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CONDUCT OF MONETARY POLICY
(Pursuant to the Full Employment and Balanced Growth
Act of 1978, P.L 95-523)
HEARING
BEFORE THE
COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-SIXTH CONGKESS
SECOND SESSION
JULY 23, 1980
Serial No. 96-63
Printed for the use of the
Committee on Banking, Finance and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON: 1980
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY S. REUSS, Wisconsin, Chairman
THOMAS L. ASHLEY, Ohio
J. WILLIAM STANTON, Ohio
CHALMERS P. WYLIE, Ohio
WILLIAM S. MOORHEAD, Pennsylvania
STEWART B. McKINNEY, Connecticut
FERNAND J. ST GERMAIN, Rhode Island
GEORGE HANSEN, Idaho
HENRY B. GONZALEZ, Texas
JOSEPH G. MINISH, New Jersey
HENRY J. HYDE, Illinois
RICHARD KELLY, Florida
FRANK ANNUNZIO, Illinois
JIM LEACH, Iowa
JAMES M. HANLEY, New York
THOMAS B. EVANS, JR., Delaware
PARREN J. MITCHELL, Maryland
S. WILLIAM GREEN, New York
WALTER E. FAUNTROY, District of
RON PAUL, Texas
Columbia
ED BETHUNE, Arkansas
STEPHEN L. NEAL, North Carolina
JERRY M. PATTERSON, California
NORMAN D. SHUMWAY, California
CARROLL A. CAMPBELL, JR., South
JAMES J. BLANCHARD, Michigan
CARROLL HUBBARD, JR., Kentucky
Carolina
JOHN J. LAFALCE, New York
DON RITTER, Pennsylvania
GLADYS NOON SPELLMAN, Maryland
JON HINSON, Mississippi
LES AuCOIN, Oregon
JOHN EDWARD PORTER, Illinois
DAVID W. EVANS, Indiana
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
JOHN J. CAVANAUGH, Nebraska
MARY ROSE OAKAR, Ohio
JIM MATTOX, Texas
BRUCE F. VENTO, Minnesota
DOUG BARNARD, JR., Georgia
WES WATKINS, Oklahoma
ROBERT GARCIA, New York
MIKE LOWRY, Washington
PAUL NELSON, Clerk and Staff Director
MICHAEL P. FLAHERTY, General Counsel
JAMES C. SIVON, Minority Staff Director
(ID
CONTENTS
STATEMENT OF
Page
Volcker, Hon. Paul A., Chairman, Board of Governors of the Federal Reserve
System
6
ADDITIONAL INFORMATION SUBMITTED FOR THE RECORD
"Midyear Monetary Policy Report to Congress" submitted by the Board of
Governors of the Federal Reserve System, dated July 22, 1980
Volcker, Hon. Paul A.:
Prepared statement
,
Response to information requested by:
Chairman Henry S. Reuss
Hon. John J. Cavanaugh
Hon. Joseph G. Minish
30
16
77
103
88
APPENDIX
"Briefing Materials for Mid-year 1980 Monetary Policy," report prepared by
F. Jean Wells and Roger S. White, specialists in money and banking,
Economics Division, Congressional Research Service, Library of Congress
285
"Briefing Materials," prepared by the staff of the Subcommittee on Domestic
Monetary Policy
310
Correspondence:
To Hon. Paul A. Volcker from:
Chairman Henry S. Reuss:
May 23, 1980
157
June 12, 1980
126
June 26, 1980
159
July 1, 1980
119
Hon. Jim Leach, July 24, 1980
284
Hon. Parren J. Mitchell, July 24, 1980
280
Response from Hon. Paul A. Volcker to:
Chairman Henry S. Reuss:
July 17, 1980
132
July 21, 1980
121, 158, 162
July 29, 1980
115
Hon. Jim Leach, August 22, 1980
282
Hon. Parren J. Mitchell, July 31, 1980
277
(m)
CONDUCT OF MONETARY POLICY
(Pursuant to the Full Employment and Balanced
Growth Act of 1978, Public Law 95-523)
WEDNESDAY, JULY 23, 1980
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met, pursuant to notice, at 10:05 a.m., in room
2128, Rayburn House Office Building; Hon. Henry S. Reuss (chairman) presiding.
Present: Representatives Reuss, Moorhead, Gonzalez, Minish, Annunzio, Hanley, Mitchell, Neal, Blanchard, AuCoin, Evans of Indiana, D'Amours, Cavanaugh, Vento, Barnard, Watkins, Stanton,
Wylie, Hansen, Leach, Evans of Delaware, Green, Paul, Bethune,
Shumway, and Porter.
The CHAIRMAN. Good morning.
The House Committee on Banking, Finance and Urban Affairs
will be in order for its semiannual inquiry into the conduct of
monetary policy.
Chairman Volcker, we meet today under grim economic conditions. Since January we have entered a steep slump. In the second
quarter the economy declined more rapidly than at any time since
the Second World War. Housing, steel, autos, and other basic industries are in crisis. Unemployment, already too high, is going
higher. Inflation has declined somewhat, but it has settled at its
underlying rate, which is determined by the pace of wage settlements and productivity gains, and it shows no signs of coming
down any further.
Under these conditions, the Federal Reserve has a lot of explaining to do. After our last review of monetary policy, this committee
called on the Federal Reserve, in 1980, "to pursue measured restraint without precipitating recession." It was our nearly unanimous view that a recession would engender irresistible pressure for
fiscal stimulus, and so jeopardize all efforts to contain inflation. We
entertained the modest hope, which the Federal Reserve and the
administration did not discourage, that a steady winding down of
inflation could be accomplished without recession. We understood
that the Federal Reserve's October shift of emphasis from interest
rate to reserve targeting was undertaken so as to achieve this goal.
It is now clear that our hopes were illusions. Monetary control
was achieved in October, as the committee acknowledged in April.
Yet, far from doing what we had hoped, the achievement of monetary control precipitated a severe recession and all that that enCD
tails: huge deficits, crises in industry, calls for protectionism, capital outflows and a falling dollar, and domestic social upheaval. And
we face every prospect of a renewed inflationary spiral as soon as
the recovery is underway.
In my view, the Federal Reserve, the administration, and we in
Congress should acknowledge our errors frankly. And we must
recognize that our present policies are not working, that they
cannot work, and that we can and must take steps that will work—
steps that will put people back to work, raise productivity, increase
real incomes, and so make it less necessary for wage earners to
exact their pound of flesh in money-wage terms. In short, we need
a monetary policy that will fight both inflation and recession.
Such a comprehensive monetary policy must have a macroeconomic, an international, and a microeconomic aspect.
First, at the broadest macroeconomic level, there is nothing
wrong under most conditions with the rule that the Federal Reserve should set, and try to meet, a target for the growth of money.
