing at the time. M r . WOLCOTT. Because there was no alternative. The Congress had to create an alternative, as between 10 percent and 4 percent; and they did; and you did not use it. That is purely academic, of course. M r . ECCLES. B u t that is just part of the truth of the whole. M r . WOLCOTT. This is what I am trying to find out. W h a t do you recommend as a figure that the Congress should enact i n respect to the reserve requirements over and above what they are at the present time? M r . ECCLES. I am not making any recommendations with reference to what Congress should enact with reference to either reserve requirements or special reserves. I am merely pointing out here what the problem has been and M r . WOLCOTT. Has the Board taken any action as to' the amount of authority which it needs in that direction; has the Board agreed upon any figure ? M r . E C C L E S . N O ; the matter has not been discussed, because at the present time, I think, it is academic. W e have been reducing reserve requirements during the past year. Eeserve requirements have been reduced below the statutory limit by 2 percent. The Board would have authority, of course, to increase reserve requirements by that amount in the future. There is certainly no immediate problem today with reference to undue bank-credit expansion. Outstanding bank loans today are less than they were at the beginning of the year. So there is no urgency at the present time. I have suggested i n my statement that I think the passing of a resolution—that was Senate b i l l 1559, which called for the creation of a National Monetary Commission—is very important. I have said that such a Commission should be set up and an extensive study made before any of these questions are determined. I have tried to point out here only a few of the high lights. M r . WOLCOTT. Should we give this Monetary Commission the authority to dictate to the Federal Eeserve, the Open Market Committee, the point at which Governments should be supported ? M r . ECCLES. The Monetary Commission was to be set up for the purpose of making a study, and would not, as I understand it, be given any authority. M r . WOLCOTT. I am not getting very far. I have been trying to centralize this authority somewhere—perhaps that is the wrong term—but I think we see here a need for coordinating these efforts; and whatever is set up, whether it is a monetary authority or a commission or whether it is a credit council, do you think that any such coordinating body should be given the authority to dictate to the Federal Eeserve the point at which the Governments should be pegged ? M r . E C C L E S . N O ; I don't. M r . WOLCOTT. W h o should have the authority? M r . ECCLES. I think the Federal Eeserve should have it. M r . W O L C O T T . Y O U are not in favor of transferring that authority to the Treasury ? 244 MONETARY, CREDIT, A N D FISCAL POLICIES M r . E C C L E S . N O ; I am not. A s I have indicated, I think that the Federal Reserve itself needs some reorganization, and I do think that there should be a consolidation of the Federal supervisory agents. Senator D O U G L A S . I can hardly keep still, because you are saying that the Federal Reserve Board should have the power to determine the price at which Federal securities are purchased, but previously you have said that the Treasury should be given the power over debt management. M r . ECCLES. W h a t I meant to say, Senator, is that, whether it be the Board as now constituted or whether it be any other credit, monetary or credit organization, they should have the authority rather than there being a direct authority of the Treasury. They should have the authority to manage the open-market operations, in line with a policy that would have to be agreed upon with the Treasury. Now they would be independent to the extent that they are able to advise the Treasury, to recommend to the Treasury, and hence, I think, have considerable influence upon the Treasury. I think that that much independence must and should be maintained; w^hereas i f you put it in the Treasury directly, eliminating the Federal Reserve Board, you would not have any agency with any independence of expression on the subject. Senator DOUGLAS. O n the principle that a subordinate can hardly give independent advice to a superior who wants to be advised i n a different direction ? M r . ECCLES. Well, i n a degree I think that is correct. A n d I don't know how you are going to get away from that. I think that the history of central banking throughout the world would indicate tHat they must be subordinate to treasuries, and particularly is that true, now that the public debt is 60 percent of the entire debt. Now, it was one thing prior to the First W o r l d War, and even during the Twenties, and even prior to the Second W o r l d W a r . But, with a public debt the size that the public debt now is and with the prospect of running into another deficit, it seems to me pretty impractical to say that there should be a body with sufficient independence that it can defeat the purposes of an administration that chooses to create public deficits. M r . WOLCOTT. M r . Eccles, do you think the trend, the immediate trend, is toward further inflation, or reflation, or deflation, or are we on a level that w i l l remain more or less static for some time ? M r . ECCLES. Well, the statistics at the present time point to, I would say, some inflationary developments, and I say that for these reasons: Bank credit is beginning to expand a little. There is an excessively rapid growth i n consumer credit on more and more favorable terms. There is a great growth i n housing credit on very small down payments. There is a very rapid growth i n State and municipal debt. There is a very substantial public deficit, of about $5,000,000,000 i n this fiscal year. I n addition, there is the payment to the veterans of close to $2,800,000,000 that w i l l be disbursed the first 6 months of next year. There is the agricultural support policy of the Government, which, of course, tends to sustain the inflationary level i n the field of agriculture. There is the present labor wage policy that is indicating a further increase i n wages that must reflect itself, i n many instances, i n prices. There are the private corporate pension programs, 245 MONETARY, CREDIT, AND FISCAL POLICIES which, I think, are a big mistake, that are equivalent to wage increases and that likewise tend to support or hold up prices. That is just part of the picture. O n the other hand I recognize the increased productivity of our machine, and I think that any inflationary development, unless it is followed up by larger budgets, Federal budgets, which I hope w i l l not be the case, and larger Federal deficits, w i l l be greatly moderated by the fact that supply may well overtake the demand all along the line. I t has done so now i n many fields, and prices are only being held up by Government action. I think that our longer-range problem is not one of inflation. I t is one of deflationary pressures. I t is one not of inadequate production, not of capital for investment—of which I think there is plenty—but it is one of consumption—being able to buy what our machine can produce. That doesn't mean ability to buy through a continued expansion of consumer credit. I think we are going to be confronted with that problem before very long. M r . WOLCOTT. W h a t do you think should be done i n respect to supporting the Government-bond market i n the face of this inflationary threat; what do you suggest should be done by way of letting the Government-bond market find its own level or pegging it at a higher or lower figure than they are selling for on the market at the present time ? M r . ECCLES. I do not think that support of the Government-bond market w i l l be required for some time to come. The long-term Governments are selling at very high premiums; and I, for one, would like to see those premiums reduced. The long-term rate, i n my opinion^ is too low and not too high. The rate on the long-term securities on the basis of which they are selling today is about 21/4. So there is quite a way to go before the decision w i l l have to be made as to whether or not it is advisable, under the circumstances that exist, to hold the long-term Governments at 2y 2 . M r . WOLCOTT. W o u l d you recommend that the rediscount rate be changed at this time ? M r . ECCLES. N O ; I d o not. M r . W O L C O T T . D O you think the amount of reserve requirements should be increased, provided you have the authority to do it? M r . ECCLES. I d o not. M r . WOLCOTT. W h a t can Congress do to help stop inflation except balance the budget and cut Government expense ? M r . ECCLES. I thought I made the point that I understood this was a discussion to determine what might be done to deal with a long-range program. M r . WOLCOTT. A n y t h i n g that would deal with a long-range program would, of course, have an immediate psychological effect. The fact that Congress was considering limitations and standards, and so forth, which might result in stabilizing our economy on a long-range basis might have a psychological effect to prevent immediate inflation. That is what I am thinking of in asking that question. M r . ECCLES. Well, I am not too much concerned about the psychological effect. I think that is very temporary. I think it is the basic economic factors that are finally the determining factors. M r . WOLCOTT. L e t me ask you, Do you think that sterilizing any part of the Government debt which is held by the banks, so that no 246 MONETARY, CREDIT, AND FISCAL POLICIES more than a certain amount would be monetized, would be of any help ? M r . ECCLES. I do. That was what we suggested i n our special reserve program. That was exactly what it was. I think that would be very helpful i f you should begin to get an inflationary development through bank credit expansion. Y o u have to consider your fiscal situation in connection with this. I f you are going to operate i n a period of great business activity financed in part by Federal deficits. T h a t creates an entirely different problem. I t is pretty difficult to adopt a restrictive monetary policy i n the banking system under conditions of a peacetime economy i f the Federal Government is going to operate heavy Federal deficits. M r . W O L C O T T . Because of the importance of the holdings by insurance companies of Government debt, i n the stabilizing effort would you recommend that the Federal Government be given more control over insurance reserves ? M r . ECCLES. I don't think so. I think that you could sterilize pretty largely the effect of the sale of securities held by insurance companies by increasing bank reserves. I do think howver, the study should take into account the operation of these huge insurance companies. They are very important factors i n this whole field of money and credit. I t may well be that certain Federal laws, certain controls, would be necessary. I am not prepared at this time to say. B u t I do think that you cannot ignore the effects of any such large pools of investment money i n private hands. Senator DOUGLAS. M a y I say that the Investment Subcommittee of our general committee is going into the question of the role of insurance companies and has scheduled about 3 days of hearings when these monetary, credit, and fiscal policy hearings are closed. M r . ECCLES. Yes, I just don't want to be put into the position of suggesting anything with reference to that because M r . WOLCOTT. W e are dealing with fiscal matters here. I t is the influence of insurance holdings, or I can shorten it up by saying, on the value of the American dollar, that is what I was asking about, and whether there was any control you thought necessary over those holdings, which might embrace other large holders of Governments, i n addition to insurance companies. M r . E C C L E S . A heavy sale of Government securities added to the inflationary pressures last year. M r . W O L C O T T . Y O U mentioned silver, you slid over it pretty fast, and for which I am thankful, but I wondered if you were i n position now to perhaps recommend changes in the Silver Purchase Act. M r . E C C L E S . Being from, I think, the No. 1 silver State i n the Union, maybe I better pass that up. M r . W O L C O T T . Well, i n the M r . ECCLES. I would like to say, however, that I am just jesting, because I haven't passed it up, and my position on silver is well known. I recognize the program for what it is, a subsidy, but I see no reason why there may not be a silver subsidy as well as many other subsidies. When we take up the question of what to do w i t h the farm and other subsidies, I think it might be well to take up the question of the silver subsidy. Senator D O U G L A S . A n d you wouldn't give up the silver subsidy until every other subsidy is given up ? 247MONETARY,CREDIT, AND FISCAL POLICIES M r . E C C L E S . I wouldn't say that. I think there are a lot of subsidies that have more merit than the silver subsidy. M r . WOLCOTT. I n the Banking A c t of 1935 we legislated to force all banks to come into the Federal Reserve System in order to participate i n the Federal Deposit Insurance Corporation. W e let that authority lapse finally. W o u l d you be i n favor of restoring that requirement ? M r . ECCLES. I f the recommendations that I have suggested here be adopted it would not be necessary to require that all State banks be members, or all insured banks be members, of the Federal Eeserve System. The important thing is that they maintain the same reserves that the member banks of the Eeserve System do. Whether they are members or not, and have to buy stock, and have to comply with the other requirements, is not too important, and I would certainly be w i l l i n g to waive that. M r . W O L C O T T . One other question. This $5,000,000,000 overdraft authority of the Treasury, I don't know whether you want to get into that or not, but that expires this next year. I think you sponsored that, didn't you ? M r . E C C L E S . That is right. M r . W O L C O T T . D O }^OU think it should be continued ? M r . ECCLES. I think it is desirable to continue it. I think it is a proper instrument, I think it is a useful instrument, i n the case of debt management. I t is often desirable to give the Treasury a substantial overdraft in order to avoid undue money market strains during tax payment periods. That authority has been helpful, and over the years that it has existed i n the Eeserve System I am sure that it has never been abused. M r . W O L C O T T . Thank you very much. Senator D O U G L A S . Thank you very much, M r . Eccles. (Whereupon, the committee adjourned until 2: 30 p. m.) A F T E R N O O N SESSION Senator DOUGLAS. M r . Brown, we are very glad indeed to have you here. W e appreciate your public spirit i n coming from Chicago to testify on this subject. STATEMENT OF E. E. BROWN, C H A I R M A N OF T H E BOARD, FIRST NATIONAL B A N K OF CHICAGO Senator DOUGLAS. M r . Brown, did you have a prepared statement which you would like to read ? M r . B R O W N . N O , Senator; I have no prepared statement. The questionnaire of your committee offered such a wide variety of subjects that it seemed to me difficult to give a prepared statement which would cover the many points i n it. I would like to express my views briefly on three points. Senator D O U G L A S . We w i l l be very glad to have you. M r . BROWN. A f t e r that I w i l l be very glad to answer any questions which you or the other members of the committee may desire to submit. These three points are : (1) The relationship of the Federal Eeserve Board to the Treasury and the national administration; 248 MONETARY, CREDIT, AND FISCAL POLICIES (2) The power that the Federal Reserve should have to fix the reserves of banks; (3) The question as to what agency or agencies should examine and supervise banks. A s to the first, the relation of the Federal Reserve Board to the Treasury and the national administration: Originally the Federal Reserve Board was conceived as an independent body. W o r l d W a r I broke out before the system was really functioning. Under the necessity of financing the war the policies of the Board had to be subordinated to those of the administration and the Treasury i n practice. A f t e r the war came the depression of 1921 and the Board policies continued i n practice to be those of the administration during the period up to 1933. When the Banking A c t of 1935 was adopted, which gave the Board additional powers, it was still the view of Congress that the Board should be independent. There were many statements to the effect that the depression wouldn't have occurred i f the Board had been an independent organization i n the Hoover and Coolidge and H a r d i n g administrations, and that the depression was partly caused by the fact that it had been subservient to the administration. T o make the Board more independent the Secretary of the Treasury and the Comptroller were removed as ex officio members. The Board, according to the debates i n Congress, was to be a supreme court of finance; statements were made that it should be as free as the Supreme Court of political pressures; the members were to have long terms, staggered, and to receive salaries equal to those of Cabinet officers. Then came deficit financing and W o r l d W a r I I with its legacy of a tremendous Federal debt and the problems of its management. The Federal Reserve Board could not, under such circumstances, have been politically independent at any stage of its history. I do not believe that at any time i n the foreseeable future it or any central bank can really be independent of the administration i n power. T h e Board, i n the final analysis, must adapt its monetary policies to the policies of the administration, no matter how it may feel about their wisdom. It must bow to the judgment of the Secretary of the Treasury i n matters affecting the handling of the public debt and the interest rates thereon. Granted that the Federal Reserve Board must conform its policies to those of the administration and the Treasury, it does not mean that it should become a subordinate bureau of the Treasury, or some other branch of the administration, or that its members should hold office only at the pleasure of the President or be appointed for short terms, or that their judgment and ability are relatively unimportant. Decisions and actions i n the field of monetary policy affect the whole economy. I t takes a high degree of ability, technical experience, and judgment to make them wisely and to appraise their effects i n advance. The giving of sound advice on monetary matters to an administration or to its Secretary of the Treasury that must make the ultimate decision, and skillful carrying out of the monetary policies designed to implement an over-all general policy, are much more probable oy a continuing board, made up of men of stature and of long tenure i n office, than by any subordinate bureau. T o make it possible to get men of proper caliber and public stature to serve on the Federal Reserve Board, terms should be long and the 249 MONETARY, CREDIT, AND FISCAL POLICIES salaries of Board members high enough both to indicate the importance of the position and not to penalize qualified men without private means. The present salaries of the Board members do neither. Senator DOUGLAS. Even with the increase of a thousand dollars ? M r . BROWN. Even with the increase of a thousand dollars. Senator DOUGLAS. O f course, I was i n favor of raising the salaries of the Federal Reserve Board members to $22,500, but wTe had a great deal of opposition from the friends of the Federal Deposit Insurance Corporation, who said that i f you raised the Federal Reserve Board members to $22,500 the F D I C salaries should go up, too, and that seemed to be out of keeping with the rather limited responsibility which that group has. Sometimes, M r . Brown, I suspected that there were certain banks i n the country which were using the principle of equality of salaries between the Federal Reserve and F D I C to keep down the salaries of Federal Reserve Board members. I am much reassured by this testimony of yours. B u t I had thought that some of your colleagues wanted to keep the salaries of the Federal Reserve Board down. That may have been an unjust suspicion on my part. M r . BROWN. I think there is probably some justification i n it. Senator DOUGLAS. I n any event without going into the question of what others think, so far as you are concerned you would be for an appreciable further increase i n the salaries of the Federal Reserve Board members ? M r . BROWN. I would. Given a competent Federal Reserve Board, the administration and the Secretary of the Treasury, I think, could be counted on to pay attention to its advice i n matters affecting the monetary field, though reserving to themselves the final decision. The Board should be allowed large freedom i n monetary methods to implement and carry out the administration's or Secretary's policy. Conversely the Federal Board should, even i f its views were not followed, carry out and administer or direct policy finally adapted as such to the best of its ability. Members of the Board differing with the policy could and should resign, i f they regarded it of sufficient importance, and fundamentally wrong. That is another reason for getting strong men on the Board. I f we get men of stature, of proper caliber, they w i l l resign i f their views are not followed on a fundamental matter. I t acts as a great check on Treasury or administration action. It seems to me so self-evident, under present conditions, and conditions that w i l l exist as long as we live, that the Board, i n the last analysis, has to follow the policy of the administration i n power, not only as regards management of the public debt, but facilitating the export of capital to Europe and the rest of the world, or what w^ill you, or making possible easy credit for agriculture, housing, even i f they disbelieve i n it. This to me is almost axiomatic, and I think a whale of a lot of the time of Congress is lost and the public is confused by talking of the Federal Reserve Board as a really independent judicial body which is immune from political pressure, or should be immune from political pressure. The second question is, what powers the Federal Reserve should have over the reserves of banks. I n the first place, I am opposed to giving the Federal Reserve any power over the reserves of nonmember banks. W i t h 85 percent or so of the deposits of the country i n member 250 MONETARY, CREDIT, AND FISCAL POLICIES banks, it does not need control of reserves against the other 15 percent to effectively control the volume of credit. I might say i n passing that the reserve requirements of a large percentage of the remaining 15 percent are set by State boards which tend to follow the reserve policy of the Federal Reserve Board. The advantage of access to credit from the Federal Reserve Bank is important, so important that no really large bank can afford not to be a member bank, and most medium-sized banks, and many small ones, are members. Too high reserve requirements make it impossible for a b&nk to make money. The fact that a small- or medium-sized bank can give up its membership i n the System if, i n its opinion, excessive reserve requirements offset the advantages of the System membership is a healthy restraini n g influence on the Federal Reserve Board i n setting requirements for its member banks. I do not want to argue here the dual banking system. I believe i n it chiefly because it affords a check against arbitrary and unreasonable action or legislation by either a State or the Federal Government. A bank can shift from a State charter to a national, and a national bank can shift to a State charter. T o give the Federal Reserve Board authority over State nonmember banks would be a first step toward the breaking down of the dual system. I can't forget that in times past we have had highly capricious and arbitrary comptrollers. More recently, many States have had to deal with capricious and unreasonable State banking authorities. The greatest check on arbitrary actions by a State or national supervisory authority is the ability, when conditions become too bad, to shift from a State into the national system, or from the national into the State. Senator DOUGLAS. O f course, they were Comptrollers of the Currency, not Reserve Board members as much, as I remember. M r . BROWN. They were Comptrollers of the Currency, yes. They were not Federal Reserve Board members. A s to the reserve requirements of member banks, I believe that the Federal Reserve Board should have power to vary them within a limit, but with a maximum limit fixed by law at a figure which w i l l enable banks to make sufficient profit so that they can absorb losses, maintain and build up their capital structures, and pay reasonable dividends. I f this is not done, I doubt i f our present system of privately owned chartered banks can survive. I believe present maximum limits to be about as high as they are tolerable. The market value of bank stock today is almost universally less than the liquidating value of banks, due, I believe, to a fear that future legislators and governmental policies w i l l cut bank earnings. Changes in bank reserves should only be made rarely and when general basic conditions have changed. Credit control should ordinarily be exercised by open-market operations and changes in the rediscount rate. 251 MONETARY, CREDIT, AND FISCAL POLICIES W i t h these instruments of credit control, the maximum reserve requirements which the law now authorizes, we give the board adequate powers to control credit. The present fixing of reserves, by central Reserve, Reserve, city, and country bank classifications lack logic, but the banking system, over many years, has adjusted itself to the arrangement. Some other method might be more logical and work as well or better, but a change should not be made without a detailed study of its effects on various classes of banks and banks in different localities. X o change should be made which would increase the over-all percentage of the maximum reserve to total deposits that would be required from member banks as a whole above the present over-all percentage. I t seems to me clear that vault cash should be counted as reserve. The question as to what agency or agencies should examine and supervise banks is the third matter which I would like to comment on. The guiding principle in bank examinations and supervision should be objective, for the purpose of protecting the banks' depositors and seeing that the bank examined or supervised is obeying the law. Bank examinations and supervision should not be used as instruments to carry out a monetary policy, contracting or expanding credit, or of directing credit in specific directions. If supervision and examination are exercised for the purpose of carrying out monetary policy, the examinations w i l l not be as efficient i n determining the safety and soundness of the bank as i f the examinations were purely objective and made for that purpose. I t has been argued by members of the Federal Reserve Board, and it was argued by M r . Eccles this morning, that examinations and supervision should be used as instruments of general over-all credit control and direction. I think that is a highly dangerous doctrine. No body of men, even the Federal Reserve Board, is able, with sufficient certainty, to predict the course of the economy, and put pressure on banks by examination or supervision as to when to loan, when to refrain from loaning, when not to make certain classes of loans. I know, in the case of my own bank i n the depression, that ninetenths of our losses came from loans made after the begining of 1930, i n an effort to, as we thought, help turn the tide, keep the depression from going deeper. Our losses weren't on loans made at the height of the boom. W e lost enough money as it was, but I tremble to think what we would have lost i f we had had pressure from M r . Hoover's Comptroller or bank examiners and we had been under pressure to go out and loan even more liberally in order to keep the economy of the country from going down. Granting my argument that bank examinations should be objective, not made for the purpose of carrying out monetary policy, the primary examinations of banks should not be made by the Federal Reserve System; they should be made by the Comptroller in the case of national banks, by the State authority in the case of State banks. Since the F D I C and the Federal Reserve Board are both Federal agencies, and they are not satisfied with taking the reports of the State banking departments, they should have the right, which they now exercise, of joining in the examinations of State banks. The Federal Reserve Board, I