Such a rule quite properly causes the Federal Reserve to "lean
against the wind": to restrain booms and to soften slumps. The
provision of numerical monetary growth targets to the Congress
also provides a valuable indication of Federal Reserve intentions,
and with this in mind I strongly object to the omission of such
targets for 1981 from the present report. But monetary growth
targets by themselves cannot cope with the forces of instability
that buffet our economy in the present world. To rely on them
alone is reckless.
Second, our national monetary policy must be coordinated with
our allies. If the United States alone pursues monetary expansion
in the midst of recession, our interest rates will fall sharply by
comparison with those abroad. If relative interest rates fall, shortterm capital will flow away from this country, and the dollar will
fall. The immediate consequence will be a new surge in the prices
of manufactured imports and raw materials; the ultimate consequence will be a new rise in the price of oil. We can afford neither.
There is no way we can pursue a monetary strategy for recovery
in a vacuum. We must coordinate our recovery from recession with
the Central Banks of our allies. To this end, the Federal Reserve
and the Treasury should begin immediate discussions with Germany and Britain, in particular, to persuade them to lower their
interest rates as we lower ours. If all of our major allies act in a
coordinated way, interest rates can come down without destablizing
short term capital flows. This will help economic expansion in all
countries without threatening anyone's currency. If our friends
need to avert inflationary pressures, that can be accomplished with
tighter fiscal policies, which will not have the same adverse international ramifications.
Third, most important, we must recognize that the indefinite
future our national reserves of credit will be scarce. We therefore
need urgently to address the microeconomic question: To whom
should our scarce credit resources go? Everyone wants credit. Only
the largest and most profitable corporations can finance their expansion plans without it. Small businesses rely on credit. So do
farmers. So do home buyers, and so do millions of consumers. A
national policy on who should have priority access to this credit is
an indispensable concomitant of a necessary national policy that
makes credit relatively scarce.
Last October, the Federal Reserve and the administration took a
first, halting step toward a policy on the uses of credit. The Fed
announced a series of objectives, and it wrote to the banking
system asking for cooperation in their attainment. The objectives
were laudable: That banks should concentrate their lending on
small businesses, consumers, home buyers, farmers and productive
capital investment, while avoiding loans for commodity, gold and
foreign exchange speculation and for purely financial activities
such as stock buy-backs and corporate takeovers. But despite these
good intentions, the Federal Reserve and the administration have
utterly failed to monitor and secure voluntary compliance with
their request.
Faced with declining loan demand at high interest rates after
October 1979, the banking system simply disregarded the Federal
Reserve's admonitions.
How else can one account for the incredible fact that a handful
of large banks channeled some $800 million—nearly 10 percent of
all bank lending in the country in February and March—to
Bunker Hunt and his associates alone? How else can one interpret
the fact that the Federal Reserve did no know of any bank lendng
against silver until March 26, and that it has allowed Bunker
Hunt's daughter to buy a silver mine despite a guarantee, made in
the Fed's own report to Congress, that the Fed-approved loan to the
Hunts and Placid Oil would bar the Hunts and "any related
entity" from all speculative activity for the lifetime of the loan?
How else can one account for such loans as the $40 million credit
from 5 large banks to Nortek, Inc., approved in late October, which
had its unvarnished purpose—"to acquire the equity securities of
a * * * 'target' corporation"—written right into the loan application?
How else can one account for the duplicitous behavior of the
large New York banks in the first quarter, who raised their official
prime rates, to which small business and housing loans were tied,
thereby squeezing small borrowers right out of the market, while
the banks made over two-thirds of their total loans—to big borrowers—at rates below the official prime?
How else, indeed can one account for the record profits turned in
by the big New York banks in the second quarter?
In mid-March, the Federal Reserve took steps that ostensibly
stiffened surveillance and control over speculative lending. This
was the special credit restraint program. Did it work? We will
never know, because, incredibly, the Federal Reserve did not ask
the banks to report on how much speculative lending they had
been doing prior to the imposition of restraints. So we cannot find
out whether the reporting requirements had their desired effect.
And in any case the issue is now academic, since only a few weeks
ago the Fed withdrew its antispeculative admonitions and abolished its reporting requirements, allowing the blindfold to slip
totally over its eyes.
Unfettered speculation has the effect of raising credit costs and
limiting credit availability to legitimate borrowers, such as small
business, home buyers and builders, consumers and farmers. It also
increases the general demand for bank loans—the Hunt brothers
alone drove up loan demand in February and March by nearly 10
percent—and so gives false signals to the monetary authorities
causing them to tighten more harshly than conditions warrant.
And of course it is not the big-time speculator, but the legitimate
small borrower who is caught in the squeeze.
This discrimination against the borrower that we ought to be
helping is made worse by the recent big bank practice of posting
phony prime interest rates—the rates which the big banks are
supposed to charge their best customers. In fact, when the prime
rate was 20 percent a couple of months ago, and the average
borrower was paying 20 percent plus, the big banks were giving
under-the-table discounts to their large corporate customers of as
much as 5-percentage points. Bank loans at below prime rates—
mainly large loans of short maturities, rose from 8.8 percent in
1977 to 16.1 percent in 1978, to 32.6 percent in 1979 and to an
astounding 58.8 percent of all new loans made in May 1980 at 48
large banks surveyed by the Federal Reserve. The main effect is to
squeeze borrowers who are not eligible for these secret-rebate
prime loans.
I have previously, on May 23, called the attention of the Federal
Reserve to the problem of the phony prime loans. The Fed's reply
says that "the data * * * do not themselves appear to justify
sweeping charges of discrimination against particular groups of
borrowers/' But the Federal Reserve concedes that the unrealistically high prime rates of this spring may have worked "to the
disadvantage of customers that do not have access to the open
market for large short-term business credit." This was precisely
what I had feared. And the Fed's study, far from invalidating my
claim of sweeping discrimination against worthy borrowers, shows
that in fact they were given the short end of the lender's stick. For
example, the study shows that the average size of loans below
prime by 48 large banks in May was $1.2 million, while the average size of loans above prime at the same banks was $208,000.
There is only one way to control credit, and that is to control it.
If the Federal Reserve is asleep at the switch, and if small business, agriculture, productive capital investment and the construction industry have been derailed, then affirmative steps should be
taken to guarantee access to credit for these vital uses. We must
use the Nation's credit resources to fight both inflation and recession by encouraging lending to productivity-enhancing capital investment, small business, housing, consumers and farmers, and
discouraging lending for commodity speculation and corporate
takeovers.
To implement this policy, no new economic inventions are required. The Federal Reserve already has the necessary tools,
through its reserve, discount and regulatory powers, to achieve an
inflation-recession breakthrough. In your July 21 responses to my
detailed questions on bank lending for silver speculation and for
corporate takeovers, you make clear that the Federal Reserve has
come a long way in its willingness to scrutinize and criticize lending practices that are not in the national interest—and I commend
you for it.