suppose, theoretically, should have the right to join i n the examination of national banks, i f it wanted to, although 252 MONETARY, CREDIT, AND FISCAL POLICIES it is difficult to consider one Federal agency not taking the report of the other. I don't believe any economy would be effected by combining the Comptroller, F D I C , and the Federal Reserve examinations. I t takes about so many examiners to examine so many banks, and I think the present system works well enough. I f it should be decided to consolidate examinations, I think the logical thing would be to put all the examinations under the Comptroller of the Currency, as being the supervising authority with the longest record in examining and supervising banks. The Comptroller's office has been at it now for a long time. Senator DOUGLAS. W o u l d you have him examine the State banks which are members of the Federal Reserve and F D I C respectively ? M r . B R O W N . I think it would do no harm. I think the present system works well enough and should be left alone; but, i f there is a consolidation of bank examinations, my first preference would be to have the Comptroller conduct the examining functions for both State member and F D I C State nonmember banks. I think the present system works relatively well, and I do not think there is any considerable overlapping, and I think examination policies are sufficiently coordinated to work out well. Senator D O U G L A S . I take it that the two reasons why you believe i f consolidation were to be carried into effect it should be under the Comptroller of the Currency, are: (a) That the group of nationalbank examiners have a longer record and you regard them on the whole as more experienced and competent than the examiners attached M r . BROWN. They have a longer tradition of freedom from political influence and political pressure. Senator DOUGLAS. They are i n a department headed by a political appointee. M r . BROWN. I t may be, but the Comptroller's office has been brought up under an enviable record of freedom from political and personal pressure. A t times it has shown signs of deterioration, but it has always come back. Senator DOUGLAS. A n d also you believe that bank examination should not be connected with credit policy. M r . B R O W N . I am very strongly of that opinion. Senator DOUGLAS. And, therefore, you want to have it divorced from an agency which is also concerned with credit policy? M r . BROWN. Yes; I think it is sound to do so. I would be glad to answer any questions on any other points of the questionnaire that I may be able to. Senator DOUGLAS. Before I turn to the first part of your testimony, could you comment upon the proposal to have the F D I C put i n the Treasury ? M r . BROWN. I do not see any advantage to be gained by it. I do not know that it would do any harm. The F D I C — t h e greatest number of its members are State banks, and I think that the State banks would prefer an independent Federal agency rather than a Treasury agency, and I think that the F D I C would probably function better independently than as a Treasury bureau. Senator DOUGLAS. M r . Brown, I was struck with many parts of your testimony, but I was struck by the statement that you thought it was desirable that State banks, members of the Reserve System, should 253 MONETARY, CREDIT, AND FISCAL POLICIES be able to get out of the Reserve System i f the reserve and other requirements imposed by the Board became arbitrary and not i n the general interest, so they could have an avenue of escape, and that this would operate as a restraining influence upon the Board itself. Now, what puzzles me is who is to tell what is arbitrary and what is i n the public interest ? There is a natural desire, which should not be condemned, on the part of the banks to not have any more of their assets tied up i n reserves than is absolutely necessary, and an increase i n reserve requirements diminishes the potential loaning power of banks. B u t suppose you are i n a period of inflation, and it may be i n the public interest to check the loaning power of banks and not let them go to the maximum. The Reserve Board raises the reserve requirements; but the member banks, which are State banks, those State banks which are members, perhaps I should say, feel that the provisions are arbitrary and get out of the System i n order to have a higher earning power. Now, that is protection for the individual bank, but is it a protection for either (a) the economy as a whole or (b) the banking system as a whole? . M r . BROWN. I think it is, because, i n the first place, giving up membership in the Federal Reserve System means giving up very valuable privileges of access to the credit facilities of the Federal Reserve. A bank is not going to give up such privileges lightly unless it thinks it is heavily penalized. I n the second place, i f the statutory maximums are not too high, the banks w i l l expect to see those statutory maximums exercised i n a period of inflation and w i l l stay i n the System. I think the proof of the pudding is i n the eating. W e had very few banks go out of the System with the present maximum during the inflationary period of the war and the immediate period following the war. Senator DOUGLAS. B u t the amount of Government securities held by the banks is so large that, i f they turn those i n and get reserves i n the Federal Reserve System for them, it gives them a tremendous potential lending power, which would not be checked by maintenance of present reserve requirements. M r , BROWN. That is another question than that of the banks getting out of the System. I think you have got to realize that the present policy of the Open Market Committee and the Treasury, i f you want to put it that way—or as I think it is fundamentally and i n the last analysis a Treasury policy—of buying all Government bonds that are tendered, and in the past supporting all Government issues at par or above, has undoubtedly weakened the credit controls of the Federal Reserve System. That applies to national banks, which cannot get out of the System without giving up their national charter and all member banks. O n the other hand, i f you raise reserve requirements sufficiently high, as I tried to point out i n my statement, you make it impossible for the private banking system to survive by cutting down on its earnings. I think it is better to take the chance of too much bank credit than to get r i d of the privately owned chartered banks and substitute a collection of Government loaning agencies i n their place. A great many economists and bankers think that reserve requirements should be fixed by law and that the Federal Reserve Board 99076—50 17 254 MONETARY, CREDIT, AND FISCAL POLICIES should have no power whatsoever to vary them. I personally think the Board should have the power to vary them—but I think the maximum limits at all times must be placed at a level which w i l l enable the private banking system to survive. I think i n a discussion of reserve requirements. Not enough attention has been paid to the necessity of enabling banks to make reasonable earnings which w i l l maintain and gradually build up their capital accounts and enable them to pay sufficient dividends. A s I said before, 99 banks out of a 100 i n this country could be liquidated and pay anywhere from 25 to 50 percent more than the present market value of their stock. That is a highly unhealthy condition. Senator DOUGLAS. I have some difficulty remembering always what the present size limits are, but as I understand it, the maximum limit for the central Eeserve cities on demand deposits is 26 percent, for Eeserve cities 20 percent, and for the country banks 14 percent. M r . BROWN. Yes. Senator DOUGLAS. A n d that this in practice results in an average maximum reserve ratio of approximately 20 percent. That is, that the deposits i n the country banks, as I remember it, are approximately equal to the deposits i n the central Eeserve city banks. M r . B R O W N . Y O U are speaking of Senator DOUGLAS. Demand deposits. M r . BROWN. Time deposits? Senator DOUGLAS. Demand deposits only. M r . BROWN. I thought the over-all percentage was slightly less, something like 18y2 or 19 percent. Senator DOUGLAS. I t is a weighted average. M r . BROWN. The weighted average somewhat less. Senator DOUGLAS. Not far from the 20 percent. M r . BROWN. I know in the original Federal Eeserve A c t as it stood up to 1935 it contained maximums of 13, 10, and 7; and the Federal Eeserve Board had no power to vary Eeserve requirements. I n the discussions of the Banking A c t of 1935 there was a great deal of discussion as to what the maximum should be. Before the Federal Eeserve System, central Eeserve city banks had operated with reserve requirements of 25 percent, which had to be kept i n cash. I t was felt that they had demonstrated they could live with a reserve of 25 percent i n that it was a figure on which they could live; 26 percent was fixed as a compromise that was not very far from the 25; and they just doubled the reserve requirements, that is, from 13 to 26 and from 10 to 20 and from 7 to 14. Senator DOUGLAS. I think I heard you say that you favored a uniform reserve requirement based on the type of deposit rather than according to the size of the city. M r . BROWN. I am quite sure I did not say that. I said that the present system was illogical and that another system might work as well or better, but that the banks of the country operated on this Eeserve city, and central Eeserve city and country classifications since the passage of the Federal Eeserve Act, and a change should not be made without a careful study of its effect on different classes of banks and banks in different parts of the country, and that i f a change was made to some other system, such as the so-called Bopp plan, the total over-all maximum reserves which could be required by the System 255 MONETARY, CREDIT, AND FISCAL POLICIES should not be higher percentagewise than the present reserve requirements. Senator DOUGLAS. I f the weighted average is 18y2 or 19 percent, would a uniform requirement on ordinary demand deposits, say, of 18% but allowing vault cash to count as part of the reserve—would that be onerous upon the banks ? M r . B R O W N . N O ; I do not think so and it probably would not make as great difference between banks in different classes of cities as you suggest. A l l these plans contemplate a higher rate on interbank deposits. They are largely centered i n New Y o r k and Chicago. Demand deposits would carry a higher rate than time deposits, and banks of central Reserve and Reserve cities generally have a higher percentage of demand deposits compared to total deposits, including time, than country banks do, but no study has ever yet been made—or, at least, I have not seen it—as to how it would hit the country bank. I t might upset whole regions or various classes of banks, and such a change should not be made until a careful study has been made of its effect. Senator D O U G L A S . Have you any rough estimate as to what percentage of demand deposits should be kept i n vault cash, as good banking practice ? Have you a rough guess ? M r . BROWN. There is no such thing as any standard practice. A large bank can keep a much smaller percentage i n vault cash than a small bank can. A bank i n Chicago, which can get currency from the Federal Reserve Bank i n 15 minutes, needs much less cash, vault jcash, than a bank i n some country town, that has not even got a railroad i n it, i n Wisconsin. Senator DOUGLAS. Suppose you had a uniform requirement of 18 or 19 percent. That would only be 5 percent above the present requirement on demand deposits for the country banks, and i f you allowed vault cash, the difference might either be negligible or nonexistent. M r . B R O W N . I do not know that there would be any particular objection by adding i n all present vault cash held with the present required reserves and counting that. The theory of counting vaulting cash a part of your reserves is that vault cash today is i n practice Federal Reserve notes, and of Federal Reserve control over reserves i n Federal Reserve notes held by banks is just as effective an over-all credit control as control over balances carried at the Federal Reserve banks. Senator DOUGLAS. I f you were to have a uniform rate of 18y2 or 19 percent,, accepting your figures as a weighted average, that would increase the earning power of banks i n the central Reserve cities by lowering their reserves and would increase slightly the earning power of banks i n Reserve cities. M r . B R O W N . I am not so sure, because I have not seen the tabulations, that i f reserve requirements on interbank deposits were to be very large and i f the deposits i n the two central Reserve cities had a disproportionate amount of interbank deposits, their total reserve requirements might work out about where they are now. Senator DOUGLAS. These differential rates of reserves, I assume, grew up in the days when the call money market was so important i n New Y o r k primarily ? M r . B R O W N / N O . I think that they date back to the formation of the national banking system i n 1863. There was not any call money 256 MONETARY, CREDIT, AND FISCAL POLICIES market. Banks had to carry certain reserves. Country banks could carry part of their reserves i n deposits with banks i n Reserve cities, which were supposed to be money centers. Banks i n the Reserve cities could carry part of their deposits i n central Reserve cities, of which there were originally three—New York, Chicago, and St. Louis. Because of this pyramiding of bank reserves the cities which held deposits of other banks were subject to more sudden withdrawals of their cash and, consequently, they were required to keep larger reserves. Senator DOUGLAS. M a y I go back to what you have discussed i n the first part of your testimony—namely, the question of pegging prices and yields on governmental obligations with Federal Reserve action. Now, M r . Burgess said he thought that the Federal Reserve System should not do this. W h a t would be your position? I think you have indicated it. M r . B R O W N . I indicated first that I think i n the last analysis the Federal Reserve Board has to follow the policy laid down by the Secretary of the Treasury and the administration, so that the decision is i n the final analysis the decision of the Secretary of the Treasury rather than the decision of the Federal Reserve Board. A s M r . Eccles stated this morning, up to 1948 I was one of those who believed that the long-term 2^'s should be supported at par. I urged that both as a banker—as a member of a committee which M r . Morganthau had during the war advising the Treasury regarding war financing, also as a member of the Federal Advisory Council. A good many statements were made by the Treasury that they intended to support the price of Government bonds at par i n the foreseeable future. N o promise was ever made to the banking system that they would always be supported. Senator DOUGLAS. M r . H a r l testified last week that i n his judgment a promise had been made. M r . BROWN. I am quite sure it was not. T h e language of the Secretary of the Treasury was generally pretty carefully chosen. The words used were generally " i n the foreseeable future." Since the middle or latter part of 1948 the price of the long-term 2 y 2 s has advanced very considerably above par. The bank eligible 2y2's of the longest issue are today selling at 106 or 107. T h e ineligible long-term 2%'s are selling around 104. That is about 2*4 percent yield basis. I think the Treasury could now announce that they intended at all times to support an orderly market, but that the "foreseeable future" h a d passed, i f you want to put it that way, that under present conditions they did not feel they had obligations to support Government bonds at par at all times, that i n the future they might very well do so but they were not obligated to do so. I do not think there is the slightest possibility i f such an announcement were made today, that Government bonds of any issue would break below par. Then I would have the Treasury or Federal Reserve Board or Open Market Committee, acting under the domination of the Treasury, maintain orderly markets. I would leave it to the future to determine that when the price got down to par or close to par on the long-term issues, whether they should not in effect step i n and 257 MONETARY, CREDIT, AND FISCAL POLICIES support the bonds at par without making any public statements that they would do so. I do not think there would be any lack of confidence. I think it would restore a great deal of flexibility to the Federal Reserve System and that in the long run it would help the Treasury i n its problem of debt financing. I want to state that I differed from a great many bankers on conditions as they existed up until about the middle of 1948. I looked at an announced policy of supporting the long-term 2%'s at par as necessary and desirable. Senator D O U G L A S . N O support is needed now, is there? M r . B R O W N . N O support is needed now with the premiums. I know, i n spite of M r . Harl's statement, of no promises by the Government that they were always going to support long-term Government bonds at par. I think M r . Eccles this morning indicated that he knew of no such promises. M r . Burgess certainly stated in his testimony, as reported in the papers, and i n his published statement, that he knew of no such promises by the Government. A good many people think they w i l l be supported, yes, but I think now is the time for the Treasury to clarify it. They did issue a sphinx-like statement between the Treasury and the Federal Reserve Board, which nobody could understand—and I think it was purposely drawn so that nobody could understand it—that they had changed their Government-support policy, and left everybody wondering whether they were promising to support bonds at par or whether it was an indication that they were edging away from the practice of doing it. Senator D O U G L A S . D i d I understand correctly that you thought the bonds should not be permitted to f a l l appreciably below par ? M r . BROWN. I did not believe they should be allowed—I did not think they should be allowed to f a l l anywhere below par up to the summer of 1948. Senator D O U G L A S . H O W about now ? M r . BROWN. I f I were running the Treasury or the Federal Reserve System as of now, I would announce I felt no obligations, and if the bonds should by any chance break to par, I would in practice support them at par, but I would not make any promise to do it. Perhaps it is fortunate for me as well as the country that I am not running the Treasury. Senator D O U G L A S . D O you think that a slight increase i n yields caused by a f a l l of 4 or 5 points i n the price of Governments would have any real deterrent effect upon the amount of private credit loaned by banks ? That would be a change of less than one-quarter of 1 percent i n yield. M r . BROWN. I do' not know so much about the credit extended by banks. I think it would have a great over-all effect on the long-term market. I think the municipalities and large corporations borrowing long-term money would be greatly influenced by a change of as much as a quarter of 1 percent in the interest rate. Senator DOUGLAS. They would not borrow as much ? M r . BROWN. They would not make improvements and capital expenditures or pay bonuses or what not i f they had to pay a higher rate of interest and, therefore, a change in the interest rate would have a deflationary effect, i f you want to call it such, on the total over-all expansion of credit. 258 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . S O you think that i f we were to go into inflation, and i f the Government bonds would still then sell above par, you think it might be a good means of checking inflation to allow the price of Governments M r . B R O W N . T O drop to par on the long ones, and it would not worry me i f some of the intermediates ones got to 99 or some such price in the process. Senator D O U G L A S . Y O U would not permit a run-away market with the price of Government bonds breaking to much lower limits ? M r . B R O W N . N O ; I think the Government has to maintain an orderly market in its bonds at all times. It cannot allow panicky conditions to get under way. Senator DOUGLAS. O f course, there are some who say don't have the Government support the price at all; let the Reserve System get out and then let the price of bonds be determined by "market forces." M r . BROWN. Well, that cannot be worked that way. The Federal Reserve System holds so many Government bonds that it can determine the yield on them by the price it pays for them, the price it sells them. I t can determine short-term rates, and short-term rates i f they rise w i l l have a somewhat depressing effect on long-term yields. Senator DOUGLAS. I n other words, the Federal Reserve System is part of the market, and if you take it out you w i l l alter the market. M r . BROWN. Yes; and the Federal Reserve System or some of the spokesmen—I think M r . Eccles said this morning we are out of the market on the long-term bonds. They cornered all the floating supply of long-term bonds, and now they w i l l not sell them when the price is up. I f that happened on the Board of Trade i n Chicago, that would be called cornering wheat or lard or something, but i f it is done by the Federal Reserve Board or the Treasury it is a somewhat different thing. I f they wanted to sell some of their large holdings of ineligible long-term bonds, they could cause the price to go down a point or two, to my mind, to the benefit of the whole economy. Senator DOUGLAS. W e had a study made, M r . Brown, on the requirements relating to the safety and soundness of banks, which requirements were imposed by the Federal Reserve System as a condition of membership of State banks in the Federal Reserve System. W e got some 30 requirements, which I read to M r . H a r l last week, which are not required by F D I C itself. W o u l d there be any value of attaching these requirements dealing with safety and soundness to membership in the F D I C system rather than to membership in the Federal Reserve System and thus reaching a broader band of deposits in banks ? M r . B R O W N . I do not know what the requirements are, Senator. I probably should know. Senator DOUGLAS. They are as follows: 1. Limitations on total loans to one borrower. 2. Regulations governing purchase of investment securities. 3. Prohibition against purchasing stocks. 4. Prohibition against engaging i n underwriting of investment securities and stocks. 5. Restrictions on loans to executive officers. 6. Restrictions on dealings with directors. 259 MONETARY, CREDIT, AND FISCAL POLICIES 7. Restrictions on interlocking directorates or other interlocking relations with other banks and with securities companies. 8. Prohibition against bank having less than 5 or more than 25 directors. 9. Provision authorizing supervisory authority to remove officers and directors for continued violations of law or continued unsafe or unsound practices. 10. Prohibition against affiliation with securities company. 11. Restriction on holding companies affiliates. 12. Restrictions on bank stock representing stock of other corporations. 13. Limitations on loans to affiliates. 14. Requirements of reports of affiliates and publication thereof. 15. Requirements for examination of affiliates. 16. Limitations on investment in bank premises. 17. Minimum capital requirements. 18. Minimum capital requirements for branches. 19. Prohibitions against loaning on or purchasing on stock. 20. Restrictions on withdrawal of capital and payment of unearned dividends. 21. Requirement that reserves specified i n the Federal Reserve A c t be maintained. That is a debatable one. 22. Prohibition against making loans or paying dividends while reserves are deficient. 23. Requirement for specific number of condition reports annually and for publication thereof. 24. Requirements in connection with the par clearance collection system. 25. Prohibition against false certification of checks. 26. Limitations on acceptance powers. 27. Prohibition against acting as agent for nonbanking institutions i n making loans to brokers and dealers in securities. 28. Limitations on loans to one borrower on stocks or bonds. 29. Limitations on aggregate loans to all borrowers on stocks or bonds. 30. Limitations on deposits with nonmember banks. As I understand it, these are provisions relating to the soundness of the individual bank which are imposed on members of the Reserve System which are State banks. M r . B R O W N . I would not say many of them had much to do with soundness. They might have something to do with over-all governmental policy. I think, i f you tried to make all those conditions a condition for membership in the F D I C , a lot of banks would decide to get along without the F D I C membership, the small banks i n particular. Senator D O U G L A S . O n the other hand, under F D I C you assume a liability that the bank may fail, and that normally should carry with it some powers to protect you against the excessive danger that the liability may occur. M r . BROWN. Yes; but I think most of those regulations that you read only incidentally deal with the soundness of a bank. 260 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. Well, I should think a good many of them dealt—— M r . BROWN. A good many do, but others deal with other matters of Federal policy. Senator DOUGLAS. Eestricting the power of the insiders to use the banks privately. M r . BROWN. A good many of them are i n the nature of restrictions which are now imposed on national banks. Senator DOUGLAS. Yes; I think they are, but not on State banks. M r . BROWN. State nonmember banks. Senator DOUGLAS. Except insofar as the States specifically provide for them. M a y I ask you a question or two on the gold and silver policy? M r . BROWN. Yes. Senator DOUGLAS. There has been some talk of advocating the restoration of the unlimited convertibility of money or Federal Reserve notes into gold coin or gold bullion. Has the Federal Advisory Council taken any position on that subject? M r . BROWN. They have. A l l 12 members as recently as last week stated their belief that at this time convertibility of the currency to gold coin was neither feasible nor desirable. W e felt that as an ultimate objective of monetary policy it was desirable and that studies should be made as to how it might be ultimately brought about. W e felt at the present time the unsettled condition of the world, the desire to hoard money, both at home and abroad, w^ould make it highly undesirable to adopt such a policy at the present time. W e did recommend, or did feel—I w i l l not say recommend—that Congrss should repeal the act of 1934, which gives the Secretary of the Treasury the power to buy or sell gold at home or abroad i n any amount at any price he may see fit. Senator DOUGLAS. It is a favorite subject of Congressman Wolcott. M r . WOLCOTT. There has been some doubt raised as to whether the Treasury has the authority to change the rate. I t all stems back to what M r . Brown referred to, the fact that they may do it, perhaps those provisions which are not completely offset by the provisions in the Bretton Woods Agreement to the contrary. The question seems to be as to whether the authority i n the Gold A c t to buy and sell supersedes or has been repealed by the Bretton Woods Act. I f there is a dispute there, it should be corrected. M r . BROWN. There seems to be some doubt about it. I think the opinion of most lawyers is that since the act adopting the Bretton Woods agreements contains the provision that the President or any person acting on behalf of the United States should not propose or consent to any change i n the gold value of the dollar the Treasury has lost its authority. M r . WOLCOTT. I think perhaps M r . B r o w n would agree with me that it was our intent to prohibit it, but whether we did or not seems to be i n dispute. M r . BROWN. I think it was a clear intent to prohibit it, and I think it has probably been done, but there seems to be enough doubt about it to make it desirable to clean up the doubt. I believe M r . Snyder i n a press release stated that the price for purchases and sales of gold could not be varied without the consent of Congress, but even that statement of his is not final. The attitude of the Council—and it is 261 MONETARY, CREDIT, AND FISCAL POLICIES my own attitude, incidentally—is that convertibility is not feasible nor desirable at the present time, but as an ultimate objective of monetary policy it is, and that the gold value of the dollar should not be changed, and it would be desirable, since uncertainty does exist because of this act of 1934 being still in force and effect, to repeal it or amend it so as to make it clear that the gold value of the dollar cannot be changed without the consent of Congress. Senator DOUGLAS. What are the advantages, as you see them, i n ultimate convertibility ? M r . BROWN. I think the value of ultimate convertibility is that it tends to check the creeping decline i n the purchasing power of the dollar. Nations devalue; they never increase the value of their currency, practically speaking. Senator DOUGLAS. England did in 1924. M r . BROWN. England did temporarily, with unfortunate results. I t went back to the gold standard; we went back to the gold standard after C i v i l W a r days; but i f currency was convertible into gold, since gold has a commodity value, i f you want to call it such, it would make it less likely that the dollar w i l l keep on decreasing in purchasing power indefinitely. I think also,' granted somewhat normal circumstances, the feeling that a lot of people may want to get gold might have some effect on Congress i n matters of deficit financing and expenditures. Y o u are familiar with the arguments against it of M r . Sproul and others, but I still believe on the whole that, granted a stable world, free of the fear of war, ultimate gold convertibility is desirable. Senator DOUGLA'S. That is on the ground that there are more r i g i d limits to the supply of gold than to the potentiality of man's foolishness ? M r . BROWN. Exactly, and also the belief that the value of gold is determined by the cost of the marginal production, and i f currency is convertible into gold the dollar as a measure of value would have more stability over a period of years than it otherwise would without convertibility. Senator DOUGLAS. O f course, we had a very sharp rise i n prices from 1896 to 1914 under the gold standard. M r . BROWN. That was due to the fact that South A f r i c a n production came i n at that time. Probably the ability of the United States to go back to the gold standard after the C i v i l W a r was largely influenced by the gold production of the V i r g i n i a lode in Nevada at that time. I do not think the gold standard is by any manner of means an infallible standard. I f you could work out Professor Fisher's stable dollar in a practical way, I think I would favor it. I do not see that it caji very well be worked out, but I am very certain that the value of gold bullion or gold coin, which is the same thing, is more likely to be stable over a period of years than an arbitrary value set by political bodies or governments on their monetary standards. M r . WOLCOTT. M r . Brown, i f the United States and the other former* gold countries went back on a gold convertible basis, what would you anticipate would happen to the international fund ? M r . BROWN. I do not know that I quite got your question. M r . WOLCOTT. I f we went back on the gold standard M r . B R O W N . Y O U mean gold convertibility standard? 