Now, it is our task as those who under the powers of the Constitution have the powers to control money and regulate the power
thereof, and you, to whom we have delegated this constitutional
authority, to adopt a monetary policy that goes beyond control over
the monetary aggregates sufficient to gladden the heart of the
monetarists, which is an admitted part of what needs to be done,
and which gets on with the job of bringing an international aspect
to monetary policy, and most important of all, a microeconomic
aspect to monetary policy which sees that housing, capital investments, farming, consumers, and other necessary users are not
sacrificed on the altar of commodity speculation and corporate
takeovers.
Thank you very much.
Mr. Stanton.
Mr. STANTON. Thank you very much, Mr. Chairman.
Mr. Volcker, I welcome you to the committee once again under
the rules and regulations of fulfilling our requirements of the
Humphrey-Hawkins bill.
Mr. Chairman, may I first compliment you on your opening
statement? It is thorough, concise. It was obvious that you did not
get up to Detroit, Mich., last week on the shores of the upper Great
Lakes in preparing that excellent statement.
The CHAIRMAN. I was in the Great Lakes area, but a bit away
from Detroit.
Mr. STANTON. I don't have any opening statement, Mr. Chairman. I would like to comment on a specific point you made and
what I understand was referred to yesterday by members of the
other body; that is, Mr. Chairman, the lack of projected target
ranges for 1981. I join in that criticism because over the years a lot
of political blood was spilled in trying to temper these hearings to
adequately reflect the independence of the Federal Reserve System.
Over the years we have come to this conclusion. We started out
with specific interest rate targets. We disagreed with that and
threw that out.
Two provisions were put into this legislation, Mr. Chairman, to
protect you in regard to the target ranges. One was the provision
that instead of single points, which was talked about at one time,
we used the ranges.
Second, there is a statement in there that basically is to the
effect that nothing requires the Fed to actually keep the targets if
they think it is unwise to do so.
I would hope under those two restraints, Mr. Chairman, that you
would reconsider this question.
It is, indeed, of importance, I believe, in keeping the letter of the
law as far as the Humphrey-Hawkins Act is concerned.
I would only make that opening comment, Mr. Chairman, that I
do join you in that regard.
I think the request would be almost universal in that regard.
The CHAIRMAN. I am sure it would be, Mr. Stanton. I thank you.
There is a pro forma vote going on. Would the committee appreciate it if I declared a 7-minute recess to make that?
I hereby do that. Mr. Volcker, if you will just relax, we will be
back shortly.
[Recess taken.]
6
The CHAIRMAN. The committee will be in session again.
Thank you for your patience, Mr. Volcker.
We have the midyear monetary policy report before us and also
in timely fashion your prepared statement for today. Both under
the rule, without objection, will be included in the record.
[Mr. Volcker's prepared statement and the midyear monetary
policy report referred to may be found on p. 16.]
Would you now proceed in your own way to summarize
STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN, BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. VOLCKER. Mr. Chairman, as you know, I testified before the
Senate yesterday. My statement this morning parallels my testimony there.
I wrote that statement in considerable part in response to a
letter from the chairman July 1 that puts the issue before us.
He reviews some of the problems of the economy, not only
changes in the economy, but changes in financial conditions of
great rapidity recently, and concludes, "I am not suggesting a
change in the monetary strategy"—a conclusion with which, of
course, we agree—"but the experience of recent months demonstrates that monetary and fiscal policies alone cannot by themselves offset the present instability of our domestic and international economic affairs. We need urgently to develop comprehensive
stabilization policies * * * ."
My statement is partly directed toward that kind of comment.
With your permission, I will proceed.
The CHAIRMAN. You may do that.
Mr. VOLCKER. I am, of course, delighted to be with you in this
semiannual occupation. My purpose today is to add some personal
perspective to the more formal report that you have.
As the chairman has emphasized, the direction of economic activity has changed swiftly in recent months. We have acute problems
of recession and inflation. There have been unprecedented changes
in interest rates and the imposition and removal of extraordinary
measures of credit restraint. The fiscal position of the Federal
Government is changing rapidly.
In these circumstances, confusion and uncertainty can arise
about goals and policies, not just those of the Federal Reserve, but
of economic policy generally.
That is why I particularly welcome the opportunity to be here to
emphasize the underlying continuity in our approach at the Federal Reserve and its relationship to other economic policies, matters
that are critical to public understanding and expectations. The
Federal Reserve has been, and will continue to be, guided by the
need to maintain financial discipline—a discipline concretely reflected in reduced growth over time of the monetary and credit
aggregates—as part of the process of restoring price stability. As I
see it, this continuing effort reflects not simply a concern about the
need for greater monetary and price stability for its own sake—
critical as that is.
The experience of the seventies strongly suggests that the inflationary process undercuts efforts to achieve and maintain other
goals, expressed in the Humphrey-Hawkins Act, of growth and
employment.
As you know, our operating techniques since last October have
placed more emphasis on maintaining reserve growth consistent
with targeted ranges for the various M's, with the implication
interest rates might move over a wider range. Those targets were
reduced this year as one step toward achieving monetary growth
consistent with greater price stability. For several months after the
new techniques were introduced in October, the various aggregates
were remarkably close to the targeted ranges.
At that time, and for months earlier, you will recall widespread
anticipations of recession. Nevertheless, reflecting a variety of developments at home and abroad—including an enormous new increase in oil prices, Middle Eastern political volatility, and interpretations of adverse budgetary developments—there was a
marked surge in the most widely disseminated price indices and in
inflationary expectations in the early part of this year.
Those expectations in the short run probably helped to support
business activity for a time; in particular, consumer spending relative to income remained very high, with the consequence of historically—and fundamentally unhealthy—low savings rates and high
debt ratios. Speculation was rife in commodity markets.
Spending and speculative activities of that kind are ultimately
unsustainable. But they carried the clear threat of feeding upon
themselves for a time, contributing among other things to a further
acceleration of wage rates and prices. In that way, inflation threatened to escalate still further in a kind of self-fulfilling prophecy,
posing the clear risk that the subsequent economic adjustment
would be still more difficult.
Credit markets reflected these developments and attitudes. Bond
prices fell precipitously. Long-term money—including mortgages—
became difficult to raise. Partly as a consequence, short-term demands for credit ballooned in the face of sharply rising interest
rates, at the expense in some instances of further weakening business balance sheets. That heavy borrowing also was reflected in
acceleration in the money and credit aggregates during the winter.
An attempt to stabilize interest rates by the provision of large
amounts of bank reserves through open market operations to support even more rapid growth in money—at that time money was
running high or above our target ranges—would probably have
been doomed to futility even in the short run, for it could only
have fed the expectations of more inflation. It would certainly have
been counterproductive in terms of the overriding long-term need
to combat inflation and inflationary anticipations. Instead, consistent with our basic policy approaches and techniques, the Federal
Reserve resisted accommodating the excessive money and credit
growth.
During this period of rising inflation and interest rates, the
administration and the Congress also appropriately and intensively
reviewed their own budget planning. Coordinated with the announcement of the results of that broad governmental effort and
the decision of the President to invoke the Credit Control Act of
1969, the Federal Reserve announced on March 14 a series of
exceptional, temporary measures to restrain credit growth, rein-
forcing and supplementing our more traditional and basic instruments of policy.