262 MONETARY, CREDIT, AND FISCAL POLICIES M r . WOLCOTT. Yes; and all the other former gold convertible conntries did likewise M r . B R O W N . A t the present time ? M r . W O L C O T T . N O ; finally when this can be brought about—what would be the future of the international fund ? M r . BROWN. Oh, I think it would lapse into innocuous desuetude that probably would not be harmful. M r . WOLCOTT. What did you call it ? M r . BROWN. Innocuous desuetude. Senator DOUGLAS. That was launched into political language, I believe, by Grover Cleveland, so it has a very respectable lineage. M r . WOLCOTT. I think I know what it means now, with the context. M r . BROWN. Pardon me for not making myself clear. M r . WOLCOTT. It is excusable under the circumstances. Senator DOUGLAS. M r . Brown, what specific recommendations, i f any, would you make to increase the effectiveness and independence of the Federal Reserve System? Y o u propose to increase their salaries ? M r . BROWN. I have already said I proposed an increase in salaries to attract men of greater stature. I do not know but that the Board could function as well or better with five members as against seven. T o be one of a group of five is probably somewhat more attractive than to be one of a group of seven. I do not believe that membership of the Board should be more than seven. I think the present size of the Board and the terms of its members are effective. I do not think any change in the number or tenure of the Board would be of sufficient importance to make it desirable to make the change. Senator DOUGLAS. D o you want to increase the statutory powers of the Board? M r . BROWN. NO. Senator D O U G L A S . D O you want to decrease the statutory powers of the Board? M r . B R O W N . N O . Believing as I do that i n the last analysis the Board has to go along with the administration, I think its statutory powers are less important than the character of the Board and its members. Senator DOUGLAS. W h a t are the weaknesses of the Board or of the System, rather, as you see it ? M r . BROWN. That is a hard question to answer. I would say the greatest weakness in the past has been that at all times it has not had men of proper stature on it. Please do not ask me to specify what times and what men. I think I have know^n every member of the Board since it was formed i n 1913, but I really think that i n the long analysis of the Board, its greatest fault has been that either proper men have not been appointed to it or that men whom it was desired to appoint would not take the appointment. Senator D O U G L A S . D O you see any advantage i n Congress giving to the Treasury and to the Federal Reserve System more definite instructions concerning the operations of the Open Market Committee ? M r . B R O W N . N O ; I think that would be highly detrimental to the working of the System. Senator DOUGLAS. A n d no instructions to the Secretary of the Treasury ? 263 MONETARY, CREDIT, AND FISCAL POLICIES M r . B R O W N . N O . The administration of government has to be worked out between men just as the organization of any large business has to be. Instructions and charts do not count as much as good w i l l and intelligent cooperation. M r . WOLCOTT. M a y I ask a question i n there ? Senator DOUGLAS. Y e s . M r . WOLCOTT. Would you recommend that the make-up of the Open Market Committee be changed i n any way ? M r . B R O W N . N O ; I think the present compromise is a good compromise. Senator DOUGLAS. Well, you say that the Eeserve Board must i n the nature of the case be more or less subordinate to the Secretary of the Treasury as regards open-market operations, but does not the Secretary of the Treasury almost inevitably tend to have a prejudice i n favor of low interest rates because that means a smaller burden of carrying the debt and makes the refunding problems less than otherwise would be the case ? M r . BROWN. I do not think that is actually the case. The Secretary of the Treasury has to consider the burden of the interest charge i n connection wTith the total budget, but I think he realizes that a proper rate structure w i l l by promoting general prosperity of the country probably increase tax receipts more than the interest charge would be increased; and i n my discussions with various Secretaries of the Treasury I have never seen any indication of such a consistent and hard-boiled attitude i n favor of very low rates on their part. Senator D O U G L A S . D O you want to comment upon the silver-purchase policy of the Government ? M r . BROWN. I cannot make any better comment than the one L o r d Keynes made at the time of Bretton Woods, and there was talk of using silver as a monetary base, the Government buying it. H e said, u W h y not buy Irish potatoes?" We are buying Irish potatoes and buying silver, and buying Irish potatoes is about the same degree of foolishness. Senator DOUGLAS. Silver is not as perishable. M r . BROWN. I f you want to subsidize both of them, all right. I f you want to subsidize the potato producer i n New Jersey or in Maine, or subsidize the silver producer, let them do it, but it should not be called monetary policy. Senator D O U G L A S . I take it, then, that you are not enthusiastically i n favor of the silver-purchase policy. M r . B R O W N . I think it is just a subsidy and I think it is an entirely unjustified subsidy, even less justified than the subsidy to the potato growers. Senator D O U G L A S . I have no more questions. M r . WOLCOTT. I do not know that I have, except the comment that 1 think we disposed of the silver question at Bretton Woods by a resolution that they study the problem. I do not know whether M r . Brown wants to do it—perhaps it has gone i n the record—but should we not have i n the record the advantages to banks of going i n and staying in the Federal Reserve System that are not enjoyed generally by nonmember banks? I do not know i f M r . Brown wants to take the time to do that. 264 MONETARY, CREDIT, AND FISCAL POLICIES M r . BROWN. Haven't some of the Federal Reserve banks published books on that? I am pretty busy and I do not have a staff of economists at my disposal. M r . WOLCOTT. That is why I put the question as I did. Y o u probably would not want to give an offhand opinion without study. W e can get it. Senator DOUGLAS. I f there is nothing further, thank you very much, sir. (Whereupon, the committee adjourned at 4 p. m., to reconvene at 10 a. m., Wednesday, November 23, 1949.) MONETARY; CREDIT, AND FISCAL POLICIEb WEDNESDAY, NOVEMBER 23, 1949 C O N G R E S S OF T H E U N I T E D S T A T E S , S U B C O M M I T T E E O N M O N E T A R Y , CREDIT, AND F I S C A L POLICIES, J O I N T C O M M I T T E E OF T H E E C O N O M I C R E P O R T , Washington, D. C. T h e subcommittee met, pursuant to adjournment, at 10 a. m., i n the caucus room, Senate Office Building, Senator P a u l H . Douglas (chairman of the subcommittee) presiding. Present: Senator Douglas (chairman of the subcommittee) ; Senator Flanders and Representative Wolcott. A l s o present: D r . Grover W . Ensley, acting staff director; and D r . Lester V . Chandler, economist to the subcommittee. Senator D O U G L A S . Ladies and gentlemen, I think perhaps it w o u l d be well i f we opened the proceedings. I n general, we have tried, by submitting questionnaires to people i n advance, to which they made detailed replies, to obviate the necessity for reading a prepared statement, and to enable us to plunge immediately into a discussion of the issues involved, but the Committee f o r Economic Development has been probing some of these issues for some years, and, since our questionnaire was addressed to individuals and d i d not cover organizations, we have asked M r . J . Cameron Thomson and M r . Beardsley Ruml, representing the Committee f o r Economic Development, to appear. W e are going to waive our usual procedure and suggest that they read the statement which they have prepared; and, after that, we w i l l move i n to questions. M r . Thomson. S T A T E M E N T OP J. CAMERON THOMSON, PRESIDENT, NORTHWEST BANC0RP0RATI0N, MINNEAPOLIS, MINN., ACCOMPANIED B Y B E A R D S L E Y RUML, V I C E C H A I R M A N OP T H E R E S E A R C H A N D POLICY COMMITTEE, COMMITTEE FOR ECONOMIC D E V E L O P M E N T , N E W YORK CITY M r . T H O M S O N . T h i s is a prepared statement. I believe that everybody has a copy. W i t h one exception, I w i l l confine my statement to this prepared statement. I am J . Cameron Thomson, president of the Northwest Bancorporation, Minneapolis. I n response to your invitation, I appear here a& chairman of the monetary and fiscal policy subcommittee of the re~ 265 266 MONETARY, CREDIT, AND FISCAL POLICIES search and policy committee of the Committee for Economic Development.1 I shall present a statement describing the views of our research and policy committee on the questions before your subcommittee. M r . Beardsley Ruml, of New Y o r k City, vice chairman of the research and policy committee, is here with me; and we shall both be available for questioning. The Joint Committee oh the Economic Report has before it one of the three or four great problems of our time—how to maintain high employment i n a free dynamic society without serious inflation. A repetition of anything like the experience of the thirties would be more than an immediate economic catastrophe to the American people. I t would set off a chain of disastrous consequences i n political and social organization, domestically and internationally. The idea that great economic instability is inevitable in a free society is one of the most dangerous ideas at large i n the world today. The Committee for Economic Development was established i n the belief that this idea is not only dangerous but false. The Employment A c t of 1946, which is the charter of your committee, expresses the national belief that economic stability can be maintained by democratic methods i n a free competitive economy. H a v i n g expressed this belief, it is now up to all of us to prove its truth. This requires, first of all, that we should actually avoid serious depression and great inflation. B u t this alone would not be enough. W e should not be satisfied just to go on from day to day avoiding depression and inflation. W e need institutions and policies that deservedly create confidence that our economy w i l l continue to be stable. W e need a positive program for greater economic stability. Such a program cannot be simply drawn up by economists and enacted by 1 The Committee for Economic Development is an organization of businessmen formed to study a n d report on the problems of achieving and maintaining a high level of employment and production w i t h i n a free economy. Its research and policy committee issues from time to time statements of national policy containing recommendations for action which, i n the committee's judgment, w i l l contribute to maintaining productive employment and a rising standard of living. F o l l o w i n g is a list of the members of the Committee for Economic Development research and policy committee : C O M M I T T E E FOR E C O N O M I C D E V E L O P M E N T R E S E A R C H A N D P O L I C Y COMMITTEE M a r i o n B . Folson, chairman, treasurer, East- J a y C. Hormel, chairman of the board, Geo. man K o d a k Co., Rochester, N. Y . A. H o r m e l & Co., Austin, M i n n . Beardsley Ruml, vice chairman, New York, Amory Houghton, chairman of the board, N Y. Corning Glass Works, Corning, N. Y . W i l l i a m Benton, chairman of the board, E r i c Johnston, president, M o t i o n P i c t u r e Encyclopaedia Britannica, Inc., and Muzak Association of America, Inc., Washington, Corp., New York, N . Y . D. C. J o h n D Biggers, president, Libbey-Owens- Ernest Kanzler, chairman of the board, IJniF o r d Glass Co., Toledo, Ohio versal C. I. T . Credit Corp., Detroit, Mich. J a m e s F Brownlee, L o n g Meadow Road, F a i r - Meyer Kestnbaum, president, H a r t , Schaffner field Conn & Marx, Chicago, 111. W L ' Clayton, chairman of the board, F r e d Lazarus, Jr., president, Federated DeAnderson, Clayton & Co., Houston, Tex. partment Stores, Inc., Cincinnati, Ohio. S. Sloan Colt, president, Bankers T r u s t Co., Robert A. Lovett, partner B r o w n Bros., New Y o r k N Y H a r r i m a n & Co., New York, N. Y . 'Gardner Cowles, president and publisher, Des F o w l e r McCormick, chairman of the board ^ ^ n e s Register and Tribune, Des Moines, ^ n i t e ^ i n ^ ; lOWcl Chioasri Til Chester C ^avis president Federal Reserve ^ £ \ j c h a i r m a n o f t h e b o a r d Gen_ B a n k of St. L o u i s St. Louis, M o eral Electric C o N e w Y o r k N Y Clarence F r a n c i s chairman of the board, H a Scherman, president, Book-of-theGeneral Foods Corp., New York, N Y . 'Y M o n t h Club> N e w York> N P h i l i p L . Graham, president and publisher, H c h r i s t i a n Sonne, president, Amiinck, the Washington Post, Washington 4, D. C. Sonne & Co., New York, N. Y . J o h n M . Hancock, partner, Lehman Bros., j . Cameron Thomson, president, Northwest New York, N. Y . Bancorporation, Minneapolis, M i n n . George L . Harrison, chairman of the board, W . Walter Williams, president, Continental, New Y o r k L i f e Insurance Co., N e w York, Inc., Seattle, Wash. N. Y . Theodore O. Yntema, vice president i n Robert Heller, president, Robert Heller a n d charge of finance, F o r d M o t o r Co., DearAssociates, Inc., Cleveland, Ohio. born. Mich. 267 MONETARY, CREDIT, AND FISCAL POLICIES legislators. I f the program is to be effective, it w i l l have to grow out of a responsible discussion in which all viewpoints are represented. It w i l l have to be understood and accepted by the American people. I n the process of discussion, we shall have to avoid accepting ideas as true just because they are old or, equally dangerous, just because they are new. Moreover, we should recognize that reaching wise decisions can only be impeded by attempts to make it appear that the goal of economic stability is the private property of any group or party. W e all share this objective in common. W e have all made mistakes; we have all learned something; and we all have much to learn. I know that the committee invited me down here to express the views of the C E D on certain specific questions, and I hope that the remarks I have just made w i l l not seem too far afield. But I am sure this subcommittee knows that it w i l l not reach final answers to all the questions before it in the limited time it has available. Even if time were unlimited, there would always be new questions emerging as old ones were settled. The job upon which you and the Nation are engaged— the pursuit of greater stability—will be a continuing job. H o w well we do it w i l l depend upon the effectiveness of the process by which we seek decisions. I hope that i n your report to your colleagues and to the American people you w i l l urge upon them the need for continuing, responsible participation in the development of policy. T H E I M P O R T A N C E OF M O N E T A R Y , F I S C A L , A N D DEBT P O L I C Y I should like to turn now to the area with which your subcommittee is chiefly concerned. I believe that the greatest opportunities in the Federal Government for contributing to economic stability lie i n this area; namely, fiscal, monetary, and debt-management policy. Obviously, the Federal Government must have a policy, or at least must act, with respect to its budget, its debt, and the money supply. I t is equally obvious that this action is going to affect the stability of the economy. And, when we face a $40,000,000,000 budget and $250,000,000,000 Federal debt, the effects of Federal action upon economic stability become of paramount importance. Senator DOUGLAS. That is now a $44,000,000,000 figure ? M r . THOMSON. That is right. I n emphasizing the importance of fiscal, monetary, and debt-management policy, I do not want to give the impression that nothing else needs to be done. O n the contrary, public and private policy with respect to international economic affairs, prices and wages, agriculture, and many other matters have much to contribute i n a rounded stabilization program. But it seems to me very unlikely that these other policies can make an effective contribution i f fiscal, monetary, and debt policies are erratic or perverse from the standpoint of stability. I want to draw a sharp distinction between fiscal, monetary, and debt-management policies on the one hand and direct controls on the other hand. B y direct controls I mean such measures as Government price controls, wage controls, rationing, allocations, and controls over the direction of investment. Failure to distinguish between these two kinds of measures is responsible for much confusion i n public discussion and could lead to serious error in public policy. T w o kinds of confusion are common. One is to reject the attempt to achieve greater stability by fiscal, monetary, and debt-management policies by 268 MONETARY, CREDIT, AND FISCAL POLICIES putting these policies i n the same class with direct controls over the details of private economic activity. The other is to accept and justify all manner of direct controls by putting them i n the same class with indirect financial measures for stability. Senator D O U G L A S . I don't want to interrupt continually, but I have felt that the banking fraternity did not always understand the difference between these two types of controls and that they argue against the control of credit as though it were an infringement solely and exclusively upon private business. M r . THOMSON. I don't think that applied to the banking fraternity solely, but I admit it does apply to us sometimes. Fiscal, monetary and debt policies are appropriate means for attacki n g the problem of instability i n a free society. T h e problem of instability is essentially a problem of broad forces affecting the overall magnitudes of the economy. The problem arises when millions of workers are simultaneously unemployed or when there is a general, although probably uneven, rise of most prices. The advantage of fiscal, monetary, and debt policies is that they allow the Government to influence the over-all forces, especially the level of aggregate demand, that determine the stability of the economy without necessarily involving the Government i n detail control of the particulars of the economy. These over-all measures will, of course, affect different individuals and businesses differently. B u t the differences are determined by the market process, not by Government decisions. The Government does not have to make decisions that are w^ith rare exceptions better left to the market—the price of shoes relative to the price of automobiles, whether the A B C company or the X Y Z company should prosper, what kind of a job J o h n Jones or Robert Smith should have. Direct controls do involve Government decision about the particular interrelationships of the parts of the economy. One virtue claimed for them by their advocates is that they are selective. B u t adding together a very large number of selective controls is surely a clumsy, expensive, inefficient, and politically dangerous way to get the over-all effect needed to deal with the stability problem. W h i l e the market process is not perfect, any general substitution of Government decisions for it would result i n serious loss of efficiency, progress, and stability. But more than efficiency, progress and stability are at stake. Freedom is also at stake. A n y widespread system of direct controls would necessarily involve widespread power of government to affect the economic fortunes of particular individuals, businesses, industries, and regions selectively; that is, discriminatingly. T h i s power would have to be exercised by the Executive subject to only the most general statutory limitations. I t would be the power to reward or punish, to coerce, !by administrative action. T h e existence of such a power would ominously threaten the survival of our free society for so long as the free society might endure. W e hear the concepts of "freedom" and "statism" used so much and so loosely that we become callous and impatient with them. B u t on the specific problem of this subcommittee I am convinced that the importance of fiscal, monetary, and debt policy w i l l not be sufficiently appreciated until we learn to make the distinction between power to coerce individuals and power to affect the general behavior of the 269 MONETARY, CREDIT, AND FISCAL POLICIES economy. A precise line cannot be drawn between appropriate and inappropriate powers, yet we must recognize that there is a direction i n which we should not move except i n cases of clearest necessity and even then only with utmost caution. Senator DOUGLAS. M a y I say that this is almost precisely the distinction which M r . Williams, president of the Federal Reserve Bank of Philadelphia, drew between general controls exercised through the supply of money and credit affected by debt management on the one hand and direct controls exercised by the Government on the other. T H E U N I T Y OF F I S C A L , M O N E T A R Y , A N D D E B T - M A N A G E M E N T POLICIES One of the things we have learned most definitely from C E D ' s studies in the fiscal-money-debt field is that the three instruments are inseparable. I might say that is one of the things we have learned. The first statement that C E D made was on taxes. Then we made one on taxes and the budget and then one on fiscal, monetary, and debt-management policies. We are going to deal with tax policy i n our statement i n January; but the long-range statement w i l l be on fiscal, monetary, and debt management as well. So we have been learning. It w i l l not be possible to work out a satisfactory policy that uses one of the three instruments alone. I f you try to develop a stabilization program relying solely on fiscal policy, you w i l l find that, while fiscal policy is very powerful, it is not sufficiently flexible to be effective alone in some circumstances and in other circumstances can be effective alone only at the sacrifice of other important objectives. I f you try to develop a stabilization program relying solely on money and debt policy, you w i l l find that, while the instrument is very flexible, it may not be sufficiently powerful for your purposes in some circumstances. This means more than that the instruments must be used consistently. I t means that the instruments should be combined i n a program that achieves the desired net effect most efficiently by using the special capacities of each instrument. A t some times this may involve having budget policy running counter to monetary-debt policy. F o r example, suppose that i n some period not calling for inflationary action we are faced by a sudden, large, and temporary increase i n Federal expenditures. T o keep the budget from having an inflationary effect, it might be necessary to raise tax rates temporarily by a large amount. However, it would ordinarily be better not to raise tax rates in this iyay. Rather, we should follow more restrictive monetary and debt policies to offset the temporarily inflationary effects of the budget. This would not be inconsistent policy so long as the combined program avoids inflation and each part of the program does what it is best suited to do. T H E STABILIZING BUDGET P O L I C Y C E D recognizes that it does not have the final answers to all the problems of an integrated money-budget-debt policy for economic stability. W e think we have learned some important things. Also, we are encouraged by the fact that a consensus seems to be emerging among students of this subject and that the C E D recommendations lie within the range of this consensus. However, we are aware of a number of unsettled problems and are planning to continue our work i n this field. 99076—50 18 270 MONETARY, CREDIT, AND FISCAL POLICIES What I have to say this morning is i n the nature of a progress report rather than a final report. Senator DOUGLAS. The modesty with which you advance this program is very disarming, I may say. M r . T H O M S O N . I am very, very humble when I sit here representing C E D on this very important subject. I would like to read from our 1947 statement, Taxes and the Budget, page 20, a description of the three alternatives on budget policy. [Reading:] T h e r e are three distinct alternatives in budgetary p o l i c y : 1. The annually balanced budget policy.—This p o l i c y a t t e m p t s to k e e p G o v e r n m e n t revenues c o n t i n u o u s l y e q u a l to or i n excess of G o v e r n m e n t e x p e n d i t u r e s , regardless of economic conditions. 2. The managed compensatory budget policy.—Under this policy, attempts w o u l d be m a d e to a d j u s t t a x r a t e s a n d e x p e n d i t u r e p r o g r a m s as o f t e n as necess a r y a n d to t h e e x t e n t n e c e s s a r y to k e e p e m p l o y m e n t o r the n a t i o n a l i n c o m e s t e a d y a t a h i g h level. 3. The stabilizing budget policy.—This policy is described herein, a n d advoc a t e d as t h e m o s t p r a c t i c a l m e t h o d of a c h i e v i n g a l l t h e o b j e c t i v e s o f b u d g e t a r y policy. I t s b a s i c p r i n c i p l e i s to set t a x r a t e s to b a l a n c e t h e budget a n d p r o v i d e a s u r p l u s a t a g r e e d h i g h l e v e l s o f e m p l o y m e n t a n d n a t i o n a l i n c o m e a n d therea f t e r to l e a v e t h e m a l o n e u n l e s s t h e r e i s some m a j o r c h a n g e i n n a t i o n a l p o l i c y or c o n d i t i o n o f n a t i o n a l l i f e . A N N U A L BUDGET B A L A N C I N G T h e a n n u a l - b a l a n c e p o l i c y c a n n o t be m a d e to w o r k , a n d t h e e f f o r t to m a k e i t w o r k a c c e n t u a t e s i n f l a t i o n s a n d depressions. W i t h its inevitable break-down fiscal p o l i c y becomes a m e r e day-to-day expedient. T h i s p r o g r a m r e q u i r e s that, w h e n e v e r a decrease i n the n a t i o n a l i n c o m e is f o r e c a s t , t a x r a t e s m u s t be r a i s e d or e x p e n d i t u r e s cut, or both, to p r e v e n t a b u d g e t deficit. W h e n e v e r t h e f o r e c a s t of h i g h e r n a t i o n a l i n c o m e p r o m i s e s l a r g e r surpluses, it not only permits but invites a cut i n t a x rates a n d a rise i n expenditure programs. O n t h e record, t h e p r o g r a m m e a n t t a x c u t s i n t h e p r o s p e r o u s twenties, a n d tax increases i n the depressed thirties. T h e i m p l i c a t i o n s of such a p r o g r a m are c l e a r : (a) T a x r a t e s a n d e x p e n d i t u r e p r o g r a m s w i l l be c h a n g e d a t t i m e s a n d i n direct i o n s m o s t h a r m f u l to h i g h e m p l o y m e n t a n d s t a b l e p r i c e s . W h e n incomes are l o w a n d u n e m p l o y m e n t i s w i d e s p r e a d , t a x r a t e s m u s t be r a i s e d a n d G o v e r n m e n t e x p e n d i t u r e s cut. I n b o o m t i m e s t h e p r o g r a m w e l c o m e s t a x r e d u c t i o n s a n d n e w expenditures. (b) A n n u a l b u d g e t - b a l a n c i n g p o l i c y does n o t i n t h e l o n g r u n p r o m o t e G o v e r n ment economy. T h e program allows a g r o w t h of public expenditures i n boom times, w i t h o u t a n y i n c r e a s e o f t a x rates, even w i t h a d e c r e a s e i n t a x r a t e s . The p o l i c y does n o t f u r n i s h s t e a d y p r e s s u r e a g a i n s t t h e i n i t i a t i o n of u n n e c e s s a r y e x p e n d i t u r e s ; t h e p r e s s u r e i t does p r o v i d e , to e n d e n t r e n c h e d e x p e n d i t u r e prog r a m s i n depressions, i s c e r t a i n to b e i n e f f e c t i v e . ( c ) T h e s y s t e m d i s s i p a t e s t h e p o t e n t i a l l y l a r g e s u r p l u s e s of g o o d t i m e s a n d s t r i v e s v a i n l y f o r b a l a n c e i n b a d times. I n a fluctuating e c o n o m y t h i s p r o g r a m w i l l n o t r e s u l t i n debt r e d u c t i o n . ( d ) T o c a r r y o u t t h e p r o g r a m r e q u i r e s a degree o f a c c u r a c y i n f o r e c a s t i n g fluctuations i n b u s i n e s s a c t i v i t y t h a t h a s n o t been a c h i e v e d i n t h e p a s t a n d t h a t is n o t p o s s i b l e n o w . (c) T h e p r o g r a m i n v o l v e s i r r e g u l a r a n d u n p r e d i c t a b l e v a r i a t i o n s o f t a x rates, w i t h u n s e t t l i n g effects u p o n b u s i n e s s a n d p e r s o n a l planning. T H E M A N A G E D C O M P E N S A T O R Y BUDGET POLICY T h e t h e o r y o f the m a n a g e d c o m p e n s a t o r y b u d g e t i s s i m p l e . W h e n e v e r e m p l o y m e n t i s j u d g e d " a b o u t to b e " b e l o w a h i g h level, t a x e s s h o u l d be c u t a n d e x p e n d i t u r e s i n c r e a s e d b y t h e a m o u n t n e c e s s a r y to p r e v e n t t h e f o r e c a s t f r o m c o m i n g t r u e . W h e n e v e r p r i c e s seem " a b o u t to b e " a b o v e t h e p r o p e r level, t a x r a t e s m u s t be r a i s e d a n d e x p e n d i t u r e s cut. D e p e n d e n c e u p o n a c c u r a t e f o r e c a s t i n g o f b u s i n e s s fluctuations i s e v e n g r e a t e r f o r the compensatory budget t h a n for the a n n u a l l y balanced budget. I f forec a s t i n g is inaccurate, the compensatory budget c o u l d easily increase fluctuations r a t h e r t h a n m o d e r a t e them. 271 MONETARY, CREDIT, AND FISCAL POLICIES Senator D O U G L A S . I suppose you could point in that connection to the failure of most of the forecasts i n the f a l l of 1945, when the vast preponderance of forecasters estimated that there would be 8 to 10 to 12 million unemployed by the spring of 1946, and i f we had followed that policy we would then have expended expenditures and reduced taxes and therefore have added enormously to the inflation which actually occurred ? M r . THOMSON. That is a very definite example in recent times, Senator, yes. [Reading.] L i k e the a n n u a l l y balanced budget system, the compensatory p r o g r a m encourages increased expenditure programs w i t h o u t higher t a x rates at some stage of the business cycle. H o w e v e r , w T hereas the a n n u a l l y balanced budget p l a n opens the door to n e w spending i n boom times, the compensatory p l a n opens the door i n d e p r e s s i o n — a c t u a l or forecast. I n either case the effect u p o n Government economy i s l i k e l y to be the same—periods of r a p i d increases i n spending, f o l l o w e d by f u t i l e efforts at retrenchment a n d a generally excessive u p w a r d d r i f t of expenditures. I f the managed compensatory system is to make any progress t o w a r d r e d u c i n g the debt, i t must count upon c r e a t i n g large surpluses i n prosperous periods by r a i s i n g taxes a n d c u t t i n g expenditures. B u t expenditures resist d o w n w a r d change a n d taxes resist u p w a r d change. I n the present state of economic forecasting, i t w i l l a l w a y s be possible to make out a p l a u s i b l e case t h a t depression is a r o u n d the corner. Such a p r e d i c t i o n w i l l p e r m i t both unpleasant alternatives to be avoided, since under the managed compensatory theory the forecast of depression requires l o w e r t a x rates a n d higher expenditures. T h i s system offers no r e a l i s t i c hope of debt reduction. U n d e r t h i s plan, as under the annual-balance plan, t a x rates are subject to frequent a n d u n s e t t l i n g changes. Senator DOUGLAS. M a y I interrupt for a minute ? Mr. THOMSON. Yes. Senator D O U G L A S . I don't want to introduce an excessively personal note, but when some of us felt that the budget for 1949-50 should be reduced, this argument was immediately advanced, that we were going to have a period of depression, and that therefore we should avoid reductions i n expenditures. So here is another illustration of what you say. M r . T H O M S O N . I am glad to have your comments. A s I have said, budget, money and debt policy should be considered as a unitary program. However, for purposes of exposition I shall describe the elements of the program separately before telling how we think of these elements as fitting together. I shall start with budget policy. The key to C E D ' s budget policy, which we call the stabilizing budget policy, is i n these two sentences: Set t a x rates to balance the budget a n d provide a s u r p l u s f o r debt retirement a t a n agreed h i g h level of employment a n d n a t i o n a l income. H a v i n g set these rates, leave them alone unless there is some m a j o r change i n n a t i o n a l policy or c o n d i t i o n of n a t i o n a l life. I should point out at once that the budget we are talking about is the cash consolidated budget and the surplus is a surplus in that budget. I shall come back to this later. C E D suggested that tax rates should be set to yield a $3,000,000,000 cash surplus at high employment. However, i n our thinking, this particular figure is less important than that there should be agreement upon a moderate surplus to be achieved at high employment. This basic proposition has a number of far-reaching implications. 272 MONETARY, CREDIT, AND FISCAL POLICIES First, the size of the surplus would remain constant so long as the level of employment and national income remains constant. I f we remain at high employment the surplus would remain at the agreed level. Senator DOUGLAS. May I interrupt ?. M r . THOMSON. Yes. Senator DOUGLAS. When you speak about the cash consolidated budget, you refer to total receipts and total expenditures by the Federal Government, including social-security receipts ? M r . THOMSON. That is correct, Senator, and the social security and the trust funds are the main element that is not i n the administrative budget. Senator DOUGLAS. I t is possible that this type of budget w i l l not be as much out of balance for 1949-50 as the operating budget because I think there w i l l be an excess of contributions for the old-age-annuity account of probably close to $2,000,000,000 with the increased rates which are going into effect, and while the unemployment-insurance account has been drawn down in the last 8 months if unemployment falls off we may have a cumulative surplus. It is probable that the budget wouldn't be quite in balance but there would be an excess of collections over disbursements in the social-security account, so that the deficit for 1949-50 for those items would not be probably more than $2,000,000,000. Senator FLANDERS. Senator, won't you have to take into account the additional purchases of mortgages by "Fanny M a y " ( F N M A ) which go into the cash budget ? They go into the regular budget, but we are talking about the cash budget. Senator DOUGLAS. Would you include veterans' insurance disbursements ? M r . THOMSON. Yes. Senator DOUGLAS. I f you make an allowance for that it would probably put the cash consolidated budget at about the same deficit as the operating budget. M r . THOMSON. That is right. M r . RUML. I think, M r . Chairman, since the point has come up now with respect to these two budgets, I might say this: I think it is of the greatest importance, when we talk about inflation and deflation, that we talk about the impact of Federal Government by way of cash expenditures and receipts, rather than the other budget, which is perfectly valid for administrative control, but which really has nothing to do with inflation and deflation. Let me give a somewhat dramatic case on the other side, namely, that the increase in the redemption value of series E bonds from year to year is counted as an expenditure in the administrative budget although no cash is distributed. It is for that reason that i n discussing fiscal policy we felt these issues of policy should be determined by the cash consolidated budget. M r , THOMSON. That is right. May I continue ? Second, the size of the surplus or deficit would vary with the national income. I f the national income declines the tax base w i l l decline and the yield of a stable set of tax rates w i l l decline. This w i l l cause a decline of the surplus or below some point an increase of the deficit. Also variation of the national income w i l l cause some change 273 MONETARY, CREDIT, AND FISCAL POLICIES i n expenditures under stable expenditure programs. F o r example, unemployment compensation payments w i l l automatically increase i f unemployment rises. The amount of variation i n the surplus or deficit with any given variation in national income w i l l be determined by the variation of tax yields and expenditures under stable tax rates and expenditure programs. Third, i n order to carry out this policy once it is embarked upon, an increase of expenditure programs calls for a matching increase of tax rates, and a decrease of expenditure programs calls for a cut of tax rates. The distinction between actual expenditures and expenditure programs may need explanation. F o r example, the unemployment compensation system sets up an expenditure program providing that certain amounts of money shall be paid to certain classes of persons i f they are unemployed for certain periods of time. Under that program actual expenditures w i l l depend upon the actual amount and distribution of unemployment. Similarly, actual expenditures w i l l vary even i f programs are held stable in the case of farm price supports, veterans' readjustment benefits, and some other programs. A change in the program calls for a change in tax rates, but a change i n expenditures i f the program is unchanged does not call for a change in tax rates. T w o exceptions to the general basic proposition are so important that they must be considered integral parts of the policy. However, I shall come to them and reserve discussion of them after I have explained the advantages that we would expect to be realized from the policy i n its general outlines. 1. The policy would contribute to the stability of the economy. I t would cushion the cumulative process by which economic fluctuations build up into great depressions or inflations. When total expenditures for goods and services decline, total incomes earned i n production of goods and services also decline, which causes a further decline of expenditures and so a further decline of incomes, and so on. A similar process works on the inflationary side. The stabilizing budget policy would insert a shock absorber i n this cumulative process,. When expenditures decline, part of the resulting decline of incomes w i l l be absorbed by the Government budget. T a x yields w i l l f a l l and as a consequence private incomes after tax w i l l not f a l l so much. A t the same time Government expenditures for unemployment compensation w i l l rise and offset part of the decline i n private incomes. The result is to reduce the decline i n private incomes available for expenditure and so to dampen the cumulative process, making fluctuations smaller than they would otherwise be. Senator DOUGLAS. I notice that this is very carefully worded, and that all you claim for that process is that it would provide a shock absorber, that it would contribute to the stability and that it would cushion the cumulative process. I n other words, the fluctuations would occur, but their magnitude would be diminished. M r . THOMSON. That is right, Senator. M r . WOLCOTT. M r . C h a i r m a n S e n a t o r DOUGLAS. Y e s , M r . W o l c o t t . M r . WOLCOTT. I n connection with stabilizing budget policy and compensatory budget policy, do you want to discuss what effect the result of this drive by retailers for a reduction i n excise taxes might have on either one or both of those ? 274 MONETARY, CREDIT, AND FISCAL POLICIES M r . THOMSON. W o u l d you like to have it discussed now or when we get through? I think M r . R u m l is thoroughly familiar with it. M r . WOLCOTT. Perhaps we can put it on the shelf until you finish your statement. M r . R U M L . I shall be very glad to discuss it at the proper time. T h a t is not C E D policy. M r . THOMSON. 2. The policy would contribute to economy i n Government. No budget policy by itself can assure economy i n Government. So far as our policy goes, it would permit an increase of Government expenditure programs whenever the Congress and the public are w i l l i n g to raise tax rates to pay for them. R u t the fact that, i f the recommended policy were followed, an increase of expenditure programs would call for higher tax rates would lead to more careful counting of the costs of higher expenditures. Senator DOUGLAS. Perhaps I am anticipating a subject which is discussed later i n your statement, but i f you were i n an especially severe depression wouldn't you approve of a stepping-up of expenditures ? M r . THOMSON. That is covered a little later, and would be taken into account, Senator. 3. T h e policy would contribute to reduction of the debt out of Government surpluses over the long period, although not necessarily in every year. The policy would assure cumulative reduction of the debt i f high employment is i n fact maintained on the average. I t seems to me very unlikely that any policy could i n fact succeed i n reducing the debt i f our average level of activity is much below high employment, and I think that the attempt to reduce the debt under such conditions would be dangerous. B u t this is not to say what is sometimes said, that the future course of the national debt w i l l be determined by events. Whether or not we succeed i n reducing the debt w i l l depend upon: (ai) Whether all public policies, plus private policies, plus events combined are such as to maintain at least reasonably high employment on the average, and (b) Whether budget policy is such as to provide for debt reduction under conditions of reasonably high employment. I w i l l now come to the two important exceptions to our basic budgetary principle which I referred to earlier. The first relates to the handling of extraordinarily large Government expenditures that are known to be temporary. I t seems to us undesirable to raise tax rates sharply i n order to finance such expenditures currently and then cut tax rates when the expenditure ceases. Therefore we suggested that it would be better not to match the temporary expenditure increase by a temporary tax increase and that any inflationary consequence of the expenditure should be offset by anti-inflationary debt and monetary policy. One of the questions that our committee wishes to examine further is the proper scope of this exception. Senator D O U G L A S . D O you have any illustration of what might be an extraordinarily large governmental expenditure that is known to be temporary ? M r . THOMPSON. W e think this whole question of what are nonrecurring expenditures should be explored, and we intend to explore 275 MONETARY, CREDIT, AND FISCAL POLICIES it i n connection with the statement we w i l l issue next year. The thing that bothers us at this time is that there seems to be so many regular nonrecurring expenditures. Somewhere along the line we hope to deal with that subject more effectively than we have been able to so far. The second important exception to our general principle relates to action to be taken in the event of an extreme depression or inflation. Under our general principle we would not cut tax rates i n depression or raise tax rates in inflation i n order to stabilize the economy. Instead, we would rely, so far as the budget alone is concerned, upon the stabilizing effect of automatic variations i n revenue and expenditures from stable tax rates and expenditure programs. W e believe that this stabilizing influence, i f combined with appropriate measures i n other fields—and I emphasize that—will certainly moderate fluctuations. W e hope they w i l l be sufficient to avoid more than moderate departures from high employment. But, of course, no one can guarantee that. We have to think about what we would do if, i n the absence of appropriate policies, or in spite of them, we find ourselves i n a severe depression or major inflation. I n such conditions, extraordinary action should and w i l l be taken. I n our opinion an emergency congressional reduction or increase of tax rates would be one of the most effective and least dangerous courses. Senator DOUGLAS. M r . Thompson, may I interject there? What you are proposing, I take it, is to make the stabilized budget policy the standard, and to apply a portion of the managed compensatory budget for severe fluctuations insofar as that refers to taxes. I t is a partial marriage of point 2 with point 3. M r . THOMSON. I don't think we would want to agree that we are adopting any part of that compensatory philosophy. Senator DOUGLAS. What I mean is this, you say i n a severe emergency that you would alter tax rates, presumably decreasing them i n a period of depression, and increasing them i n a period of severe inflation ; so there is at least one element of the compensatory principle which you graft on to your stabilized budget. Senator FLANDERS. Perhaps there is a secret liaison instead of a marriage. Senator DOUGLAS. That could be as effective, but i f it is put into effect it would be legitimatized; we want no illicit relationships. M r . RUML. I think there are two important distinctions. One is a real one; the other semantic. The "compensatory" term has a bad odor. Therefore we want to make a very large distinction between this policy and the compensatory. The chief distinction, M r . Chairman, is on this point, that these actions on either the tax reduction or the expenditure side would take place after the fact, rather than in anticipation of the fact. Senator DOUGLAS. A f t e r the depression has occurred ? M r . RUML. That is right. Therefore, the element of forecasting is eliminated. I f you take the situation that existed i n 1949,1 think probably most people would have looked for more trouble by September than actually occurred, and would have taken actions i n J u l y that would have been very untimely i n October. 276 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. W o u l d you apply the same modification i n the field of expenditures, that after an appreciable depression has occurred you should expand expenditures ? M r . THOMSON. W e do suggest that, i n the public works program later on. Senator DOUGLAS. A n d reduce expenditures i n a period of severe inflation after the inflation had occurred ? M r . THOMSON. That is correct. Senator D O U G L A S . I would say that you have affected a partial marriage between theory 2 and theory 3. Senator F L A N D E R S . A trial marriage. M r . THOMSON. Since the question has come up recently I want to say a word about "automatic guides to policy." Neither the guides nor the policy recommended by C E D is automatic. A s we said 2 years ago i n first presenting the stabilizing budget policy: T h e p o l i c y recommended here cannot be " a d o p t e d " a n d l e f t to r u n w i t h o u t c o m m o n sense a n d vigilance. B a s i c a l l y , w e a r e p r e s e n t i n g the p r i n c i p l e s t h a t a r e i m p o r t a n t i n m a k i n g the decisions t h a t must be made. T h e p o l i c y w i l l n o t y i e l d the results of w h i c h i t i s capable unless the p r i n c i p l e s a r e c o n s i s t e n t l y foll o w e d a n d reasonably interpreted. W e have tried to describe our principles as specifically as possible, and to provide within the policy itself for the most important exceptions to the general principles. W e do not think it an adequate policy to say that sound judgment must be used about the relevant facts, without saying what the relevant facts are and how they are to be taken account of. A n y policy that is followed w i l l have certain consequences, which may be called automatic. W e choose our particular policy not because its consequences are automatic but because we believe its consequences are good. MONEY-DEBT POLICY I should like now to describe briefly the money-debt elements of the program and then turn to an appraisal of the whole program as a unit. I think it may be useful to distinguish between two aspects of money-debt policy: 1. The contribution to stability that a sound financial structure can make by not itself initiating or aggravating fluctuations. T h i s means that random changes i n monetary reserves—say as a result of gold flows—should not initiate undesired expansion or contraction of the money supply. I t means that fear about the soundness of financial institutions should not cause intense pressure for contraction. Business recession should not make the banking system so illiquid that the flow of credit is frozen and the money supply shrinks. T h e economy should not bear an excessive burden of private debt, especially shortterm debt. I think we tend to underestimate the importance of these factors, possibly because they are not dramatic. F o r instance, we tend to forget the simple fact that between 1929 and 1933 our money and banki n g systems were allowed to collapse. T h a t collapse added materially to the severity of the depression. There is nothing more essential to avoiding another great depression than avoiding another financial collapse; and we have done something about this, as I shall point out i n a moment. 277 MONETARY, CREDIT, AND FISCAL POLICIES 2. I n addition to this more or less neutral function there is a positive function of monetary-debt policy for stability. This means i n times of recession, deliberate action by the monetary and debt authorities to increase the reserves of the banking system and the money holdings of the public, to increase the availability of credit and, i n general, to make holding liquid assets less attractive and to make investment and consumption more attractive. W i t h appropriate reversal of direction the same policy holds good for inflation. W e think of this positive stabilizing policy as coming into operation quickly i n response to relatively moderate departures i n either direction from high employment and price stability. I t is one of the great virtues of monetary-debt policy, as compared w i t h deliberate fiscal policy, that it can come into operation quickly. Monetary-debt policy does not involve cumbersome legislative or administrative procedures. Moreover, it can take some risks of being wrong because it can reverse itself quickly. Our financial institutions are now much stronger than they were, say, 20 years ago. T h i s is partly the result of legal changes in the Federal Eeserve System and the establishment of deposit insurance. I n part, our financial structure is more stable because of the change i n the composition of bank assets from predominantly private loans to predominantly Government securities. Our private financial structure has been strengthened by the use of the amortized mortgage for home and farm financing and the growth of the term loan for business, Moreover, the total burden of private debt on the economy has been much reduced i n relation to total incomes and total asset values. W e should remember that this relatively favorable private debt position is largely the product of the war and the accompanying inflation. I t w i l l not be maintained unless more favorable conditions for equity financing are created. The present tax structure and the fact that a large proportion of our current savings flow through financial institutions both restrain equity financing. T h i s w i l l not only make our economy more vulnerable to depression, it w i l l make our economy less able to meet urgent needs for productive investment at home and abroad. T h e tools and techniques for a positive, stabilizing monetary policy are well known and available. They inclucje open-market operations, changes of reserve requirements, and changes of rediscount rates. The main requisite in this area is recognition that economic stability is the primary objective of monetary policy in association with fiscal and debt policy. I believe this proposition is recognized by the Federal Eeserve. It and its implications need to be more fully understood by the public generally. One implication of the proposition is that monetary policy must concern itself first with the over-all state of the economy and should not allow responsibilities with respect to particular markets and particular prices to interfere with its over-all responsibility. Another implication is that monetary policy w i l l involve risks, particularly the risk that action to restrain inflation may be followed by recession. This risk may be reduced by prompt and flexible action, but cannot be entirely eliminated. Failure of the public to understand this may tend to make the monetary authority unduly cautious. More problems arise in connection with the debt aspect of the moneydebt combination. Certain general features of a debt management 278 MONETARY, CREDIT, AND FISCAL POLICIES policy for stability may be described. I n times of inflation the Government should retire debt held by the banks, using for this purpose the budget surplus and the proceeds of borrowing from the public, I n times of recession the Government should borrow from the banks to finance its budget deficit and to retire debt held by the public. But there are problems beyond this. One is how to devise the terms and selling methods of a Government bond that would more effectively attract savings when needed. The issue and redemption of such security would be a valuable additional stabilization instrument. Another problem, which w i l l become acute i n a year or two, is how to handle the refinancing of savings bonds as large amounts mature. O f course, the best-known problem i n this area is that a vigorously anti-inflationary monetary policy might lead to a major drop i n the market prices of Government bonds, with possibly serious adverse consequences. I believe that this problem is likely to be less acute i n the future than it was in 1947 and 1948. F o r one thing, recent events have reminded us that the Government bond market is not a one-way street. I t can go up as well as down. Moreover, as time passes since the warbond drives, holders of Government securities probably come to regard them more as permanent investments and become less concerned about market prices. Senator D O U G L A S . I suppose you are referring to the fact that i n recent months the price of Government bonds has risen, and I believe they are now selling at a premium of around 4 points above par ? M r . THOMSON. That is right, Senator; yes. These remarks are not intended to dispose of the problem, which may still remain or may recur, even i f possibly i n less acute form. Our committee has taken the position that the Federal Reserve, while it has a continuing responsibility for maintenance of an orderly bond market, should make its decision i n terms of the effects of its action upon the whole economy. More specifically, "the Federal Reserve should feel free to reduce the support level unless it finds a superior alternative way of bringing about a monetary restriction i f and when that is required by the objective of economic stability." General stability is the primary objective, and the objective of stability i n the bond market should be reconciled to that, rather than the other way around. Probably the most immediate question about this situation is whether it requires or justifies an increase of the powers of the Federal Reserve. A r e there powers not now possessed by the Federal Reserve that would significantly add to its ability to reconcile the objectives of general stability and bond-market stability ? W o u l d the existence or exercise of these powers have other effects that would make them on balance undesirable ? Chairman McCabe has presented to this subcommittee a clear and thoughtful statement of the case for additional powers. I think these questions require more consideration, and I would not be prepared to answer them definitely now. They would be appropriate questions for the National Commission to which I shall refer later. T H E COMBINED PROGRAM W h a t we are seeking i n the whole program I have outlined is this: A combination of neutralizing, cushioning, and compensating influences achieved by a suitable division of responsibility among budget, money, and debt policies. 