The demand for money and credit dropped abruptly in subsequent weeks, reflecting the combined cumulative effects of the
tightening of market conditions, the announcement of the new
actions, and the rather sudden weakening of economic activity.
In response, interest rates within a few weeks fell about as fast—
in some instances faster and further—than they had risen in earlier months. Growth in the aggregates slowed, and for some weeks
MiA and MiB turned sharply negative.
There is no doubt in my mind that these lower levels of interest
rates can play a constructive role in the process of restoring a
better economic equilibrium and fostering recovery. Indeed, there
is already evidence—if still tentative—that homebuilding and other
sectors of the economy sensitive to credit costs and availability are
benefiting. Meanwhile, progress is being made toward reducing
consumer indebtedness relative to income and toward restructuring
corporate balance sheets as bond financing has resumed at a very
high level. The sharp improvement in credit market conditions has
been accompanied by slower rates of increase in consumer and
producer prices, helping to quiet earlier fears of many of an explosive increase in inflation.
The suddenness of the change in market conditions has, however,
raised questions in some minds as to whether the interest rate
declines were in some manner "contrived" or "forced" by the Federal Reserve—whether, to put it bluntly, the performance of the
markets—together with the phased removal of the special credit
restraints—reflects some weakening of our basic commitment to
disciplined monetary policy and the priority of the fight on inflation. These perceptions are not irrelevant, for they could affect
both expectations and behavior, most immediately in the financial
and foreign exchange markets, but also among businessmen and
consumers.
The facts seem to me quite otherwise.
Growth in money and credit since March has certainly not exceeded our targets; the Mi measures have in fact been running
below our target ranges. Bank credit has declined in recent
months; while the decline in commercial loans of banks can be
explained in part by exceptionally heavy bond and commercial
paper issuance by corporations, there is simply no evidence of
excessive rates of credit expansion currently. In these circumstances, it is apparent that interest rates have responded—and
have been permitted to respond—not to any profligate and potentially inflationary increase in the supply of money, but to changes
in credit demands, and—so far as long-term interest rates are
concerned—to reduced inflationary expectations.
It is in that context—with credit demands reduced and growth of
credit running well within our expectations and targets—that the
special credit restraint programs simply served no further purpose.
Those measures were invoked to achieve greater assurance that
credit growth would in fact slow, and that appropriate caution
would be observed in credit usage. The special restraints are inevitably cumbersome and arbitrary in specific application. They involve the kind of intrusion into private decisionmaking and com-
9
petitive markets that should not be part of the continuing armory
of monetary policy; their use was justified only by highly exceptional circumstances—circumstances that no longer exist. Our normal
and traditional tools of control—which in fact have been solidified
by the Monetary Control Act passed earlier this year—are intact
and fully adequate to deal with foreseeable needs.
Neither the decline in interest rates nor the removal of the
special restraints should be interpreted as an invitation to consumers or businessmen to undertake incautious or imprudent borrowing commitments, or as lack of concern should excessive growth in
money or credit reappear. That is not happening now. But markets—and the public at large—remain understandably extremely
sensitive to developments that might aggravate inflationary forces.
As we saw only a few months ago, consumers and businessmen will
react quickly in their lending and borrowing behavior to that
threat.
While the recent easing of financial pressures helps provide an
environment conducive to growth, we should not be misled. A
resurgence of inflationary pressures, or policies that would seem to
lead to that result would not be consistent with maintenance of
present—much less lower—interest rates, receptive bond markets,
and improving mortgage availability. We in the Federal Reserve
believe the kind of commitment we have made to reduce monetary
growth over time is a key element in providing assurance that the
inflationary process will be wound down.
I noted earlier the money stock actually dropped sharply during
the early spring. In a technical sense, working on the supply side,
we provided substantial reserves through open market operations
during that period, but commercial banks, finding demands for
credit and interest rates dropping rapidly, repaid discount window
borrowings as their reserve needs diminished. In general terms, it
seems clear that, at least for a time, the demand for money subsided—much more than can be explained on the basis of established
relationships to business activity and interest rates—apparently
because consumers and others hastened debt repayment at the
expense of cash balances and because the earlier interest rate
peaks had induced individuals to draw on cash to place the funds
in investment outlets available in the market.
As the report illustrates, Mi growth has clearly resumed, and the
broader aggregate M2 is now at or above the midpoint of its range.
In the judgment of the Federal Open Market Committee, forcing
reserves onto the market in recent weeks simply to achieve the
fastest possible return to, say, the midpoint of the Mi ranges may
well have required early reversal of that approach, have been
inconsistent with the close-to-target performance of the broader
aggregates, and therefore led to unwarranted interpretations and
confusion about our continuing objectives. Depending on the performance of the broader aggregates and our continuing analysis of
general economic developments, the FOMC is in fact prepared to
contemplate that Mi measures may fall significantly short of the
midpoint of their specified ranges for the year. That is this year,
1980.
I have emphasized the committee's intention to work toward the
lower levels of monetary expansion over time. In reviewing the
10
situation this month, the committee felt that, on balance, it would
be unwise to translate that intention into specific numerical targets for 1981 for the various M's at this time. That view was
strongly reinforced by certain important technical uncertainties
related to the introduction of NOW accounts nationwide next January, as well as by the need to assess whether the apparent shift in
demand for cash in the spring persists.
If I might elaborate on that, Mr. Chairman, you have referred to
the failure to provide a specific numerical range next year, and so
did Mr. Stanton. I want to explain just what the committee had in
mind there.
It seems to have led to some questioning and uncertainty as to
what our intentions are. I think my statement makes clear that
the general philosophy and intent of reducing the targets remains
intact. We attempted some very careful wording in that report to
express that intention.
Then we ran into a problem. We are not living in quite the world
that we would like to live in in some respects.
One of the things we face is the certainty of technological change
next year, growing out of the Monetary Control Act. Particularly, I
am thinking of the fact that NOW accounts go nationwide.
We have run into a situation this year where it appears that MiA
is somewhat depressed relative to MiB, just as to the technical
relationships between them, because we are getting more movement out of demand deposits into NOW accounts than we expected
at the moment.
We expected about half a percent depression of MiA. It is more
like 1.5 percent in the first 6 months. The staff thinks it will be a
little less for the year as a whole.
Technically, we might have changed the relationship between
MiA and MiB to allow for that, but it didn't look big enough to be
worthwhile.
Next year we go nationwide. We have some estimates from our
deliberations as to what the impact might be on the relationship
between MiA and MiB. MiA might be depressed anywhere from 1 to
5 percentage points by shifting out of demand deposits to NOW
accounts, while M JB might be raised substantially by shifting from
regular savings accounts into NOW accounts.
That poses a very difficult problem for us, and uncertainty as to
what target we could present that does not mislead more than it is
helpful.