279 MONETARY, CREDIT, AND FISCAL POLICIES First, as a minimum and all the time we want the financial system to be at least neutral. That is, the financial system should not itself originate or intensify unstabilizing disturbances. W e would get this effect with respect to the budget, under our policy, by the provision that the surplus should remain constant i f the national income remains constant. W e would also get this effect by maintaining, what we already essentially have, sound financial institutions that do not give rise to perverse movements of money and credit, that are not subject to panic and collapse, and that avoid an excessive burden of private debt. So long as we have high employment and price stability, all we expect from our policy is neutrality. Senator DOUGLAS. I notice that you use as your norm high employment. Now, when the stabilization b i l l was first introduced, the objective was stated as f u l l employment. I n the act as finally passed, the objective was to be maximum employment, production, and purchasing power. M r . THOMSON. Yes. Senator DOUGLAS. I have a dictionary, but, as I remember those comparative terms, you have great, greater, greatest. I assume that maximum is "greatest," i f I remember my Latin. Now, your standard is, apparently, somewhat lower than maximum, somewhat lower than greatest, and I wonder what definite meaning you attach to the word "great." Now, the advocates of f u l l employment, as you remember, were willing to concede that i n this country you could have, say, 3 to 4 percent unemployment caused by seasonal and transitional factors; somewhat higher i n this country than i n England, because of the greater fluctuations of the weather and more rapidly a fluctuating tempo; and it was said that, when unemployment is greater than 3 or 4 percent, then these compensatory or stabilizing devices should be called into play. Now, apparently you do not contemplate as r i g i d a standard as 3 percent. M r . T H O M S O N . I think we started with the idea, Senator, that there would be seasonal and transitional unemployment, as classified, and that high employment would include employment of everyone i n the labor force outside of those unemployed for seasonal or transitional reasons. Senator DOUGLAS. I think the advocates of f u l l employment would concede that. A s I remember M r . Beveridge's book, he said that we should not expect to eliminate seasonal and transitional unemployment. Let us say that the figure is somewhat higher for the United States than for Great Britain. Say it is 4 percent. Would you say that we should keep unemployment down to 4 percent, or would you allow a further figure above that ? M r . THOMSON. Our estimates were based on 4-percent unemployment representing high employment. Senator DOUGLAS. And, when unemployment exceeded 4 percent, then you thought there was a departure from the norm which we would try to maintain ? M r . THOMSON. Yes. M a y I just read a paragraph here? Senator DOUGLAS. Y e s . M r . THOMSON. W e did cover this. T h e s e precise figures— [Reading:] 280 MONETARY, CREDIT, AND FISCAL POLICIES that is the 4 percent— cannot be rigorously defended against other figures i n the same neighborhood, and some adjustments may be indicated after the system has been i n operation. H o w ever, the appropriate figures cannot be f a r away i n either direction. A c t u a l unemployment may, f r o m time to time, lie below 4 percent, as it does n o w — this was written i n 1947— it probably cannot be much below this figure without serious inflationary pressure. W i t h 4-percent unemployment, most involuntary idleness is of the betweenjobs variety. That was our thinking at that time. Senator DOUGLAS. When you say 4 percent, do you mean 4 percent of the total labor force or 4 percent of the nonagricultural working force ? M r . THOMSON. F o u r percent of the total labor force. Senator DOUGLAS. W h i c h would be around 2.4 million ? M r . THOMSON. That is correct. Senator FLANDERS. F o r the record, I suggest that you tell us what „ the document is that you just read from. M r . THOMSON. That is from our 1947 statement called Taxes and the Budget, page 32. Senator DOUGLAS. When with the present labor force unemployment rose above 2y 2 million, then you would want to have some of these stabilizing influences go into effect? M r . THOMSON. Yes. A s a matter of fact, some are i n effect now. Senator DOUGLAS. Let me raise another query: H o w severe would unemployment have to be before you think your added compensatory feature should go into effect? M r . T H O M S O N . I don't believe that we have arrived at an answer to that. I don't think that it is anywhere near the present situation. W e haven't arrived at a definite answer. Senator DOUGLAS. The Congress has to do so, however. M r . THOMSON. That is right. Senator DOUGLAS. W o u l d you say 10 percent ? M r . T H O M S O N . I think, Senator, that I would have to let the statement stand, that we never have taken a position. W e w i l l consider that further i n connection with the statement next year. Senator DOUGLAS. I t would be very helpful, because frequently the Members of Congress feel that they are given an adjective but not given the definition of the adjective, and it is always a question as to whether the actual facts justify one policy or another. M r . THOMSON. That is right. Senator FLANDERS. M a y I introduce here a statement of the Princeton conference which was held on September 16 and 18. Their recommendation was [reading] : Congress should act i n case of a decline i n activity involving a genuine increase i n unemployment of more t h a n i y 2 m i l l i o n persons above present levels. This w o u l d mean total unemployment of about 5,000,000 according to present methods of computation. Senator DOUGLAS. E i g h t and one-third percent ? Senator FLANDERS. Yes; 8y3 percent. M r . RUML. M r . Chairman, it might be worth pointing out that, i n case we gradually moved into a high level of unemployment such as you talk about, the measures i n this program become extremely power- 281 MONETARY, CREDIT, AND FISCAL POLICIES f u l all by themselves. W h a t we do not know yet is how powerful they really are, and for that reason we don't know when the crisis action should be taken; but notice that unemployment insurance begins to pay out, tax receipts from withholding stop being paid, other things begin to happen, that accelerate as the amount of unemployment increases. F o r that reason, without more experience than we have had today, it would be a little dangerous to say much more than that at some point you would take crisis action; when you would have to do that, we do not know. M r . T H O M S O N . A S I understand it, these communities that are supposed to be i n distress are supposed to have 12-percent unemployment. They are using 12 percent as a yardstick now |pr trying to put Government orders into effect there. I suppose there must be a history or an experience back of that. B u t in the event of departure i n either direction from this target position we want more than neutrality. W e want a strong cushioning influence to come into play to restrain the deflationary or inflationary movement. We would get this cushioning influence mainly from the variations i n tax yields and i n some expenditures under stable tax rates and expenditure programs. I have already described this factor, which the economists call built-in flexibility. W e expect it to be a very powerful force, much more powerful than it could have been before the war, simply because of bigger budgets, greater use of income taxes, including the pay-as-you-go feature, and the unemployment-compensation system. The purpose of the cushioning factor is not merely to moderate fluctuations, to make little depressions out of big ones, although that i n itself is highly important. W e expect the cushioning force to help retain the conditions under which such natural forces for stability as do exist can operate. That is, we want to prevent the natural forces that make for stability from being swamped by the cumulative process of instability. So long as departure from high employment and price stability are small, our policy calls for no more than neutralizing plus cushioning measures. B u t i f the departures are larger we want to do more. W e want positive compensating action to get us back to the position of high employment and price stability. Under our policy this compensating action would be of two kinds and would come into play at two different levels. First, i n case of moderate, even rather small, recessions or inflations, deliberate monetary and debt policy would be called for. The precise timing and amounts of action would be a question for the judgment of the monetary and debt authorities. W e can only say i n advance that it should be prompt and large. There is, I know, considerable skepticism about the effectiveness of monetary policy, especially against depression. This feeling is partly derived from consideration of conditions i n which a severe collapse has so impaired the outlook for future sales, incomes, and profits that no flooding of the economy with money and credit can stimulate investment and consumption. But it is the purpose of our whole program to prevent such conditions from developing. That is, we look to the other parts of the program to prevent conditions from getting so bad that monetary policy cannot work, and we look to monetary policy to make conditions better. 282 MONETARY, CREDIT, AND FISCAL POLICIES Finally, i f the combination of neutralizing measures, cushioning measures, and compensating money-debt measures is not sufficient, if we run into an extreme depression or inflation, we would want to do more. W e would call for positive compensating action i n the budget to give a strong impetus back to high employment at stable prices. W e would mainly rely on cutting tax rates i n severe depression, because it is practical to do much more in a short time i n this way rather than by increasing expenditures. However, we would not rule out such deliberate changes of public works or other expenditures as might be feasible. That is a more definite answer to the question you put a while ago. Senator D O U G L A S . Y O U don't rule it out, but you don't say "No' f and apparently you don't say "Yes." M r . T H O M S O N . I wouldn't think that. I would think that what we are saying is that it is a matter of information and of judgment as to when you do these things, with the emphasis on being able to do a better job, using present techniques, better understood, and with a policy. Senator DOUGLAS. The argument i n favor of increasing expenditures, you see, rather than reducing taxes i n periods of depression is the contention that, i f you reduce taxes, that w i l l not result i n a corresponding increase in private expenditures, due to hoarding, whereas the direct expenditure by the Government w i l l translate itself into such an initial outlay. M r . T H O M S O N . Y O U can get the effect by tax reduction and make it more effective quicker than you can by a public-works program. Senator DOUGLAS. But the argument is that it w i l l not translate itself into corresponding increases i n either investment or i n expenditure. Senator FLANDERS. M a y I make an observation, Senator? Senator DOUGLAS. Surely, Senator Flanders. Senator FLANDERS. W e had from the early 1930's through the thirties, what was, for the period, a very high compensatory spending by the Government, with no satisfactory result i n increasing employment. A s I remember, under that period, we increased our national debt about $15,000,000,000, which then looked very large indeed. A t the same time, i n making those expenditures, we went into war preparations with somewhere around 10,000,000 people unemployed. It seems to me that there is another factor that was missing during that period, and that was a sympathetic state of mind on the part of the administration toward private business, toward private enterprise, toward profits, toward the whole structure of our enterprise system. That not only can but did negate these expenditures to a very large measure, and it seems to me that that factor must be kept i n mind by governmental forces i f the increases i n expenditures are to become effective. Otherwise, the funds go right into unused liquid capital and remain stagnant and ineffective i n their results. M r . RUML. M r . Chairman, I think, to complete the record, that period was also characterized not only by increases i n expenditures but also by increases in tax rates, which is, of course, just contrary to the type of program we are suggesting. Senator DOUGLAS. That was only in the first 2 years, as I remember, 1933 and 1934, wasn't it? 283 MONETARY, CREDIT, AND FISCAL POLICIES Senator FLANDERS. The undistributed profits tax came i n at that time. M r . RUML. I n 1936 and 1939 there was an upward change i n the corporate rate, I believe. I think there were more than two changes, M r . Chairman. Senator FLANDERS. The undistributed profits tax was one of those measures which, to my recollection, negated the other results, in that it put a penalty on a new investment and the plowing back of such profits as there were into business expansion and revival. So that while we had that one measure of increased taxation, it was increased taxation that worked unfavorably and, furthermore, i n putting a damper on business enterprise, it was one of those features which tended to reduce the effect of increased governmental expenditures. Senator D O U G L A S . I am sure that it is not our purpose to relight the battles of the New Deal, but I would say i n reply to my very esteemed colleague that i f the tax policy followed by the Roosevelt administration during this period was not precisely perfect, that does not prove that the expenditure policy was wrong. Senator FLANDERS. I n looking back to that period, what we are looking for is to gain from it some experience as to making increased governmental expenditures during a depression period. Senator DOUGLAS. That is right. What I am saying is that it is possible that the tax policy may have dampened down the beneficial effect of an expenditure policy, and that i f that is true you should lay the blame at the door of the tax policy rather than at the door of public works, P W A , and so forth. Senator F L A N D E R S . I haven't argued against that. Senator D O U G L A S . I understand. B u t you are a very subtle man. The implications were there, and I wanted to prevent the stream of opinion from moving in a direction contrary to what I, at least, believe to be thev truth. M r . WOLCOTT. M r . Chairman, perhaps this is as good a place as any to bring this up. A s to compensatory actions on the part of the Federal Government to take up the slack, and so forth, I think we are all agreed that they are desirable. I wonder i f M r . Thomson or M r . Ruml could clear up a point which has been bothering a great many people: The relative importance of public works as compared to private activities. Somewhere, at some time or other, I read or heard that a Government-created dollar of credit turns over i n velocity with a ratio of about 2, or 2y2, to 1, and that normally a privately created dollar of credit turns over at a ratio of about 10 to 1. M r . RUML. I think your judgment on that would be affected by one paramount fact, that is, the scale of income of the recipient of the dollar. Obviously, i f a governmental dollar goes to the poor it w i l l be spent rapidly by the recipient; if it goes to people who are better off, some part of it might be saved. I f it goes to a corporation, some part might go into depreciation; some into withheld profits. I think you can't draw any general rule except perhaps to say this: That when there is a lack of confidence in governmental spending it tends to create an attitude of unrest and a feeling of lack of confidence. I think that some of that has happened in the past because of the unconventional character of some of the things done. Senator DOUGLAS. M a y I interject? I would say that lack of confidence in business conditions may impede private expenditure or 284 MONETARY, CREDIT, AND FISCAL POLICIES investment. I t was that lack of confidence i n business conditions during the middle thirties which the Government strove to offset by an increase in public expenditures, which would not necessarily be forthcoming from funds i n the possession of private business. Senator FLANDERS. I could follow with my point of view on this, but I think it is understood, so it doesn't have to be reiterated. Senator DOUGLAS. That is right. Then, I understand, the flag of truce has been put up on both sides. M r . RUML. M r . Chairman, could I just p i n a bright ribbon on the flag of truce ? I n studying the public-works situation specifically, it has seemed to me—and this is a personal view which the C E D has not adopted— that the objective i n the public-works program can hardly be more than to stabilize the over-all construction picture; that i f the publicworks program tried to stabilize the whole economy the consequences would be to give a terrifically unstable character to that particular industry, creating public demand for labor and materials that would preclude private activity. So that there is a limitation of that character on the usefulness of public works as such. M r . WOLCOTT. I n that connection there is a formula, which we have heard about, that heavy-goods-industries expenditures and construction-industry expenditures are usually about 16 percent of the income i n all the effort. Could the Government determine—that is, broadly— what the national income could be by providing always that this base be maintained ? Perhaps I am not on the right premise i n taking at face value that 16 percent is the base, but, whatever it is, could the Government, through Government spending or reductions, and so forth, determine, within certain reasonable bounds, what our income would be, i f the Government provided that base, i f private industry was not providi n g it? M r . R U M L . I think i n aiming at it we would come closer to it than in the past. The record of 1931-32 is that when private building went off so also did State and municipal building. They all went off at the same time due to the general attitude with respect to building. Senator DOUGLAS. A great change occurred i n 1933, 1934, and 1935. M r . RUML. W e made an enormous amount of progress, but d i d not quite hit the State and municipal level. Senators FLANDERS. M r . Chairman, I wonder i f I might state the terms of this truce ? Senator DOUGLAS. Yes, Senator Flanders. Senator FLANDERS. A r e not we all interested in having the increase i n Government expenditures i n slow times as effective as possible in generating a general increase i n business ? Senator DOUGLAS. Yes; certainly, that is correct. M r . W O L C O T T . I S there substance to the contention that we can, through Government expenditures in the heavy goods and construction lines provide, within reasonable bounds, for a level of national income? M r . R U M L . I think not. I think it can only be a contributing factor. Certainly we can keep it from going i n reverse. M r . WOLCOTT. I t doesn't necessarily follow. 285 MONETARY, CREDIT, AND FISCAL POLICIES M r . R U M L . I think the amount of preliminary planning, the amount of work that w i l l have to be ready, and all the rest of it, would involve such fantastic engineering operations that they might be out of date when the time came to exercise it; but a great deal more can be done than ever has been done, I think, along those lines. Senator DOUGLAS. Then your preference for using a reduction i n taxes at the time of a severe depression rather than an increase i n expenditures is primarily based on the fact that you think public works would be slow to start; whereas the effect of a reduction i n taxes would be immediate ? M r . RUML. Primarily that. There is one collateral thought, however, that i f the amount that would have to be spread is very large indeed, it probably is more consistent with our way of life to let individual consumers decide what they want rather than to have a central •agency decide. Senator D O U G L A S . S O far as the first objection is concerned, i f engineering plans are drawn i n detail i n advance, would that not reduce the time required ? M r . RUML. Yes; it would very much. B u t you would have to be very careful to make sure i f the plans were drawn 4 years ago that they are still up to date and there have been no technological changes. Senator DOUGLAS. Congress just appropriated $100,000,000 for the detailed planning of a large series of works. M r . THOMSON. I f I may make a couple of observations: (1) The C E D has been in favor of the kind of advanced planning you speak of; (2) I do not know, M r . Wolcott, the exact measure of the impact, but I do recall some studies along this line. I f you conceive of public works being augmented, you have to deal with some 250,000 governmental units, and it has seemed to me that the effect on all these governmental units is going to be influenced by the level of business thinking, and it is not as easy as you might think to get either business or Government or smaller governmental units to go ahead and say that this is a time of low prices, this is the time we need employment, and we are going ahead. There is one more point to be made here. I was trying to find the exact statement used i n the 1946 Employment Act, but as I recall it, it says we are trying to promote economic stability within a framework of a free enterprise economy. I t seems to me the act says that i f you have a choice between Government expenditure and incentives to make the free enterprise economy operate, that you give the preference to things that w i l l create incentive. I f there are no other questions I w i l l continue my statement. A P P R A I S A L OF T H E C O M B I N E D P R O G R A M The program I have outlined does not guarantee perfect stability. W e do not think perfect stability can be guaranteed. A n d the small ups and downs, i f kept small, serve a useful purpose. The number one economic problem of the United States is great fluctuations, not small fluctuations. W e believe that this program, i f accompanied by reasonable policy i n other fields, would prevent great fluctuations. Perhaps it is more relevant to say that we have worked hard, and I believe objectively, on this problem and that this is the best we know 99076—50 19 286 MONETARY, CREDIT, AND FISCAL POLICIES at present. W i t h more study and experience we, or the Nation, w i l l certainly learn more. One question that is sometimes asked about our policy is why we propose to wait until extreme conditions arrive before we take affirmative compensatory fiscal action. I hope I have made it perfectly clear that our policy proposes strong action to avoid, moderate, and combat depressions or inflations before they reach extreme dimensions. It is the purpose of the program to prevent severe depression or inflation. The provision for extraordinary budget action i n extreme conditions is not the heart of our program. It is an exception, and if the rest of the program operates as we think it can, the exception would be rarely invoked. W e provided the exception, not because we thought the rest of the program would fail, but because we could not guarantee that it would succeed. Nevertheless, it is pertinent to ask whether what we call extraordinary budget measures should not be made the ordinary procedure. F o r example, instead of waiting for severe depression before cutting tax rates, shouldn't we cut tax rates when depression is forecast or at least in the case of an actual moderate recession? This is a question essentially involving judgments about two factors: (a) The possibility of forecasting economic fluctuations reliably, and ( i ) The possibility of quick action to change tax rates (or expenditure programs). I don't think it is necessary to say more about forecasting than that we share what is now almost the universal opinion that forecasts of economic fluctuations are not sufficiently reliable to serve as a basis for public policy. Senator FLANDERS. M a y I at this point again read a paragraph from the report of that group of economists which met at Princeton? I t indicates a little difference i n optimism as to the effect of the automatic flexibility, although you are not confining yourself to automatic flexibility at all. So perhaps this paragraph should be read i n view of the fact that you are not relying completely on automatic flexibility. This paragraph reads : A u t o m a t i c flexibility can slow d o w n a n d perhaps h a l t a decline of a c t i v i t y or a rise of prices. I t can give time for restorative forces to come into play, but i t w i l l not by itself p u l l activity back to a f u l l employment level or restore prices to a p r e i n f l a t i o n level. A s I followed your testimony, it would seem as though you were not too far off from that, although you do, after all, limit the possibilities of the automatic flexibility and call for definite action particularly in the monetary and credit and debt control fields. M r . THOMSON. That is correct, Senator. The more reasonable proposition is that we should take fiscal steps,, say cut tax rates, in response to actual but moderate recession. T h i s does not escape the forecasting problem unless the response takes effect much more quickly than the economic situation is likely to reverse itself for other reasons. I f we call for a cut of tax rates in a moderate recession and the economy is on its way to inflation by the time the tax cut takes effect, the result of the fiscal action is unstabilizing rather than stabilizing. The smaller the fluctuations are to which stabilization policy is to respond, the quicker-acting must be the response i f it is to do any good. 287 MONETARY, CREDIT, AND FISCAL POLICIES Built-in flexibility can respond to very small fluctuation because its response is instantaneous. Monetary and debt policy can respond to moderate fluctuations because it can respond quite quickly, although not instantaneously. B u t so far as we can see, the deliberate response of fiscal policy via changing tax rates or expenditure programs w i l l be rather slow and should be confined to major fluctuations. However, it may not be impossible to devise ways to speed up the process of making fiscal decisions and putting them into effect; in that case it might be desirable to reconsider this conclusion. I t is possible that in the future the problem of maintaining high employment without inflation i n a free economy may arise i n a form rather different than the form it has taken i n the past. I n the past the main problem has been great instability i n the total demand for output. It w i l l certainly be essential to avoid such instability i n the future. B u t it is conceivable that this, while it would have been sufficient i n the past, w i l l not be sufficient i n the future. Suppose that prices and wage rates are, or come to be, predominantly determined not by the market process but by the administrative decisions of business organizations, trade-unions, and government. A n d suppose that these decisions are made i n a way that lead to continuous increase of prices and to increase of wage rates more rapidly than productivity rises. It would then not be possible to maintain high employment without inflation, as it is uncertain whether high employment could be maintained even with inflation. W e do not know whether this kind of problem exists now, or whether it w i l l exist in the future. However, the possibility does suggest a reservation to the claims that should be made for any program of fiscal, monetary and debt policy. T H E CASH-CONSOLIDATED BUDGET A s I pointed out earlier, C E D recommends that over-all budget policy should be decided i n terms of the cash-consolidated budget. This committee is already familiar with the significance of the cashconsolidated budget. The President has regularly included in his annual economic reports, which this committee studies, a statement of Federal cash receipts from and payments to the public. This statement is what we call the cash-consolidated budget. The Economic Report uses this budget, rather than the ordinary budget, because the cash-consolidated budget presents a better picture of the over-all effects of Federal finance upon the economy. I t is therefore more useful in developing over-all economic policy. B u t of course it is not solely the President and the Joint Committee on the Economic Report who are concerned with over-all economic policy. T h e President in his budget message, and your colleagues i n the revenue and appropriation committees, are making over-all economic policy, as well as making policy about a lot of particular programs. I t is our suggestion that when total budget policy is considered— questions such as whether or not the budget is balanced, how big the surplus should be, what should be done to achieve the desired surplus— we should look at the cash-consolidated budget. 