There is also a question, which the committee deliberated at
great length, as to the persistence of this short fall in Mi that
developed in the first half, which is off the schedule, so to speak, of
past equations. And I think you can understand that the committee
thought that before putting its name on the line, so to speak, with
a specific number, we would like to have a little more time to see
how that shortfall works out.
There is a much less important but nonetheless a real question
about the treatment of money market funds, which we now include
in M-2, but that has some of the characteristics of a transaction
balance. In any event, they are growing very rapidly.
We thought it would be less misleading, in fact, to express the
general intention of achieving a reduction of size unspecified.
11
Rather than to attempt in this very difficult situation to specify a
specific range for numbers that would be moving in different directions because of the technological impact.
The sense of what we were doing was to indicate that the basic
policy of gradual reduction would be unchanged as we now see
1981.
We did not see this as a legal question or a legal argument. In
fact, I asked the question whether this kind of expression was
consistent with the law, and the advice I got was there was no real
question; it was consistent with the law. I understand there is some
argument about that now.
I just want to make the point that we thought this was the best
practical way to proceed. We weren't making any philosophical,
legal statement. We understand the desirability of stating the general tenor and direction we think these things should move in next
year.
We reached a practical conclusion in that area. I am not sure
there is any philosophical difference between the comments of the
members and our own, but we did have some very practical problems.
Mr. STANTON. Mr. Chairman, if the gentleman would yield, I
hate to interrupt the statement, but you diverted from it a moment
ago. I am willing to let the subject drop, but on February 19, at
your previous meeting before this committee—and I quote—you
made the following statement:
Enactment of nationwide NOW account legislation would be expected to raise the
growth of this money stock measure this year and the present range would have to
be reconsidered in that light.
That was basically the same statement you made now. At that
time you went ahead
Mr. VOLCKER. That is right. These targets are operational on a
current year basis. We need a target for our reserve path and all
the rest. Obviously we don't need one for operational purposes
right now.
Last year, as I recall, in February—and I am going from memory
now—the figure that we put down was one we thought would be
appropriate if the law to trigger nationwide NOW accounts was not
enacted this year; we didn't know what the law was going to say at
that point.
As it turned out, the law included nationwide NOW accounts,
but effective December 31. In those circumstances, we felt we
didn't have to change the target which was predicated on no nationwide NOW accounts.
As I indicated, the estimate appears to have been slightly wrong
in the area of
Mr. STANTON. I am glad you are trying to clarify this. What you
have done inadvertently, Mr. Chairman, is add to the element of
confusion about those who want a tax break and those who don't
want a tax break.
You will be quoted on it.
Mr. VOLCKER. I have some sense that some element of confusion
has arisen; in trying to avoid confusion, we may have inadvertently
created some.
Mr. STANTON. Certainly have.
12
Mr. VOLCKER. The other side of the coin is that we set down,
ranges. We said these are highly tentative in view of all these
circumstances; we may have to come back and change them fairly
soon. We were afraid that would be confusing. I think the substance of this, in a sense, is an indication that the committee does
want to work toward somewhat lower ranges, if one visualized
those ranges abstracting from technological change.
The reason I am not so sweeping about that is very simple. If we
got a big shift into NOW accounts, partly out of demand deposits
and partly out of savings accounts, that would affect the MiB just
as a technical matter. It has no policy significance; it is a technical
matter. It affects the growth trend of MiB in a way which we have
to allow for when we have to make these targets operational.
To move beyond the question of targets at the moment, for the
purpose of completing the statement, I think this whole targeting
procedure is the critical question. As we approach these targets,
the general nature of the potential problems and dilemmas for
1981 and beyond is clear enough; these are important questions,
not just for monetary policy but for the full armory of public
policy.
The targets for the monetary aggregates are designed to be consistent with, and to encourage, progress toward price stability without stifling sustainable growth. But in the short run, the demand
for money—at any given level of interest rates—tends to be related
not to prices or real output alone, but to the combined effects of
both—the nominal GNP. If recovery and expansion are accompanied by inflation at current rates or higher, pressures on interest
rates could develop to the point that consistency of strong economic
expansion with reduced monetary growth would be questionable.
Obviously, a satisfactory answer cannot lie in the direction of
indefinitely continued high levels of unemployment and poor economic performance. On the other hand, ratifying strong price pressures by increases in the money supply offers no solution; that
approach could only prolong and intensify the inflationary process—and in the end undermine the expansion. The insidious pattern of rising rates of inflation and unemployment in succeeding
cycles needs to be broken; with today's markets so much more
sensitized to the dangers of inflation, economic performance would
likely be still less satisfactory if that pattern emerges again. The
only satisfactory approach must lie in a different direction—a
credible effort to reduce inflation further in the period ahead, and
policies that hold out the clear prospect of further gains over time,
even as recovery takes hold.
We are now in the process of seeing the inflation rate, as recorded in the consumer and producer price indices, drop to or even
below what can be thought of as the underlying or core rate of
inflation of 9 to 10 percent. That core rate is roughly determined
by trends in wages and productivity. We can take some satisfaction
in the observed drop of inflation, and the damping of inflationary
expectations. But the hardest part of this job lies ahead, for we now
need to make progress in improving productivity or reducing underlying cost and wage trends—as a practical matter both—to sustain the progress.
13
The larger the productivity gain, the smoother will be the road
to price stability—partly because that is the only way of achieving
and sustaining growth in real incomes needed to satisfy the aspirations of workers. Put in that light, the importance of a concerted
set of policies to reconcile our goals—not simply relying on monetary policy alone—is apparent. While those other policies clearly
extend beyond the purview of the Federal Reserve, they obviously
will bear upon the performance of financial markets and the economy as the Federal Reserve moves toward reducing over time the
rate of growth in money and credit.
In that connection I recognize the strong conceptual case that
can be made for action to reduce taxes. Federal taxes already
account for an historically large proportion of income. With inflation steadily pushing income tax payers into higher brackets and
with another large payroll tax increase to finance social security
scheduled for 1981, the ratio will go higher still.
The thesis that this overall tax burden—and the way our tax
structure impinges on savings and investment, costs and incentives—damages growth and productivity seems to me valid. Moreover, depending on levels of spending and the business outlook next
year, the point can be made that the implicit and explicit tax
increases in store for next year will drain too much purchasing
power from the economy, unduly affecting prospects for recovery.
But I must also emphasize there are potentially adverse consequences that cannot be escaped—to ignore them would be to jeopardize any benefits from tax reduction, and risk further damage to
the economy.
Whatever the favorable effects of tax reduction on incentives for
production and productivity over time, the more immediate consequences for the size of the Federal deficit, and potentially for
interest rates and for sectors of the economy sensitively dependent
on credit markets, need to be considered.
Many of the most beneficial effects of a tax reduction depend
upon a conviction that it will have some permanence, which in
turn raises questions of an adequate commitment to complementary spending policies and appropriate timing. We are not dealing
with a notion of a "quick fix" over the next few months for a
recession of uncertain duration, but of tax action for 1981 and
beyond at a time when Federal spending levels, even for fiscal
1981, appear to be a matter of considerable uncertainty, with the
direction of movement higher.