288 MONETARY, CREDIT, AND FISCAL POLICIES W e are not suggesting that the present administrative budget should be abolished. W e think that most of the business of the Government would continue to be done i n terms of an administrative budget. B u t for certain important decisions the cash-consolidated budget would be used. There is nothing wrong with having two budgets. W h a t is wrong is not to have all the relevant information for making policy about a $40,000,000,000 budget—$44,000,000,000 now—even i f that involves two budgets. The difference between the two budgets is not minor or technical. I n fiscal 1949 there was a surplus of $1,000,000,000 i n the cash-consolidated budget and a deficit of $1,800,000,000 in the administrative budget. I n our opinion one of the simplest and most useful things this subcommittee can do is to explain the facts of the cash-consolidated budget to its colleagues i n the Congress. SOME U N S E T T L E D QUESTIONS I would leave an inadequate impression of the state of our current thinking i f I did not refer to one of the problems that now troubles us and that we plan to consider during the next year. T h i s problem arises from the fact that the present tax system i n the United States is extremely heavy as well as badly constructed. Continuation of the existing tax system would be a serious menace to the strength of the American economy and to the welfare of a l l the American people. I shall not elaborate upon this fact, which we have discussed i n several policy statements, but merely raise some questions about its implications for fiscal policy. W h i l e the ideas of proper fiscal policy now held i n the United States differ i n many respects, most of them, including ours, would agree that any substantial increase i n Federal expenditures would call for higher taxes and that substantially lower taxes would have to wait for reduction of expenditures. T h i s leaves one route to tax reduction, namely, expenditure reduction. W e believe that some steps along this road can be taken now. B u t we must recognize that substantial progress along this road, i f achieved at all, may take a long time. There are possibilities of reducing the adverse effects of the present tax system without reducing total revenues; these possibilities should be fully exploited. But there are obvious limitations, economic and political, to these possibilities that would not apply i f revenue reduction could be permitted. T h i s raises the question whether we can devise a fiscal policy that w i l l permit more rapid total tax reduction. A r e we relying too heavily upon taxation in our present economic policies? Can we discover ways other than taxation to perform some part of the functions we now count upon high taxes to perform ? One important aspect of these questions is how far we may consider our present level of Federal expenditures as an abnormal and temporary reflection of the transition from war to peace, possibly justif y i n g some temporary departure from normal fiscal policy. W e do not know the answers to these questions, and I hope I have succeeded i n raising them in a way that does not imply an answer. Senator F L A N D E R S . I think you have. 289 MONETARY, CREDIT, AND FISCAL POLICIES M r . WOLCOTT. M r . Chairman, may I clear this up ? A s I understand from your statement, you are advocating that we put less stress upon our tax structure as a stabilizing influence, that taxes should be raised for purposes of carrying on the functions, extraordinary as well as ordinary, of the Federal Government, but should not be used purely for the sake of siphoning off purchasing power, et cetera, as we have so frequently done, excepting where that might be necessary, of course, to build up reserves against lower tax income in periods of depression. M r . THOMSON. W e suggest that question as one that very properly has to be considered, and it is a very proper question for the Monetary Commission, and we say we are going to study it next year. I t is a very proper question. Senator DOUGLAS. I am a little puzzled by the meaning of the two following sentences i n your statement : A r e we relying too heavily upon taxation i n our present economic policies? C a n we discover ways other than taxation to perform some part of the functions we nowT count upon high taxes to perform ? I confess that leaves me completely mystified. M r . THOMSON. I think I w i l l ask M r . R u m l to comment on this. M r . RUML. D u r i n g the war we knew that the sale of savings bonds to the public was an anti-inflationary measure, and as soon as the war ended we suddenly seemed to forget that the sale of savings bonds to the public is an alternative to taxation insofar as the immediate consequences of inflation are concerned. W e knew that some day the savings bonds would have to be paid out of taxation, but it would be over a period of time. Therefore, we operated our war program and financed it partly by taxes, partly by deflationary financing, and partly by inflationary financing. Senator D O U G L A S . I n the form of bank-created deposits, which were used to take title to Government bonds ? Is not that the inflationary type? M r . RUML. That is right. Now, then—and here I want to make it perfectly clear that I am speaking only for myself and not for the Committee on Economic Development, and I w i l l be quite concrete with the risk that concreteness brings—in my opinion it is worth thinking about these refunds to the veterans of life-insurance premiums as a nonrecurring expense and as part of the consequences of the war. I t would seem to me that the inflationary consequences of that disbursement, which they certainly are, might be properly offset by similar net sales of savings bonds to the public rather than to cover them by taxation. That would be not a departure from our policy, but would be consistent with the second exception, namely, that our tax structure should not be distorted by what are obviously transitional and nonrecurring expenditures; and even though these are inflationary, there are other ways of countering them than by taxation. Senator D O U G L A S . Y O U are not proposing that you use these bonds to have a permanent increase i n the public debt, are you ? M r . RUML. The bonds, when they mature, w i l l either be refunded or paid off. The point is that the people living and breathing i n 194950 w i l l not by themselves take up this expenditure. I t w i l l be like other war expenditures, spread over the period of the life of the bonds, 290 MONETARY, CREDIT, AND FISCAL POLICIES or their refunding. I t is, i n other words, a national emergency not yet liquidated and not an ordinary expense of the National Government. Senator F L A N D E R S . T O put that concretely—you spoke of being concrete—does that justify that part of the deficit for the coming year? M r . EUML. M y personal answer is that it does i f it is financed by the sale of savings bonds to the public net, because that would be deflationary debt management and would have the equivalent effect of taxation, except for one important exception—namely, that the payment would be over the period of the life of the bonds and their refunding rather than out of the current year's income. Senator DOUGLAS. I suppose there is one exception you would want to make to that—although perhaps you would not. The amount devoted to the purchase of these E bonds, the net addition to the total amount of savings, would this not be a diversion of at least a portion of savings that would otherwise be made for private purposes and placed i n the bonds ? M r . EUML. I t almost certainly would be a diversion in part. I n other words, you would have to allow some elbow room in the picture to get your complete effect. But, on the other hand, so also w i l l there be some savings made out of these life insurance premiums, so that it is not all net expenditure either. A l l you can do is come to some practical judgment as to the consequence. M a y I mention one other concrete example that occurs to me where this alternative principle might be used? That is in the question of the expenditures for Fanny M a y ( F N M A ) of taking over mortgages that presumably w i l l be paid off someday. I t seems to me quite discussable as to whether those should not be refunded by deflationary debt operations rather than be covered out of this year's taxes. Those are the types of considerations that give us a great deal of pause, which really make us have this humility that is referred to, because the consequences of these policy decisions are so vast i n terms of what might happen to the tax structure. M r . WOLCOTT. W o u l d you suggest, M r . Euml, that the insurance premiums be refunded i n the form of interest-bearing nonnegotiable certificates, perhaps ? M r . EUML. Yes. M r . WOLCOTT. O n the chance that most of them would have been kept as savings and not immediately liquidated ? M r . EUML. O n the basis of our past experience, yes. M r . WOLCOTT. Such as the veterans' bonus certificates, I believe. M r . EUML. But I want to say again that these are strictly personal views, and I am very grateful to M r . Thomson for having permitted me to make that statement, because I feel much happier about getting my views on the record. M r . THOMSON. I want to emphasize what M r . E u m l said, and that is that the illustration of the way of handling it does represent one of the points of view that is discussed and is a proper subject for the Monetary Commission. M y only personal views are that, one, we have not studied the question; two, we are concerned about the present situation of deficit financing at a time of high level employment; and, three, I would like to explore more carefully with more information than I have now as to the volume of these so-called nonrecurring ex- 291 MONETARY, CREDIT, AND FISCAL POLICIES penditures that seem to be more or less current, before I make a decision ; but it is one of the points that is raised and is a proper subject, in our opinion, for consideration by the Commission. Senator F L A N D E R S . I would like to raise a question or two about F a n n y M a y ( F N M A ) . Now, the expenditures for purchasing these mortgages by the R F C would appear, would they not, in the cash budget ? Mr. RUML. Yes. Senator F L A N D E R S . S O that, appearing in that cash budget, they have the economic effects which you assign to the situation so far as the cash budget is concerned. There is another type of double budget which is under consideration. This may perhaps lead to a triple budget. T h a t is the investment budget. I t seems to me that, i f there is any case i n which the investment budget is justified, "Fanny M a y " would be the case, because the investment is one which w i l l result in the profit to the Government; the investment is justified from a strictly business basis. The degree of risk i n it is small on the basis of past experience or any future expected experience. So that, i f we begin to talk about an investment budget, that is one of the items which I think, on a strictly business basis, might well appear i n it. I do not want to raise the question of the investment budget and the expenditure budget at this time, but I do feel that it is perhaps the best case you can add to this as an example of a valid governmental investment, but it does have the economic effects that you attribute to the cash budget. NATIONAL COMMISSION M r . T H O M S O N . There are, of course, a great many other questions that should be raised. I have, for example, not talked at. all about organizational matters, such as the possibility of f ormalizing the cooperation between the Federal Reserve and the Treasury. I have not raised any of the questions that arise from the fact that the United States is part of a world economy and not a closed economy. We are talking about an area in which the questions still outnumber the answers. This brings me to the recommendation on which I shall close. Last year our committee recommended the establishment of a temporary commission on national monetary and financial policy to make a comprehensive study of the possibilities of improving the structure and policies of monetary, budgetary, and related institutions. Similar suggestions were made by other groups. W e were very much encouraged by the establishment of this subcommittee, by the quality of its membership, and by the workmanlike way in which it has approached its task. W e think the materials assembled by this subcommittee w i l l be invaluable i n pointing out the main questions and laying the basis for the comprehensive study we recommended. Now that such a good start has been made, it would be folly not to follow it up. H o w long a thorough study would take, I don't know. Probably 2 or 3 years would not be an overestimate. I n any case, as much time as is necessary should be allowed. W e think the membership of the commission should extend outside of Congress. 292 MONETARY, CREDIT, AND FISCAL POLICIES These are people i n the administration who have much to contribute, not as witnesses merely but as active collaborators. Also, outside the Government there are people whose wisdom and experience should be brought directly to bear on these problems. A f t e r all, my good friend R a l p h Flanders could have made a major contribution to this study 3 years ago, when he was not yet a Senator. I might say, i f you let R a l p h retire, we w i l l put him back on the committee. I don't think we can find another R a l p h Flanders. But there may be three or four private citizens who together make nearly his equivalent. F r o m a broader commission I think you would get not only somewhat better answers but also more attention paid to the answers, which is very important. I think you for your courtesy i n hearing me at such length on this difficult subject. Senator FLANDERS. M r . Chairman, may I rise to a point of personal privilege? I may say that I have looked upon my connection with the C E D as a very valuable course of adult education, and I think that is about all that I can claim for it, and I do not think I am educated yet completely. This process that the C E D goes through is rather complicated and time consuming, and is, I think, the greatest project i n adult education among both businessmen and economists that has been undertaken. A l l the credit I want to claim is that of having pursued that process of adult education assiduously over a period of years, but I do not think a diploma is yet ready for anybody. M r . T H O M S O N . I would like, i f it is satisfactory, to give M r . R u m l a chance to make any comments. H e has been listening and may have comments. M r . RUML. I am afraid I have spoken a good deal. I would like to just briefly touch some of the high points i n the report you have already read. I would like to emphasize the fact that we distinguished between three different budget policies and accepted one and rejected the others. Senator DOUGLAS. The others? Mr. RUML. Yes. Senator D O U G L A S . I think you took number three, but you also took a portion of number two. M r . RUML. I would not be so stubborn as to deny that i n periods of depression the stabilized budget policy which we advocate has i n it strong compensatory mechanisms, but there is a necessity for a distinction because the extreme position that was taken i n the thirties as to the possibility of using Federal expenditures and perhaps taxes to even out the economy is quite a different measure from introducing built-in stabilizing influences that do not require either legislative or administrative discretion. Particularly we reject the policy that requires an annual balancing of the budget, because we know that, i f business falls off, the only way to balance the budget is to raise taxes, and the only thing you are going to do then is make it f a l l off more, and then you w i l l have to raise taxes some more, and then in the end you w i l l have to abandon the policy, and you might as well abandon it i n the first place. I t w i l l save time and headaches. 293 MONETARY, CREDIT, AND FISCAL POLICIES I call attention to the exceptions again of the stabilizing budget policy. They are not exceptions; they are parts of the policy, actions for exceptional circumstances. Senator DOUGLAS. Compensatory modifications of the policy. M r . RUML. One is and one is not. Yes; the first exception is how to behave under conditions of extreme deflation or inflation. T h e other is how to handle the extremely difficult problem of nonrecurring expenditures and also how to handle this new question that is now becoming so important, the question of investments that have an inflationary consequence. These things must be part of any over-all program. Let me leave that for a minute and refer to the administrative measures that are necessary to make any policy work, whatever policy you adopt. First, on the side of the executive branch, my good friend Tom McCabe, in testifying before this committee, said that good friends would always be able to work together, and I am sure that is true. O n the other hand, I think it is a good thing for them to have minutes of their meetings so that their successors can find what the causes for their actions were. I therefore believe that some modification with recognition of contemporary events should be made of the short-lived Fiscal and Monetary Advisory Board that was created in 1938 and lasted, I think, for 4 weeks into 1939. The record of that Board is quite extraordinary i n showing both the difficulties of getting cooperation among independent agencies and also the extraordinary power they have when they cooperate. I believe it would be worth while to note that, and I spoke to T o m McCabe about it, and he said, " B y all means take exception to my friendship plan, i f you please," and so I do. I think something more formal than that is necessary i n the executive branch. I n 1938 we brought together—I say "we" because I was working with M r . Delano at that time i n the National Resources Planning Board—the Secretary of the Treasury, the Director of the Budget, the Chairman of the Federal Reserve Board, and the Chairman of the National Resources Planning Board. The Resources Planning Board is now extinct; there are new agencies that have been set up. W e note the actions of the National Advisory Committee and find it to be an extroardinary example of interagency cooperation. Senator D O U G L A S . D O you favor the Hoover proposal for a National Commission on Monetary Policy composed of the chief officers of the Government to deal with such matters ? M r . R U M L . I think it would have to be broader than that, M r . Chairman. I certainly would refer questions of debt management i n principle and also questions of taxes i n principle for recommendation. Senator D O U G L A S . T O the Council as a whole and not to the Secretary of the Treasury ? M r . RUML. T h a t would be the conception, not that they would have power of decision, but they would have power of discussion and coordination and reference to the President i n case of a serious dispute. I do not know what should be recommended on that. That probably would be another study. The other administrative measure would be that something needs to be done on the legislative side to see that there is brought together 294 MONETARY, CREDIT, AND FISCAL POLICIES the over-all problem of expenditure and taxation and the consequences of actions in either area. The Congress has had before it recommendations along those lines. I have nothing to add. I do not even know that I can do more than simply say that, in moving into a world where you have this vast debt and vast expenditure and vast taxation, with the consequences of policy i n taxation on the lives of people, I really think that something more is needed to tie the activities of the legislative branch more i n harmonj each with the other, the executive branch more i n harmony, and the channel of communication between the two. I think that is all I have to say, M r . Chairman. Senator FLANDERS. M r . Chairman, I had passed over my shoulder by some person unknown to me this little note, which I would like to read. I think it is in the interest of peace and harmony. Is it correct to say that, i f you remove action on the basis of forecasts from a compensatory budget policy and act only after an economic trend becomes clear, as recommended by the 15 university economists at Princeton, you approach the C E D ' s proposal of a stabilized budget policy ? M r . EUML. Yes; with one addition, which I am sure the author would have put in i f he had recalled it, and that is that the program within the area of small fluctuations should have as an essential part some built-in flexibility. T h a t would have to be part. T h a t would be the essence. There must be some flexibility in the program that does not require administrative or legislative action. M r . T H O M S O N . I would like to indicate that what M r . E u m l said about better procedure on the part of Congress is covered in our statement, T a x and Expenditure Policy for 1949, on page IB. T h a t w i l l give you a reference to it. Senator FLANDERS. There was one point raised by the Princeton people, and that was the possibility of formula flexibility. That apparently has not been i n the recommendations of the C E D . M r . T H O M S O N . I think, Senator, that would be covered in our general statement that you cannot consider this as an automatic device, that it is something which has to be used with judgment and with all the facts before you. I take it that would provide for the flexibility they had i n mind. M r . EUML. I t is a little more serious than that, and we shall undoubtedly have to consider it, but for myself I have always felt it rather impractical that Congress or the Executive would delegate to some operating board or committee the type of powers that would be necessary for built-in flexibility, because, as this report indicates, these powers involve changing the withholding rate on the income tax. I t seems to me that hardly any formula could be set up that would cause you to refer that to an executive agency or even a board like the Federal Eeserve Board. I t w i l l have to be studied. T o say it is politically impractical really is no answer. M r . W O L C O T T . Y O U have not forgotten my question on excise taxes, have you ? M r . EUML. Again, I am not speaking for the C E D . I am speaking for myself only. I think that, to discuss excise taxes, it is absolutely necessary to define what we are talking about, because there are three areas of 295 MONETARY, CREDIT, AND FISCAL POLICIES excise taxes that must be distinguished: No. 1 is the excise taxes as a whole, including gasoline, alcohol, and tobacco. I think that the situation from a public-revenue point of view on gasoline, tobacco, and alcohol is sufficiently distinct so that those taxes can be removed from consideration from the rest. Senator DOUGLAS. W o u l d you remove the taxes or merely separate them ? M r . RUML. They should be considered separately. I f you take all the rest, there is another distinction, and that is the excises we have used traditionally prior to the war as a means of getting revenue, and the excises and rates that were put on i n 1941 and 1943. Now, what I want to do next is to remove from consideration everything except the excises that were put on i n 1941 and 1943 for wartime purposes, excluding gasoline, alcohol, and tobacco. Senator FLANDERS. Did. you give us an example of the second group you wish to exclude ? M r . RUML. The second group that I wish to exclude—there was an excise tax, I believe, on automobiles prior to 1941. There was a tax on oleomargarine prior to 1941. Senator F L A N D E R S . W i l l you please avoid discussing that? M r . RUML. That is why I hesitated. Senator F L A N D E R S . G O directly to your third group now. M r . RUML. These taxes I am talking about have one thing i n common. They were put on during the war for punitive purposes against certain particular types of consumption and types of production. They were put on there to save materials, to save labor, or because it was presumed that a good moral influence on the war would be had, such as the tax on admissions to cabarets, et cetera. Now, then, it seems to me that this bundle of taxes should be repealed as being contrary to a nondiscriminatory tax position for peacetime. It also seems to me that, after they are repealed, the revenue consequences of the repeal should be studied to see i f anything needs to be done, because I have a feeling, having observed what has happened to the fur industry i n New Y o r k and the jewelry industry i n New England and the leather goods industry, et cetera, that the net loss of revenue will be much less than what would appear to be the gross loss. I n other words, there w i l l be taxes on manufacturers' profits, taxes on retail profits, taxes on withholding taxes, on employees' income, a lessening on out-payments on unemployment insurance. I f I may go back, I think by taking these punitive taxes as a group they should be repealed as being contrary to a peacetime policy of taxation, and that after that is done the revenue effects should be appraised to see what, i f anything, needs to be done to make up for loss of net revenue. M r . W O L C O T T . H O W would you fit that into our discussions with respect to a compensatory budget policy or stabilizing budget policy? W o u l d you give consideration i n these budgets to the renewal of them under certain circumstances? M r . R U M L . I would consider this, sir, just as the community-property reform was considered. That is, the correction of an inequity which has prior consideration to revenue consideration. This thing should be done, because the employees of these industries and their 296 MONETARY, CREDIT, AND FISCAL POLICIES families have done nothing wrong to justify the punitive action taken against them. H a v i n g done that and having come to a figure that represents the net loss, I would then say: "Is this so large that we cannot absorb it? Must we find revenue from some other source ? W h a t should we then do about i t ? " M r . W O L C O T T . A S I understand it, i n respect to a consideration of a budget, whether under the compensatory system or stabilizing system, you eliminate these punitive taxes altogether? M r . RUML. Or even under the annual balanced budget. I think under any policy they have no place in a peacetime scheme of taxation. M r . WOLCOTT. T h a n k you. M r . THOMSON. I might add I w^as glad to have M r . R u m l make that comment, because he has studied the subject so definitely, and he is expressing his viewpoint. A s chairman of the committee, the committee has i n mind that they are going to bring out a tax-policy statement i n January, and that one of the subjects we w i l l deal with is this matter of excise-tax removal i n part or in total, and we have said so far that our tax-policy statement for January w i l l be considered i n terms of the C E D ' s previous policy statements. So I am not saying at this time whether the committee w i l l agree with M r . R u m l or not, but we are working on it and we w i l l have a statement i n January that w i l l deal with that subject. M r . WOLCOTT. I am glad to have these statements, and I w i l l have to explain that they are somewhat personal and perhaps a little selfish on my part. However, I do not think my mail on the subject is any different from that which other Members of the Congress are receiving. I think perhaps I have more information now upon which to base an answer to the complaints against the baby-oil tax and the cosmetics tax, which come v/ithin that category. M r . R U M L . I did make it clear that I was giving my personal views, did I not? M r . THOMSON. Yes; you did. Senator DOUGLAS. I f I may question you about your personal views for a minute, suppose it were to be found that by the reduction of these excise taxes you caused a very severe reduction i n revenues and contributed to the governmental deficit in a period of high employment, and therefore added to inflationary pressures. Wouldn't you regret, as a citizen of the country, that you had offered this advice to the Congress and led them down a path which later turned out to have bad results? Mr. RUML. NO. Senator DOUGLAS. A n d wouldn't we regret having been led down that path ? I would. Senator FLANDERS. I would not. I would rather get the taxes some other way than that way. M r . RUML. M r . Chairman, I think that is the whole point of this business. I f you have an unjust and inequitable tax, the thing to do is get r i d of the tax and then decide what you are going to do to have an equitable system of revenue rather than perpetuate the wartime legacy that is unjust to towns, communities, and families, and has nothing to do with the current needs. 297 MONETARY, CREDIT, AND FISCAL POLICIES Today most of our unemployment, or a great part of it, is in these affected industries—it was last summer. There are no public works I know of that can give employment to fur workers and jewelry workers and leather workers and cosmeticians. Senator FLANDERS. They would not make good cement mixers. Senator DOUGLAS. M a y I raise a question? Y o u mentioned the liquor industry. Y o u say you would not favor reducing the taxes on liquor; but, as I remember it, the taxes on liquor were increased during the war. I was not here, but I believe they were trebled. A n d i f you say that the imposition of these fresh taxes on the items that you mentioned w^as a war measure, which should be discontinued as soon as possible, would not the same line of reasoning lead you to a reduction i n the very high liquor taxes ? A n d it may be argued that distillery workers do not adapt themselves very readily to other occupations. Senator FLANDERS. A r e they not as well employed as they were before the war ? Senator D O U G L A S . I am asking M r . R u m l whether he is going to remove the wartime increases on liquor as well as the fresher portion of the imposition of war taxes on leather goods, jewelry, and furs. M r . RUML. M r . Chairman, I think I was quite precise i n my original statement, not that I would not reduce the taxes; I would not consider them in this package, because of the Senator DOUGLAS. They are to have secondary treatment ? M r . RUML. That is right, because of many secondary considerations of a moral, ethical, and perverse character. Senator D O U G L A S . I think you have lingering traces of prohibition inside your moral consciousness. M r . WOLCOTT. I f M r . R u m l has the figures, it might be helpful for the record i f we could have the amount of revenue which is being received from those three different categories. M r . R U M L . I have three estimates which differ so widely that I trust none of'them; and, i f I might be excused, I can give you their orders of magnitude. I t is some place between a gross of about $1,700,000,000 and $2,500,000,000. W h a t is included, what is excluded, what estimates are made on the volume to occur i n 1950, are all bases for variation, and all I can say is it is within that gross. What the net is, I do not really feel that I ought to even try to make an estimate. W e are going to try—not the C E D , but another group—to make a study to see i f we can present to the Congress i n January or February an honest estimate on this extraordinarily difficult question as to what the net loss might be. M r . WOLCOTT. Can we assume the major part of that revenue comes from the first group of liquor, tobacco, and gasoline? M r . RUML. Excluding that altogether. This is only the package of the wartime rates and taxes excluding tobacco, gasoline, and liquor. M r . W O L C O T T . They vary between $1,700,000,000 and $ 2 , 5 0 0 , 0 0 0 , 0 0 0 ? M r . RUML. That is gross. W h a t the net is, I do not know, but less than that. Senator D O U G L A S . Y O U may be able to throw away $ 1 , 7 5 0 , 0 0 0 , 0 0 0 or $ 2 , 5 0 0 , 0 0 0 , 0 0 0 i n this free-hearted gesture; but, much as I would like to be a public benefactor to these industries, I find a certain reluc- 298 MONETARY, CREDIT, AND FISCAL POLICIES tance i n abandoning these sources of revenue until we know what other sources of revenue we could get. I f our aim is a balanced budget—and some of us are trying as best we can to get it balanced—to throw it out of kilter by a reduction of $1,700,000,000 or $2,500,000,000 M r . WOLCOTT. I t would be offset somewhat by an increase in employment i n those fields and an increase i n production. M r . RUML. I f I may say so, M r . Chairman, I hope you w i l l not decide an issue until after the estimates are in hand, and then you can seQ whether the estimates are good and what alternatives there are. There is an inequity here hanging over from wartime, which ought to be gotten r i d of i f we possibly can. Senator D O U G L A S . I would agree, but I think we ought to count the cost before we take final action. M r . RUML. That is right. M r . THOMSON. I said the C E D Committee is studying the question, and our idea is to make recommendations on that and other questions i n line with our budgetary policies. Senator D O U G L A S . W e want to thank you for this very valuable presentation, which I think we have all enjoyed. W e w i l l shortly be working on the budget for fiscal 1951. W h a t concrete adjustments would you recommend i n the light of this general policy which you have outlined ? M r . THOMSON. That again I would have to defer and tell you we are working harder than we have usually worked to get a statement out i n January dealing specifically with the 1950 situation, but we are not prepared to make our statement now. Senator DOUGLAS. W o u l d you like to make a personal statement ? M r . T H O M S O N . I think not. I have a strong feeling that the chairman of the committee should not anticipate what a very good and capable committee is going to decide. Senator DOUGLAS. W h a t about the vice chairman? M r . RUML. I n spite of the fact that I have been free i n expressing my opinion on general matters, when it comes to something specific about budgets for fiscal 1951, and now it is almost the 1st of December and we w i l l have that recommendation the first part of January, I think I am bound by courtesy to the committee to reserve what I have to say until the committee reports. Senator D O U G L A S . W e thank you very much for your appearance before the subcommittee and for your interesting contribution. M r . T H O M S O N . W e thank you very much and hope we made some contribution. (Whereupon a recess was had at 12:10 p. m., to reconvene at 2 p. m.) A F T E R N O O N SESSION Senator DOUGLAS. Ladies and gentlemen, I wonder i f it would not be better i f we came to order. W e had invited M r . E m i l Rieve, who is president of the Textile Workers U n i o n of America, and vice president of the C I O , and administrative chairman of the C I O f u l l employment committee, to testify this afternoon. M r . Rieve is unable to be present, but he has sent a statement which w i l l be read by two of his representatives, M r . Stanley H . Ruttenberg 299 M O N E T A R Y , CREDIT, A N D FISCAL POLICIES and M r . Everett M . Kassalow, and we would like to have the statement read. I assume that you w i l l be ready to entertain questions at appropriate points during the reading of the memorandum. M r . Kassalow, w i l l you read the statement % STATEMENTS OF E V E R E T T M. KASSALOW, EXECUTIVE SECRETARY, CIO F U L L EMPLOYMENT COMMITTEE, CIO; AND STANLEY H. RUTTENBERGr, DIRECTOR OF EDUCATION AND RESEARCH, CIO M r . K A S S A L O W . I should like to say that M r . Rieve was sorry he could not be here today. H e has followed very closely the workings of the Employment A c t and the activities of the joint committee, but he was detained in New Y o r k this afternoon. [Reading:] I do not appear before this subcommittee in the role of a fiscal or monetary expert. Y o u r subcommittee already has received statements, written and oral, f r o m many Government officials who are certainly f a r more learned i n the techn i c a l aspects of this subject than I or the C I O f u l l employment committee of w h i c h I am a member. L e t me add, however, that this particular C I O committee was formed immediately after passage of the Employment A c t of 1948 for the specific purpose of enabling C I O to develop policy and shape support to carry out the broad mandate established by this act. W e are, therefore, extremely interested i n the activities of the Joint Committee on the Economic Report, which, like our committee, is a k i n d of child of the Employment Act. Consequently, we welcome this opportunity to testify, if even only to present general views on fiscal and monetary policy. Our own consideration of th£ Employment Act and the policies w h i c h can bring about its successful operation have convinced us that there is no more important single area for bold Government action than i n the fields of credit, fiscal, and monetary policy. A s a nation we have come a long distance from the 1930's when a national debt of $25,000,000,000 or $80,000,000,000 and an annual deficit of $3,000,000,000 or $4,000,000,000 looked like a catastrophe. Economically speaking, we are living i n a new climate. I n the space of less than 12 years our national debt has grown 7 or 8 times over. Yet, i n spite of a debt of $250,000,000,000, I don't believe there is much disagreement w i t h the fact that as a nation we are stronger economically today than ever before. A s a nation we have learned that fiscal problems such as the size of the debt, taxes, and F e d e r a l budget surpluses or deficits cannot be considered as entities unto themselves. They can only be regarded intelligently i n relationship to the Nation's total income i n a given period as w e l l as its prospects for economic growth and development. I say that as a nation we have learned this, and let me add that we i n the labor movement are frank to admit that much of the fiscal experience of the past decade has been eye opening and highly educational for us. W e like to believe other groups have undergone similar education, and we hope the joint committee can do something about extending a broader understanding of Federal debt problems. Consider, for example, that our national debt today of 250 b i l l i o n dollars has an annual interest-carrying charge of 5% billions. T h i s interest charge is more than five times the 1939 level, but it shapes up against a current national income of 230 billion dollars compared to national income i n 1939, to choose a so-called normal prewar peacetime year, of 72 billion dollars. T h e level of current interest payments on the debt is referred to here because we think i t is a matter too easily overlooked. I n at least a limited sense, the real burden of the debt is the annual c a r r y i n g charge. L e t me remark, aside, that we recognize that the size of the debt itself as w e l l as the kinds of annual deficits it has involved creates other problems and is not an unmixed blessing, but we shall discuss budget balancing and related questions later i n this testimony. Getting back to the c a r r y i n g charges, we cannot help but be struck by the fact that a more than fivefold increase i n annual Federal interest payments doesn't seem too serious a load i n the light of the 180-billion-dollar increase i n national income over the same period. E v e n i n real terms, national income is 300 MONETARY, CREDIT, AND FISCAL POLICIES up over 100 percent. Obviously this great rise i n income has raised the tax-bearing capacity of the N a t i o n and thereby makes the c a r r y i n g charge of 5% b i l l i o n dollars i n interest much less of a burden t h a n even the 1-billion-dollar charge was i n the late thirties. Senator DOUGLAS. M a y I interrupt ? F i v e and a half billion is approximately 2y3 percent of $230,000,000,000 of national income, A $1,000,000,000 interest charge upon a national income of $72,000,000,000 would be 1.4 percent. So I think you do well to point out that the increase i n the carrying charge, as a percentage of the national income, has not increased as much as the gross amount of the debt would indicate; still it does seem to be an increase from 1.4 percent of the national income to around 21/3 percent, which is an increase. M r . K A S S A L O W . I would agree that on a strict proportionality basis it was an increase, but we mentioned the fact that Ave think it must be seen i n contact of prospects for growth. S e n a t o r DOUGLAS. Y e s . K A S S A L O W . I wouldn't Mr. ing:] disagree with you on that point. [Read- A s to just where F e d e r a l fiscal policies fit into this great growth i n income, w h i l e there were undoubtedly many economic influences at work, our own analysis convinces us that the wartime F e d e r a l spending was the i n i t i a t i n g force that j a r r e d the economy back into f u l l operation and enabled the country to put its idle manpower and resources to work. T h e result was a record flow of both w a r a n d nonwar goods. Moreover, the lasting favorable effects of these huge F e d e r a l expenditures have undoubtedly contributed to the high levels of postwar economic activity. H u g e wartime-created accumulations of cash i n the hands of both consumers a n d business provided an unprecedented peacetime demand for the products of f a r m and factory i n 1946, 1947, 1948, a n d even i n 1949. I t may w e l l be that, when historians come to assess the role of Federal spending i n the past decade, they w i l l conclude that, w i t h a l l its shortcomings and dangers, its major significance l a y i n the fact that i t furnished the leverage w h i c h moved the economy off the dead center i t h a d hit i n the stagnant thirties. Once under way, the basic strength w h i c h was inherent i n the system but h a d remained dormant f o r over a decade came into play. L o o k i n g back, it seems p a r t i c u l a r l y unfortunate that this spending, so f a r as many of the goods produced were concerned, had to be of so largely a wasteful, w a r l i k e character. Can anyone here conceive w h a t our instruments of health, welfare, and education, to choose but three, might be today i f the two-hundredodd-billion-dollar debt had been poured into more useful channels ? L e t me make one final comment on the positive side of this debt question. I don't pretend quite to understand a l l the mysteries of the F e d e r a l debt and budget deficits; perhaps, therefore, some member of this subcommittee can tell me w h y is it that when a private utility company floats a bond issue and uses the funds thus obtained to b u i l d a new power plant or a series of transmission lines, i t is entered on the books as an asset; yet, when a Government agency, a T V A or the like, borrows money and does the same thing, i t becomes an all-terrible public debt, w i t h nothing good to be said for it. Senator DOUGLAS. I n other words, you would suggest having an operating budget and an investment budget to differentiate the amounts which are spent for current purposes from, those which are used to build up capital investment ? M r . K A S S A L O W . I believe that i n an earlier period we made such a recommendation, but it strikes me that this is more than simply a technical problem or one of semantics; it is a matter of concept. I t is unfortunate that the notion of varying types of Federal expenditures is not sufficiently differentiated i n many people's minds. Senator DOUGLAS. W h a t you are saying is that some Federal expenditures are highly productive, even though they involve the operation of a deficit? 301 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . KASSALOW. Yes. I agree that the division of the budget into the two categories you suggested might serve a very educational purpose. [Reading:] W h i l e I have here emphasized w h a t might be called the positive aspects of F e d e r a l monetary, fiscal, and credit policy, types of spending that under certain^ conditions may help raise levels of national income and output, I hasten to add that we i n C I O believe that the application, i n reverse, of s i m i l a r fiscal tools can also help check inflation and prevent w i l d booms. W e believe, f o r example, that the F e d e r a l surpluses piled up i n the years of 1947 and 1948 certainly reduced the force of inflation and lent additional stability to the economy. T h e S E C Act, to cite another phase of F e d e r a l fiscal policy, has also been a healthy, restraining influence d u r i n g the past 3 years. Another c r i t i c a l phase of F e d e r a l fiscal policy is the t a x field. I might add, we didn't go into taxes very substantially because we didn't want to add to the length of the statement, but we would be glad to answer questions on that. That is a related fiscal policy. M r . Ruttenberg is the secretary of the CIO's tax committee. [Reading:] Indeed, i n our judgment, one reason w h y F e d e r a l deflationary policies were not entirely successful i n the immediate postwar years was because of some bad tax legislation that was passed. These bad tax c h a n g e s — w h i c h we opposed,, incidentally—helped b r i n g on serious inflation and ultimately greased the skids for the current recession. If, for example, the excess-profits t a x h a d been r e t a i n e d on the statute books, there is good reason to believe inflation w o u l d have been lessened. B y the same token, the ill-timed, ill-staged income-tax b i l l of 1948 undoubtedly f e d the fires of demand at the worst time. But, i f anything, these past mistakes only point up the general conclusion that proper F e d e r a l fiscal monetary a n d credit policies can help to stabilize the economy. These types of F e d e r a l activity, incidentally, have special added attractions^ F o r example, they f a l l clearly into the realm of accepted Government responsibility. Not even i n this day and age of the attack on the w e l f a r e state w o u l d many question the F e d e r a l Government's right to use these policies, i n keeping w i t h its powers of regulating the value of money and credit under the Constitution. Another compelling reason that leads us to put so much reliance on these policies is that they are exercised on a very broad general plane. They can help guide the general movement of the economy, but they do not, by and large, extend to i n d i v i d u a l industries and workers. Thus, they fit into the accepted A m e r i c a n t r a d i t i o n of leaving fundamental areas free for action by i n d i v i d u a l companies, unions, and consumers. M u c h of what is unique and dynamic i n the A m e r i c a n economy can continue to function and grow i n the face of well-executed F e d e r a l fiscal and monetary action. Senator DOUGLAS. M a y I interrupt? W h a t you are saying now is substantially what the Committee for Economic Development said this morning and what the president of the Philadelphia Federal Reserve Bank, M r . Williams, said last week—that the Federal Government should use, primarily, indirect controls to regulate the total quantity of money, credit, the general price level, and so forth, but that the matter of individual adjustment be left to competition and to the market rather than the exercise directly by the Government ? M r . KASSALOW. Well, we w i l l agree generally with that provision. A s we indicate later on, we don't believe that fiscal policies are by any means sufficient. [Reading:] F o r these reasons, we believe that this subcommittee w o u l d be w e l l advised to give sympathetic consideration to proposals to strengthen these policies and the agencies exercising them. F o r example, we are not prepared to say ourselves precisely what should be done about bringing the seven-thousand-odd commercial banks w h i c h are not members of the F e d e r a l Reserve System under the general jurisdiction of t h e central banking system. Whether membership i n the System should be com99076—50 20 302 MONETARY, CREDIT, AND FISCAL POLICIES pulsory or whether the mere requirement that a l l banks must observe the reserve ratios established by the F e d e r a l Reserve System w o u l d be sufficient, we don't pretend to know. W e sincerely hope, however, that this subcommittee w i l l see fit to recommend either of these lines of action, whichever it judges best, to make our banking structure more rational. Senator DOUGLAS. But you think that one or two others should be adopted, that others shouldn't be left as they are now ? M r . KASSALOWt. That is right. Those, as we understand it, have been the major proposals to accomplish that general end. [Reading:] W e think Congress' f a i l u r e to renew the F e d e r a l Reserve Board's consumer credit was an appalling mistake. Clearly this was a F R B h a d justified its existence. Of course, there w i l l be periods when it necessary to exercise it, but this is one of those flexible fiscal powers be available for use when necessary. power over power that may not be that should Senator DOUGLAS. M a y I interrupt there? The continuance of regulations on consumer credit was attacked by some on the ground that it would be unfair to unduly restrict the ability of low-income groups to command durable consumer goods, who were able to borrow on mutually acceptable terms from the consumer-goods financing institutions. I gatner that you do not agree with that criticism, and I think it would be informative for the sake of the record i f you would state why you do not. M r . RUTTENBERG. M i g h t I comment on that ? It is generally the people who have i n the past shown no regard for the welfare of the low-income individuals who make the argument which you quote; it comes from people who oppose the extension of Regulation W . I n other words, they show their tremendous interest in the welfare of the low-income people by saying we ought to permit them to become so indebted that they can't get out of it, and they might even lose the products they buy because they have gone into the consumer credit market to buy them. W e take the position, and the very strong position in which wTe have supported Regulation W from the beginning that it is a power and authority which ought to exist to be used i n times of inflation to curtail expenditures of durable and hard goods production. Senator DOUGLAS. Have you given any thought to the desirability of requiring concerns which sell on the installment plan to state what the interest rate is which they are charging on unpaid balances ? There is a concealed rate, of course, i n all installment purchasing, and frequently that concealed interest rate, I found i n the past when I looked into the matter, was very high. W o u l d you favor requiring, as one of the conditions of installment sale, a statement—not necessarily a regulation, but a statement—as to what the interest rate actually is which the person buying on the installment plan pays ? A n d furthermore, to have that interest rate computed on the unpaid balance, which is what the purchaser owes ? M r . R U T T E N B E R G . I think that is an excellent suggestion, and your committee, I think, could do considerable good service i f during the course of your report you point out and analyze just this question of interest rates on consumer buying. O f course, it relates to the whole field of the Small Loans Act. S e n a t o r DOUGLAS. Yes. M r . RUTTENBERG. Actually efforts have been made in past years to get the Congress to take some action i n the field of small loans, and,. 303 M O N E T A R Y , CREDIT, AND FISCAL POLICIES of course, they haven't. B u t regulation over that whole field, or at least pointing up the problem in an educational way, w i l l go farther toward accomplishing something useful than any other measure i n this field of consumer loans. The general charge is made that workers buy regardless of the situation. That is generally true. Sometimes it might be well to help them understand the problem they are getting into in terms of high interest rates they pay and i n terms of what w i l l happen to the products they buy i f they default on payments. Senator DOUGLAS. I know some years ago I looked into this matter and found in a great many cases of installment selling that the interest rate was never mentioned, and when the interest rate was mentioned it was commonly stated as a percentage of the original figure whereas it should have been at least twice the rate of interest on the unpaid balance. M r . RUTTENBERG. O f course, the interest rate is always figured on the original balance, not the unpaid balance. Senator DOUGLAS. The proper analysis is on the unpaid balance, which is that which the purchaser owes the seller or the borrower owes the lender. M r . KASSALOW. Or, I suppose, the rate at which the lender refinances it. M r . R U T T E N B E R G . I think it might be well to suggest that another worthy service which your committee could perform would be an analysis of the existing Small Loans A c t as it applies to this whole field of consumer lending. Senator DOUGLAS. Thank you very much. M r . K A S S A L O W (reading) : These are details, however, and we prefer to rest this testimony on the broad needs for adequate Federal fiscal, monetary, and credit policy and actions. N o statement on fiscal and related policies can avoid the question of budget deficits and budget balancing, particularly at the present time, when the current budget deficit has been a subject of such great controversy. I have earlier referred to the fact that we by no means see large deficits or a growing F e d e r a l debt as an unmixed blessing. Indeed, w h i l e we pointed out how Federal spending helped move the economy off dead center, we appreciate the fact that this k i n d of stimulation provided by liberal F e d e r a l fiscal, monetary, and credit policy can only be effective i f it isn't a steady k i n d of dosage. No one would recommend the huge F e d e r a l spending of the forties as a steady diet. Moreover, the growing burden of interest charges does raise some serious questions as to income redistribution. A n internally held F e d e r a l debt—that is, one owned p r i m a r i l y (as is the status of our current national debt) by the people of this country—is not like an ordinary private debt. B r o a d l y speaking, i t is something we owe to ourselves and the interest payments on it don't constitute a real d r a i n i n g off of wealth f r o m the Nation. T o the extent, however, that the debt is held by any particular economic group, it makes for an unfavorable flow of income to that part of the economy. Progressive taxation may mitigate this unfavorable flow of interest payments and income distribution, but the problem of trying to hold down the size of the debt in order to keep the level of interest payments as low as possible remains. Then, too, we have always taken the position that waste i n Government can no more be condoned than waste i n private industry—and we realize there is plenty of it i n both. T h e principle of striving, as far as possible, for a balanced budget and a budget surplus, then, appeals to us as a sound economic canon. Senator DOUGLAS. M a y I interrupt at that point ? I am very glad, indeed, to have you make the statement—I think it is very important— namely, that you believe waste i n Government should be reduced, and 304 MONETARY, CREDIT, AND FISCAL POLICIES that the presumption in normal times is probably i n favor of a balanced budget, with whatever meaning you attach to "normal." I f , for instance, it were developed that there were an excessive number of Federal employees, you would not regard it as an antilabor policy i f their number were reduced ? M r . KASSALOW. I think we could agree with that. I f it were a demonstrable form of waste, no one could really defend it. Senator DOUGLAS. I f there were more people i n Federal service than needed to perform the functions of the Federal service. M r . KASSALOW. Frankly, we would be doubtful that you could pose it on such a grandiose scale and decide that there were more people i n the Federal service broadly than needed. I suppose that you could well attack it on the basis of this or that department, or this or that function. Senator DOUGLAS. But, you see, Congress gets lost when they have to search out each individual unit, because of the hundreds and almost thousands of individual units. The question is, Isn't there a general presumption that there probably is an excessive number of persons i n Government employ ? M r . KASSALOW. I f you w i l l forgive a bit of levity, we are opposed to "5 percenters" or "10 percenters," on any kind of operation, but let me explain. I think that kind of broad cut which might be envisaged under a broad attack on this question of waste, i f there is waste, is a regressive kind of action. I daresay that there are some departments where there is waste. W h i l e I don't know all of the details of Secretary Johnson's handling of the armed services, it would seem he found waste. Senator DOUGLAS. H e was trying to save $2,000,000,000 out of a $15,000,000,000 budget. Is it your belief that there are no reductions which could be made i n the civilian budget? M r . K A S S A L O W . I would say that when you get down to the situation where you are trying to impose a 5 or 10 percent cut on a budget say as small as the Labor Department, it is about as regressive as a 2-percent sales tax for the low-income person. Senator D O U G L A S . I S it your assumption that there is no waste i n the Labor Department? M r . RUTTENBERG. I think what M r . Kassalow is saying is that he is using the Labor Department as an example. Senator DOUGLAS. That is right. M r . RUTTENBERG. I f you take the Federal Trade Commission, or the Department of Justice, the Antitrust Division, and try to cut 5 percent out of those Departments, which are now completely inadequately staffed to do a job, they w i l l not be able to carry out their functions. Senator DOUGLAS. Let the record show that I went on the floor of the Senate and advocated an increase in the appropriations for the Federal Trade Commission because I believed that they needed more people to perform their functions, and that I was in favor of an increase i n the number of internal revenue tax agents to diminish evasions under the income-tax law. Isn't there a presumption, however, that most governmental departments are somewhat overstaffed, some more than others—not every department, but nearly every department ? 