Experience is replete with examples of stimulation, undertaken
with the best motives in the world, that has turned out in retrospect to have been ill-timed and excessive. Given the demonstrable
frailty of our economic forecasting, it takes a brave man indeed to
project with confidence the precise nature of the budgetary and
economic situation that will face the Nation around the end of this
year. Moreover, an intelligent decision on the revenue side of the
budget implies knowledge of the spending priorities of an administration and a Congress, a matter that by the nature of things can
only be fully clarified after the election.
For all the developing consensus on the need for "supply side"
tax reduction—and I share in that consensus—some time seems to
me necessary to explore the implications of the competing propos-
14
als and to reduce them to an explicit detailed program for action. I
have emphasized the need to achieve not only productivity improvement but also a lower trend of costs and wages; despite its
importance, I have seen relatively little discussion in the current
context of how tax reduction plans might be brought to bear more
directly on the question of wage and price increases.
The continuing sensitivity of financial markets, domestic and
international, to inflationary fears is a fact of life. It adds point
and force to these observations and questions. Tax and budgetary
programs leading to the anticipation of excessive deficits and more
inflation can be virtually as damaging as the reality in driving
interest rates higher at home and the dollar lower abroad.
I believe it is obvious from these remarks that a convincing case
for tax reduction can be made only when crucial questions are
resolved—questions that are not resolved today. The appropriate
time for decision seems to me late this year or early 1981. Fiscal
1982 as well as fiscal 1981 spending plans can be clarified. We will
know if recovery of business is firmly underway. There will have
been time to develop and debate the most effective way of maximizing the cost-cutting and incentive effects of tax reduction, and to
see whether a tax program can contribute to a consensus—a consensus that has been elusive in the past—on wage and pricing
policies consistent with progress toward price stability. To go ahead
prematurely would surely risk dissipating the potential benefits of
tax reduction amid the fears and actuality of releasing fresh inflationary forces.
I have spoken before with this committee and others about the
need for changes in other areas of economic policy to support our
economic goals. Paramount is the need to reduce our dependence
on foreign oil—a matter not unrelated to tax policy.
We need to attack those elements in the burgeoning regulatory
structure that impede competition or add unnecessarily to costs.
And I believe it would be a serious mistake to seek relief from our
present problems by retreat to protectionism, at the plain risk of
weakening the forces of competition, the pressures on American
industry to innovate, and undermining the attack on inflation.
We are now at the critical point in our efforts to reduce inflation
while putting the economy back on the path to sustainable growth
in the eighties.
I sense the essential objectives are widely understood and
agreed—the need to wind down inflation even as recovery proceeds;
the importance of restoring productivity and increasing incentives
for production and investment; the maintenance of open, competitive markets; a substantial reduction in our dependence on foreign
energy.
You know as well as I how much remains to be done to convert
glittering generalities into practical action, to achieve and maintain the necessary fiscal discipline, to make responsible tax reduction and reform a reality, to conserve energy and increase domestic
sources, to tackle the regulatory maze. But I also know there is no
escape from facing up to the many difficulties. Our policies must be
coherently directed toward the longer range needs. In that connection I believe that economic policies, public and private, should
recognize that the need for discipline and moderation in the
15
growth of money and credit provides the framework for decisionmaking in the Federal Reserve.
Thank you.
[Mr. Volcker's prepared statement and the "Midyear Monetary
Policy Report" of the Board of Governors of the Federal Reserve
System follow:]
16
Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
I am pleased to be here today to review the conduct of
monetary policy and to report on the Federal Reserve's economic
objectives for the year as a whole, as well as its tentative
thinking on policy goals for 1981.
Our so-called "Humphrey-
Hawkins Report" has already been distributed to you.
I would
like simply to add some personal perspective this morning on
the course of monetary policy, in the context of the economic
prospects and choices facing us with respect to other policy
instruments.
Seldom has the direction of economic activity changed so
swiftly as in recent months.
Today the country is faced simul-
taneously with acute problems of recession and inflation.
There
have been unprecedented changes in interest rates and the imposition
and removal of extraordinary measures of credit restraint.
The
fiscal position of the Federal Government is changing rapidly.
In these circumstances, confusion and uncertainty can arise
about our goals and policies, not just those of the Federal
Reserve, but of economic policy generally.
Therefore, I
particularly welcome this opportunity to emphasize the underlying continuity in our approach in the Federal Reserve and its
relationship to other economic policies, matters that are critical
to public understanding
and expectations.
The Federal Reserve has been, and will continue to be,
guided by the need to maintain financial discipline —
a discipline
concretely reflected in reduced growth over time of the monetary and
credit aggregates —
as part of the process of restoring price
17
stability.
As I see it, this continuing effort reflects not
simply a concern about the need for greater monetary and price
stability for its own sake —
critical as that is.
The experi-
ence of the 1970's strongly suggests that the inflationary process
undercuts efforts to achieve and maintain other goals, expressed
in the Humphrey-Hawkins Act, of growth and employment.
As you know, our operating techniques since last October
have placed more emphasis on maintaining reserve growth consistent
with targeted ranges for the various Ms,
with the implication
interest rates might move over a wider range.
Those targets
were reduced this year as one step toward achieving monetary
growth consistent with greater price stability.
For several
months after the new techniques were introduced in October,
the various aggregates were remarkably close to the targeted
ranges.
At that time, and for months earlier, you will recall widespread anticipations of recession.
Nevertheless, reflecting a
variety of developments at home and abroad —
including an enormous
new increase in oil prices, Middle-Eastern political volatility,
and interpretations of adverse budgetary developments —
there
was a marked surge in the most widely disseminated price indices
and in inflationary expectations in the early part of this year.
Those expectations in the short run probably helped to support
business activity for a time; in particular, consumer spending
relative to income remained very high, with the consequence of
18
historically (and fundamentally unhealthy) low savings rates
and high debt ratios.
Speculation was rife in commodity
markets *
Spending and speculative activities of that kind are
ultimately unsustainable.
But they carried the clear threat
of feeding upon themselves for a time/ contributing among other
things to a further acceleration of wage rates and prices.
In
that way, inflation threatened to escalate still further in a
kind of self-fulfilling prophecy, posing the clear risk that
the subsequent economic adjustment would be still more difficult.
Credit markets reflected these developments and attitudes.
Bond prices fell precipitously.
mortgages —
Long-term money —
became difficult to raise.
including
Partly as a consequence,
short-term demands for credit ballooned in the face of sharply
rising interest rates, at the expense in some instances of further
weakening business balance sheets.
That heavy borrowing also was
reflected in acceleration in the money and credit aggregates
during the winter.
An attempt to stabilize interest rates by the provision of
large amounts of bank reserves through open market operations to
support even more rapid growth in money would probably have been
doomed to futility even in the short-run, for it could only have
fed the expectations of more inflation.
It would certainly have
been counter-productive in terms of the overriding long-term need to
combat inflation and inflationary anticipations.
Instead, con-
sistent with our basic policy approaches and techniques, the
19
Federal Reserve resisted accommodating the excessive money
and credit growth.
During this period of rising inflation and interest rates,
the Administration and the Congress also appropriately and
intensively reviewed their own budget planning.
with
Coordinated
the announcement of the results of that broad governmental
effort and the decision of the President to invoke the Credit
Control Act of 1969, the Federal Reserve announced on March 14
a series of exceptional, temporary measures to restrain credit
growth, reinforcing and supplementing our more traditional and
basic instruments of policy.
The demand for money and credit dropped abruptly in subsequent
weeks, reflecting the combined cumulative effects of the tightening
of market conditions, the announcement of the new actions, and the
rather sudden weakening of economic activity.
In response,
interest rates within a few weeks fell about as fast —
instances faster and further —
months.
in some
than they had risen in earlier
Growth in the aggregates slowed, and for some weeks M-1A
and M-1B turned sharply negative.
There is no doubt in my mind that these lower levels of
interest rates can play a constructive role in the process of
restoring a better economic equilibrium and fostering recovery.
Indeed, there is already evidence —
if still tentative —
that
homebuilding and other sectors of the economy sensitive to credit
costs and availability are benefitting.
Meanwhile, progress is
being made toward reducing consumer indebtedness relative to
20
income and toward restructuring corporate balance sheets as
bond financing has resumed at a very high level.
The sharp
improvement in credit market conditions has been accompanied
by slower rates of increase in consumer and producer prices,
helping to quiet earlier fears of many of an explosive increase
in inflation.
The suddenness of the change in market conditions has,
however, raised questions in some minds as to whether the
interest rate declines were in some manner "contrived" or
"forced" by the Federal Reserve —
whether, to put it bluntly,
the performance of the markets (together with the phased removal
of the special credit restraints) reflects some weakening of
our basic commitment to disciplined monetary policy and the
priority of the fight on inflation.
These perceptions are not
irrelevant, for they could affect both expectations and behavior,
most immediately in the financial and foreign exchange markets,
but also among businessmen and consumers.
The facts seem to me quite otherwise.
Growth in money and credit since March has certainly not
exceeded our targets; the M-l measures have in fact been running
below our target ranges.
Bank credit has declined in recent
months; while the decline in commercial loans of banks can be
explained in part by exceptionally heavy bond and commercial paper
issuance by corporations, there is simply no evidence of excessive
rates of credit expansion currently.
In these circumstances, it
is apparent that interest rates have responded —
and have been
21
permitted to respond —
not to any profligate and potentially
inflationary increase in the supply of money, but to changes
in credit demands, and (so far as long-term interest rates
are concerned) to reduced inflationary expectations.
It is in that context —
with credit demands reduced and
growth of credit running well within our expectations and targets
that the special credit restraint programs simply served no
further purpose.
Those measures were invoked to achieve greater
assurance that credit growth would in fact slow, and that appropriate caution would be observed in credit usage.
The special
restraints are inevitably cumbersome and arbitrary in specific
application.
They involve the kind of intrustion into
private decision-making and competitive markets that should not
be part of the continuing armory of monetary policy; their use
was justified only by highly exceptional circumstances —
circumstances that no longer exist.
Our normal and traditional
tools of control (which in fact have been solidified by the
Monetary Control Act passed earlier this year) are intact and
fully adequate to deal with foreseeable needs.
Neither the decline in interest rates nor the removal of
the special restraints should be interpreted as an invitation
to consumers or businessmen to undertake incautious or imprudent
borrowing commitments, or as lack of concern should excessive
growth in money or credit reappear.
That is not happening now.
22
But markets (and the public at large) remain understandably
extremely sensitive to developments that might aggravate
inflationary forces.
As we saw only a few months ago,
consumers and businessmen will react quickly in their
lending and borrowing behavior to that threat.
While the recent easing of financial pressures helps provide
an environment conducive to growth, we should not be misled.
A resurgence of inflationary pressures, or policies that would
seem to lead to that result, would not be consistent with maintenance of present — much less lower —
interest rates, receptive
bond markets, and improving mortgage availability.
We in the
Federal Reserve believe the kind of commitment we have made to
reduce monetary growth over time is a key element in providing
assurance that the inflationary process will be wound down.
I noted earlier the money stock actually dropped sharply
during the early spring.
In a technical sense, working on the
supply side, we provided substantial reserves through open market
operations during that period, but commercial banks, finding
demands for credit and interest rates dropping rapidly, repaid
discount window borrowings as their reserve needs diminished.
In general terms, it seems clear that, at least for a time, the
demand for money subsided (much more than can be explained on
the basis of established relationships to business activity and
interest rates) apparently because consumers and others hastened
debt repayment at the expense of cash balances and because the
earlier interest rate peaks had induced individuals to draw on
23
cash to place the funds in investment outlets available in
the market.
As the Report illustrates, M-l growth has clearly resumed,
and the broader aggregate M-2 is now at or above the mid-point
of its range.
In the judgment of the Federal Open Market Com-
mittee, forcing reserves on to the market in recent weeks simply
to achieve the fastest possible return to, say, the mid-point
of the M-l ranges may well have required early reversal of that
approach, have been inconsistent with the close-to-target
performance of the broader aggregates, and therefore led to
unwarranted interpretations and confusion about our continuing
objectives.
Depending on the performance of the broader ag-
gregates and our continuing analysis of general economic
developments, the FOMC is in fact prepared to contemplate that
M-l measures may fall significantly short of the mid-point of
their specified ranges for the year.
I have emphasized the Committee's intention to work toward
the lower levels of monetary expansion over time.
In reviewing
the situation this month, the Committee felt that, on balance,
it would be unwise to translate that intention into specific
numerical targets for 1981 for the various Ms at this
time.
That view was strongly reinforced by certain important
technical uncertainties related to the introduction of NOW accounts
nationwide next January, as well as by the need to assess whether
the apparent shift in demand for cash in the spring persists.
At the same time, the general nature of the potential problems
and dilemmas for 1981 and beyond is clear enough; these are important
questions, not just for monetary policy but for the full armory of
public policy.
24
The targets for the monetary aggregates are designed to
be consistent with, and to encourage, progress toward price
stability without stifling sustainable growth.
But in the
short-run, the demand for money (at any given level of interest
rates) tends to be related not to prices or real output alone,
but to the combined effects of both —
the nominal GNP.
If
*
recovery and expansion are accompanied by inflation at current
rates or higher, pressures on interest rates could develop to
the point that consistency of strong economic expansion with
reduced monetary growth would be questionable.
Obviously, a satisfactory answer cannot lie in the direction
of indefinitely continued high levels of unemployment and poor
economic performance.
But ratifying strong price pressures by
increases in the money supply offer no solution; that approach
could only prolong and intensify the inflationary process
and in the end undermine the expansion.