305 M O N E T A R Y , CREDIT, AND FISCAL POLICIES M r . KASSALOW. There seems to be too many dangers i n that broad approach. Senator DOUGLAS. Have you ever worked for a Government department? M r . KASSALOW. Yes. Senator DOUGLAS. Wasn't it your general judgment that there was excessive personnel? M r . K A S S A L O W . I worked for several Government departments. Senator DOUGLAS. Then you have had quite a wide range of experience. M r . K A S S A L O W . I would say I really couldn't generalize on that point. Senator D O U G L A S . Y O U mean you can't tell on the whole ? M r . K A S S A L O W . N O , sir; because not i n the case of each of the divisions that I worked for would I make the same judgment. Senator DOUGLAS. But i n totality, i f you add them all up, D o you feel that there is ? M r . K A S S A L O W . D O we think that there is a possibility of trimming some of the budget and eliminating some of the waste ? Senator DOUGLAS. Y e s . M r . K A S S A L O W . I think we would agree with that. Senator DOUGLAS. Reducing the number of personnel ? M r . KASSALOW. Yes. The only fear we have is i n a too broad attempt to get at that question. Senator D O U G L A S . N O one proposed, so far as I know, that a 5 percent cut be imposed on every unit, division, section, bureau, or even department. W h a t we did propose was that within a given department a percentage figure cut be imposed and that either the members of the Appropriations Committee or the department itself apportion those cuts. B u t what we aimed at, at least what I aimed at, was a general reduction of some 6 percent i n the number of governmental employees, an average over-all reduction, but distributed differently from department to department, and from unit to unit. I had hoped from the statement that I was going to get reinforcement from you and now I feel my hopes are beginning to be a little bit dashed. M r . KASSALOW. I daresay the only hope we could give you is that we are i n general sympathy with your position, and when specific appropriations are under question we would have our specific positions on them. Senator DOUGLAS. W h e n you start on specific appropriations you always hit somebody's pet bureau or department, and it is always said that that is not the place to make cuts, or the manner i n which you are proposing it is not the proper manner, or that now is not the proper time. So that it is like sin, everybody is against it, as a general principle, but a great many seem to dally on the primrose path. M r . RUTTENBERG. Isn't it the duty of the Appropriations Committees, its subcommittees, to review the budgets of the various departments? Senator DOUGLAS. Yes; but it is not completely staffed, and besides an appropriations committee needs the support of public opinion. M r . RUTTENBERG. B u t this proposal, as it looked to us when it was made during the past session of Congress, was that Congress was attempting to pass the buck to the Executive. 306 MONETARY, CREDIT, AND FISCAL POLICIES Senator DOUGLAS. I think you are confusing the last move that was made, after everything else had failed, with the previous attempts. The previous attempts had been to reduce specific appropriation bills. The last and final attempt was, having failed i n all these efforts, we asked the Executive to do it. I n any event, I take it that the C I O is opposed to waste ? M r . KASSALOW. They are against sin, too. Senator DOUGLAS. W e hope that we w i l l get sympathetic and strong support when the specific proposals to reduce waste are brought forward. Have you thought of any possible ways of reducing waste ? M r . KASSALOW. W h a t about these pork-barrel projects which I think you made a speech about once ? Senator DOUGLAS. I feel very keenly about those. I would like to see them reduced by $300,000,000. M r . KASSALOW. A n d Senator DOUGLAS. A reduction in rivers and harbors. M r . KASSALOW. A n d the substitution therefore of a good conservation program ? Senator DOUGLAS. I would not say you should substitute another, an equivalent $300,000,000 for it. I think we need to reduce the total budget. M r . KASSALOW. One difficulty we have i n focusing on this question is that the appropriations have been quite inadequate over the years. Such as those M r . Ruttenberg mentioned, for the Federal Trade Commission, the Department of Labor, and to some extent Federal Security. Senator DOUGLAS. I think the regulatory agencies, i f they are rigorous, tend to be starved by Congress. I f they are tame they probably can get all the money they legitimately want. B u t I wondered i f you felt that the Labor Department and the Social Security Division have reached a 100 percent efficiency, so that you can effect no reduction i n their personnel. M r . R U T T E N B E R G . Y O U can always improve efficiency, i n the Government, i n an industrial plant, or wherever you go. Senator D O U G L A S . Y O U can get the same amount of work done with fewer people. M r . KASSALOW. W e think fundamentally the things the Labor Department should be doing and is not doing, and the things the Federal Trade Commission should be doing and is not doing, could not be done merely by an increase i n efficiency, whether it was 6 percent or 10 percent. That is not answering you directly but maybe gives some idea of the problem as we see it. Senator DOUGLAS. W e are getting into colloquy, but I have never seen how the protection of underpaid men, women, and children i n factories depended upon the maintenance of an excessive number of highly marcelled stenographers in the Department of Labor. M r . RUTTENBERG. Take a look at the wage and hour enforcement branch. Take a look at that problem. They need far more people i n that department as inspectors i n the field to investigate violations of wages and hours, and unless they get more people the 75-cent minimum which the Congress passed w i l l become totally ineffective. M r . K A S S A L O W . I think the estimate now is that a check is possible i n about every 10 years i n the ordinary establishment. 307 MONETARY, CREDIT, AND FISCAL POLICIES M r . R U T T E N B E R G . They can make only 3 5 , 0 0 0 inspections every year with their present budget. Y o u can't enforce wages and hours with that kind of personnel. Y o u have got to increase it. So that, obviously, where you take it away in certain areas, i n other areas equally important personnel ought to be added. Senator D O U G L A S . I take it the net result is that you do not believe the appropriations for the Department of Labor or the Social Security Administration should be cut, and economies should be made elsewhere ? M r . R U T T E N B E R G . I f we can be shown that economies can be made in the administration of the Federal Security Agency and the Department of Labor, the Antitrust Division, and others, we would be glad to accept them. Senator D O U G L A S . A S to the Antitrust Division and the Federal Trade Commission, I think those in the past have been understaffed. What is your feeling on the Post Office? Should the Post Office approximately pay its way? M r . R U T T E N B E R G . I think the current deficit is approximately $500,000,000 Senator D O U G L A S . Approximately $ 5 5 0 , 0 0 0 , 0 0 0 . M r . R U T T E N B E R G . The Congress doesn't seem to be willing to act on the rates which people must pay. Senator D O U G L A S . I am trying to get your opinion on that. The Postmaster General estimates that the value of unpaid services performed by the Post Office Department to other governmental agencies is about $ 1 5 0 , 0 0 0 , 0 0 0 and he does not propose that those costs should be assumed by the private users of the system, but does propose that the other $ 4 0 0 , 0 0 0 , 0 0 0 be assumed. H e estimates that it costs $ 2 4 7 , 000,000 to take second-class matter, newspapers, and magazines through the mail, for which the Federal Government only gets $40,000,000. There is, therefore, a subsidy of some $ 2 0 0 , 0 0 0 , 0 0 0 on second-class matter; it is $120,000,000 on third-class matter, unsealed advertising matter, i n the main. Do you think those rates should be increased ? M r . R U T T E N B E R G . What is the franking privilege cost? Senator D O U G L A S . F o r Members of Congress ? That is included in the $ 1 5 0 , 0 0 0 , 0 0 0 of unpaid services to other Government departments, for which the Post Office Department grants that the private users should not pay. B u t $ 1 5 0 , 0 0 0 , 0 0 0 from $ 5 5 0 , 0 0 0 , 0 0 0 leaves $ 4 0 0 , 0 0 0 , 0 0 0 as a subsidy of second-, third-, or fourth-class matter. Have you given that subject any thought? M r . R U T T E N B E R G . W e would have to say that we have really not given the subject a careful enough consideration to give any general opinion on it. Senator D O U G L A S . I f that deficit could be reduced, obviously the Government would be put in a sounder fiscal position. M r . R U T T E N B E R G . A n d probably that deficit could be used to develop a real sound welfare program which the Government ought to become engaged in doing. Senator D O U G L A S . A t least to reduce the deficit. Do you think it would be a good contribution to sound budgeting i f the newspapers and magazines of the country would voluntarily come forward with a request that the subsidies be discontinued and 308 MONETARY, CREDIT, AND FISCAL POLICIES that their rates be increased to the point where they would pay for the cost of services rendered ? M r . RUTTENBERG. Shall we answer that i n the presence of all these newspapermen ? Senator D O U G L A S . Yes. M r . KASSALOW. I f they voluntarily did it Senator DOUGLAS. I f they did not voluntarily do it, then what would your answer be ? M r . RUTTENBERG. W e haven't given careful enough consideration to it. Thus far, the C I O has restricted its public utterances on this question merely to expressing opposition to proposals to eliminate the special mailing rates allowed for nonprofit publications. Such elimination, we have pointed out, would create special hardships, for example, for the labor press. Senator D O U G L A S . W o u l d you go ahead ? M r . K A S S A L O W (reading) : W e do not believe, however, that this canon or principle can be applied to very r i g i d periods of time. N o one seriously proposed that w e try to balance the budget d u r i n g the war, nor, looking back, w o u l d anyone say we were w r o n g i n spending beyond the limits of a balanced budget to care for the hungry and homeless millions of Americans during the depression of the thirties. W e were quite impressed w i t h Budget Director F r a n k Pace's formulation of t h i s problem i n his recent statement to the committee when he noted that "budget surpluses cannot ordinarily be achieved i n a declining national economy. Rather, the way to achieve such surpluses is to preserve the types of budgetary and other policies w h i c h w i l l increase national income and taxpaying capacity * * * the fundamental fiscal consideration should be the long-run outlook for expenditures, receipts, and public debt. T h e policies contemplated i n the budget of any given year, therefore, should be judged p r i m a r i l y i n terms of their impact on the budget and the public debt over a period of years rather than i n terms of their interior effects." B a l a n c i n g the budget, then, as we see it, gets to be a k i n d of offshoot of the business cycle. W h e n times are good and f u l l employment and high levels of national income prevail, every effort should be made to pile up F e d e r a l surpluses a n d pay off part of the debt. W h e n unemployment rises, however, a n d national income drops, the F e d e r a l Government must use its fiscal powers to help stabilize the economy, including, i f necessary, spending f o r programs w h i c h may result i n budget deficits for ajwhile. Senator DOUGLAS. M a y I ask a question: H o w much must unemployment rise before the Government should, i n your judgement, use such a policy? M r . KASSALOW. This question was recently put to M r . Rieve, and I think you might be interested i n his answer, because, after all, his judgment is more of a critical importance, and I think it reflects C I O leadership. H e said his feeling was that to him it was just about untenable to talk about normal hard-core unemployment; as far as he was concerned, unemployment at a level of 1 percent of the labor force might not appear to be a very serious problem, but he w^ould not want to be i n that 1 percent category; that he was interested i n a policy which continually strove for employment, suitable employment for all those able, willing, and seeking work, as stipulated i n the Employment A c t of 1946. I f you want to get our current judgment, we certainly don't believe that 4- or 5-percent unemployment is a frictional figure, or an irreducible minimum of unemployment. Senator DOUGLAS. Let's see. O f course, there is some unemployment created by seasonal fluctuations which exist even at the top of a 309 MONETARY, CREDIT, AND FISCAL POLICIES business boom, and there is other unemployment caused by the waning of some industries and localities. So that even at the peak you have, I suppose, 3- or 4-percent unemployment. W o u l d you use Government deficits to try to put that 3 to 4 percent back to work ? M r . K A S S A L O W . I can answer you indirectly. W e would never be satisfied with unemployment at 3 or 4 percent, but we did not advocate deficit spending i n 1947 and 1948, for example, when unemployment was running about 3 percent of the labor force. Senator DOUGLAS. That is, you would try to reduce it i n other ways, by better employment services, and so forth ? M r . KASSALOW. Yes. Senator DOUGLASS. But i f unemployment rose above 3 or 4 percent? M r . KASSALOW. It isn't strictly a matter of Federal spending, because I don't think Federal fiscal action reduces itself to that, or our program, or the things we believe are necessary for f u l l employment, don't get down to just Federal spending, either. But let me read on. W e w i l l discuss the current budget, and maybe that anticipates your question. Senator DOUGLAS. Well, I would like to go back, i f I may, to your statement. Personally, I think you are quite correct in saying that we couldn't probably have balanced the budget during the war, and that we shouldn't have balanced the budget during the thirties. I agree with you. Have you, however, heard of Dr. Pavlov's discovery of the conditioned reflex ? That may seem to be a tangential question which has no bearing, but I think it does. Y o u may remember Dr. Pavlov took his dogs and oifered them steaks and rang a bell at the same time. The dogs would see the steaks and hear the bell and their saliva would flow at a very lively rate. Then after a while Dr. Pavlov took the steaks away and rang the bell and the saliva continued to flow for a time, but the dogs then became confused and finally were sent to the equivalent of an animal psychiatrist. I wonder i f this same moral couldn't be drawn in this particular instance. Is it not possible to f a l l into a frame of mind which welcomed deficits i n order to avert the misery of the depression and to help us get out of a depression, and which accepted deficits and high spendi n g as a necessary consequence of the war; and that, when the depression is removed and the war is nonexistent, for the emotional and intellectual saliva of men to continue to flow i n the presence of deficits, irrespective of the purpose for which they are incurred ? Y o u w i l l forgive me for this fanciful story; but, since this is supposed to be, i n part, a physiological matter, i wondered i f you would make any comment upon it? M r . K A S S A L O W . I think part of the answer to your question lies i n one's notion of what a recession or depression is. I think we probably both would agree, for example, that at a level of 7 or 8 million unemployment was something which warranted serious Federal action, whether fiscal or otherwise. W e believe that at a level of 3y 2 or 4 million it is also a rather serious economic problem. Senator DOUGLAS. A t a level of one and a half or two ? M r . KASSALOWt. W e might not recommend the same things at the level of 1 y 2 to 2 that we would recommend should be done at a level of 310 MONETARY, CREDIT, AND FISCAL POLICIES Sy2 to 4. I don't believe that it is strictly a matter of deficits or surpluses. There are certain programs which we believe should not be sacrificecl at any stage of the cycle, and i f it happens that those programs w i l l entail deficits we go ahead with them, because we think that i n the long run they might add to the productive strength of the country, and it so happens we think that the current budget discussion entails those kinds of considerations. I would agree that there is the danger of getting into that rut. W e would hope, however, that we have a kind of good watchdog on the H i l ] i n the form of the Appropriations Committee, and I know it usually gives us a good deal of trouble on our programs. I hope they are not responding to any bells. I don't think they have been up to now. Senator DOUGLAS. Assuming that you regard certain expenditures as necessary, couldn't those be met i n normal times by taxes, so thai you don't have a deficit, i n normal times—whatever the definition of "normal" may be ? M r . RUTTENBERG. W e think so. That is why during all of the Eightieth Congress, and in that attempt of Congressman Knutson of Minnesota to impose his tax cut, we opposed it, and we supported the President when he vetoed the measure, and supported the Congress when they upheld the veto; and finally, when they did override his veto and put into effect in 1948 a tax-reduction bill, we criticized it wholeheartedly, because, we said, i n times of high national income it was no time at all to begin cutting taxes. W e also had the same thing to say i n 1946 when the Congress was considering the elimination of the excess-profits tax as well as the reduction in certain individual-income taxes by about 5 percent. So that we feel very strongly on that question. M r . KASSALOW. W e go on i n the. statement to indicate that we don't think that all sources of revenue have been tapped even at this point of a recession. Senator DOUGLAS. W i l l you proceed? M r . RUTTENBERG. W e also make a strong point i n that i f we could really develop the full-employment economy with an ever-increasing national income our tax structure could remain stable and still produce much higher levels. Senator DOUGLAS. Because of an increase i n income? M r . RUTTENBERG. Yes. I f the Government followed the proper policies to establish a full-employment economy. Senator DOUGLAS. W i l l you go ahead ? M r . K A S S A L O W (reading) : A p p l y i n g this standard, we feel the President i n his midyear report was on sound grounds i n resisting cuts i n essential F e d e r a l programs. F o r so long as the private economy is f a i l i n g to provide useful employment for a l l those able, willing, and seeking work, budget cutting doesn't make sense, socially or economically. P a r t i c u l a r l y is this true when cuts are aimed at programs w h i c h i n the long r u n w i l l add to our productive power. Again, let me emphasize that i n taking this position we are not suggesting a discontinuation of sincere efforts to eliminate actual waste; but this is a different proposition f r o m merely striving to balance the budget at any cost. It is w e l l to remember the one thing no country can afford is wasted manpower and idle resources. Those, too, are real deficit threats to national economic development. So f a r as the current situation is concerned, however, we are not prepared to say that nothing can be done about increasing F e d e r a l revenue and scaling d o w n the prospective deficit. W e pleaded i n 1945 against the premature l i f t i n g 311 MONETARY, CREDIT, AND FISCAL POLICIES of the corporate excess-profits tax. T h e staggering profits of the giant-size corporations i n each of the past 4 years has convinced us we were correct. W e s t i l l believe the enactment of an excess-profits tax, especially i n a f o r m w h i c h "would exempt the smaller-size company, is desirable, and w o u l d help take up the slack i n revenue? A s an organization, we strongly disapprove the iniquitous income-tax l a w of 1948. W e s t i l l feel it was a mistake. W h i l e it may be difficult to reverse a l l o f this ill-advised action, at the very least we feel such features of the l a w as the provision for split returns should be revised to enable the Government to recapture some of the lost revenue. But, again, these are detailed considerations; and, as we understand it, this committee is p r i m a r i l y interested i n the broad aspects of fiscal, monetary, and credit policy. Before I conclude, let me set the record clear. A s I have indicated, we place considerable hope i n fiscal and related aspects of Government economic policy. P a r t of this hope stems from the f a c t that as a N a t i o n over the past 16 years we have adopted other policy measures w h i c h lend great basic support to the Nation's economy. T h e social-security system, the minimum wage, the farm-support program, the securities and bank-deposit legislation, the public-housing law, these and other phases of national economic policy help create an environment i n w h i c h the tasks of fiscal policy are reduced. A s a consequence, the prospects for successf u l fiscal-policy operations are enhanced. B u t the lesson shouldn't be lost. F i s c a l policy can be a major tool for f u l l employment, economic growth, and stability. B y no means, however, is it sufficient i n itself. A d d i t i o n a l measures are needed, such as broadening and improving of social security, additional housing legislation, resource and publicw o r k s development, and Federal a i d to education, to name but a few. Necessary adjustments i n wage, price, profit relationships, looking toward a f a i r e r distribution of income, also should not be minimized. There are, of course, no conflicts between these policies and a vigorous F e d e r a l fiscal program designed to help stabilize the economy. Indeed, sound fiscal policy complements the other measures I have briefly mentioned here. L e t me thank you again for this opportunity of appearing. T h e C I O strongly supports the work currently being done by the J o i n t Committee on the Economic •Report. Hearings and studies such as these have a real function i n the effective execution of the Employment A c t of 1946. Senator D O U G L A S . M r . Wolcott ? M r . W O L C O T T . N O questions. Senator D O U G L A S . I have no more questions. Thank you very much. M r . Ruttenberg, did you want to submit a supplementary statement ? M r . RUTTENBERG. NO. Senator D O U G L A S . Thank you very much. Is M r . Warren here? I t was understood that M r . Warren, of Moorestown, N. J., was to testify. W e w i l l recess for 10 minutes to find out M r . Warren's whereabouts and convene again at 3:10. (Short recess taken.) Senator D O U G L A S . M r . Warren, we appreciate very much your readiness to come down and testify before our committee, and we are very glad, indeed, to have you. W o u l d you care to make a general statement, and then perhaps there might be a few questions that I would like to ask you on the basis of your statement. STATEMENT OF ULYSSES GRANT WARREN, A. S. RIECKE & CO., INVESTMENTS, PHILADELPHIA, PA. M r . W A R R E N . M r . Chairman, I am very glad I did finally get here. I am sorry that my train was late because I should have gotten here much earlier. 312 MONETARY, CREDIT, AND FISCAL POLICIES The only general statement that I would have at the present time, in addition to what I have here i n the memorandum, is the fact that while I have been i n the investment-banking business all my business life, since 1931, I do not consider myself a high-powered economist, but I think I would qualify as an expert i n the investment-securities field. Senator D O U G L A S . W e are very glad to welcome you, indeed. W o u l d you go ahead. M r . WARREN. Yes, sir. A s I see it, gentlemen, over the recent years the impact of the monetary and fiscal policies of the Federal Government upon the private-investment problem has been manifold i n its aspects. When I refer to the monetary and fiscal policies of the Federal Government, I mean its easy-money policy and its deficit financing. A n d when I refer to the private-investment problem I mean the investment-securities markets. I believe the low interest rates occasioned by this easy-money policy have enabled many corporations—utilities, rails, and industrials— successfully to refund many hundreds of millions of high coupon bonds with long-term low-interest bonds. This cheap borrowed money helps these corporations to render their services or manufacture their products at a lower cost. This also applies to the Federal, State, county, and municipal governmental agency services. T h i s refunding market thus created proved to be a stimulant to the underwriting phase of the investment-securities business. Also, this change i n interest rates has driven a lot of money out of the high-grade market into the semi-investment and speculative markets, from high-grade bonds, preferreds, and commons into lowergrade bonds, preferreds, and commons. Unfortunately, this has hurt a lot of people, some elderly and retired, who bought high-grade securities with good dollars. They now find that they have had these securities taken away from them by call and replaced with securities of comparable quality but yielding fewer dollars which i n turn are not worth as much as they were when they invested them originally. I n other words, their income consists of fewer and smaller dollars. Their standard of living i n some cases has been reduced, and they are w orried and mad. Senator D O U G L A S . Y O U mean angry ? M r . W A R R E N . Yes, sir; angry; that is right. T h i s would appear to be an unfortunate corollary to what some people term a redistribution of wealth. Also, the higher taxes attending the afore-mentioned fiscal policies combined with the capital-gains aspects of the present tax laws has tended to increase the speculative activity of those persons i n high* tax brackets because of the premium placed on
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