—
The insidious pattern
of rising rates of inflation and unemployment in succeeding
cycles needs to be broken; with today's markets so much more
sensitized to the dangers of inflation, economic performance
would likely be still less satisfactory if that pattern emerges
again.
The only satisfactory approach must lie in a different
direction —
a credible effort to reduce inflation further in
the period ahead, and policies that hold out the clear prospect
of further gains over time, even as recovery takes hold.
We are now in the process of seeing the inflation rate, as
recorded in the consumer and producer price indices, drop to or
25
even below what can be thought of as the underlying or core
rate of inflation of 9 to 10 percent.
That core rate is
roughly determined by trends in wages and productivity.
We can
take some satisfaction in the observed drop of inflation, and
the damping of inflationary expectations.
But the hardest
part of this job lies ahead, for we now need to make progress
in improving productivity or reducing underlying cost and wage
trends —
as a practical matter both —
to sustain the progress.
The larger-the productivity gain, the smoother will be the
road to price stability —
partly because that is the only way
of achieving and sustaining growth in real incomes needed to
satisfy the aspirations of workers.
Put in that light, the
importance of a concerted set of policies to reconcile our
goals —
apparent.
not simply relying on monetary policy alone — is
While those other policies clearly extend beyond
the purview of the Federal Reserve, they obviously will bear
upon the performance of financial markets and the economy as the
Federal Reserve moves toward reducing over time the rate of
growth in money and credit.
In that connection, I recognize the strong conceptual
case that can be made for action to reduce taxes.
Federal
taxes already account for an historically large proportion of
income.
With inflation steadily pushing income tax payers into
higher brackets and with another large payroll tax increase to
finance social security scheduled for 1981, the ratio will go
higher still.
The thesis that this overall tax burden — and
the way our tax structure impinges on savings and investment,
26
costs and incentives —
to me valid.
damages growth and productivity seems
Moreover, depending on levels of spending and
the business outlook next year, the point can be made that
the implicit and explicit tax increases in store for next year
will drain too much purchasing power from the economy, unduly
affecting prospects for recovery.
But I must also emphasize there are potentially adverse
consequences that cannot be escaped —
to ignore them would
be to jeopardize any benefits from tax reduction, and risk
further damage to the economy.
Whatever the favorable effects of tax reduction on incentives
for production and productivity over time, the more immediate
consequences for the size of the Federal deficit, and potentially
for interest rates and for sectors of the economy sensitively
dependent on credit markets, need to be considered.
Many of the most beneficial effects of a tax reduction
depend upon a conviction that it will have some permanence,
which in turn raises questions of an adequate commitment to
complementary spending policies and appropriate timing.
We
are not dealing with a notion of a "quick fix" over the next
few months for a recession of uncertain duration, but of tax
action for 1981 and beyond at a time when Federal spending
levels, even for fiscal 1981, appear to be a matter of considerable uncertainty, with the direction of movement higher.
Experience is replete with examples of stimulation,
undertaken with the best motives in the world, that ha<6 turned
out in retrospect to have been ill-timed and excessive.
Given
27
the demonstrable frailty of our economic forecasting, it takes
a brave man indeed to project with confidence the precise nature
of the budgetary and economic situation that will face the nation
around the end of this year.
Moreover, an intelligent decision
on the revenue side of the budget implies knowledge of the
spending priorities of an Administration and a Congress, a
matter that by the nature of things can only be fully clarified
after the election.
For all the .developing consensus on the need for "supply
side" tax reduction —
and I share in that consensus —
some time
seems to me necessary to explore the implications of the competing
proposals and to reduce them to an explicit detailed program
for action.
I have emphasized the need to achieve not only
productivity improvement but also a lower trend of costs and
wages; despite its importance, I have seen relatively little
discussion in the current context of how ,tax reduction plans
might be brought to bear more directly on the question of wage
and price increases.
The continuing sensitivity of financial markets, domestic
and international, to inflationary fears is a fact of life.
adds point and force to these observations and questions.
It
Tax
and budgetary programs leading to the anticipation of excessive
deficits and more inflation can be virtually as damaging as the
reality in driving interest rates higher at home and the dollar
lower abroad.
I believe it is obvious from these remarks that a convincing case for tax reduction can be made only when crucial
28
questions are resolved —
questions that are not resolved today.
The appropriate time for decision seems to me late this year or
early 1981.
Fiscal 1982 as well as fiscal 1981 spending plans
can be clarified.
underway.
We will know if recovery of business is firmly
There will have been time to develop and debate the
most effective way of maximizing the cost-cutting and incentive
efforts of tax reduction, and to see whether a tax program can
contribute to a consensus —
in the past —
a consensus that has been elusive
on wage and pricing policies consistent with
progress toward price stability.
To go ahead prematurely would
surely risk dissipating the potential benefits of tax reduction
amid the fears and actuality of releasing fresh inflationary
forces.
I have spoken before with this Committee and others about
the need for changes in other areas of economic policy to support
our economic goals.
on foreign oil —
Paramount is the need to reduce our dependence
a matter not unrelated to tax policy.
We need
to attack those elements in the burgeoning regulatory structure
that impede competition or add unnecessarily to costs.
And I
believe it would be a serious mistake to seek relief from our
present problems by retreat to protectionism, at the plain risk
of weakening the forces of competition, the pressures on American
industry to innovate, and undermining the attack on inflation.
We are now at the critical point in our efforts to reduce
inflation while putting the economy back on the path to sustainable
growth in the 1980's.
29
I sense the essential objectives are widely understood
and agreed —
the need to wind down inflation even as recovery
proceeds; the importance of restoring productivity and increasing
incentives for production and investment; the maintenance of
open, competitive markets; a substantial reduction in our
dependence on foreign energy.
You know as well as I how much remains to be done to
convert glittering generalities into practical action:
to
achieve and maintain the necessary fiscal discipline, to
make responsible tax reduction and reform a reality, to
conserve energy and increase domestic sources, to tackle the
regulatory maze.
But I also know there is no escape from
facing up to the many difficulties.
Our policies must be
coherently directed toward the longer-range needs.
In that
connection, I believe that economic policies, public and
private, should recognize that the need for discipline and
moderation in the growth of money and credit provides the
framework for decision-making in the Federal Reserve.
30
Board of Governors of the Federal Reserve System
Midyear Monetary Policy Report to Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
July 22, 1980
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., July 22, 1980
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES.
The Board of Governors is pleased to submit its Midyear Monetary Policy Report to the Congress pursuant
to the Full Employment and Balanced Growth Act of 1978.
Sincerely,
Paul A. Volcker, Chairman
31
CHAPTER 1
THE OUTLOOK FOR THE ECONOMY AND MONETARY POLICY OBJECTIVES
SECTION 1.
THE OUTLOOK FOR THE ECONOMY
The economy moved into recession in the first half of this year.
A cyclical downturn had been widely anticipated for some time, but the decline in spending, output, and employment, once under way, has been steeper
than most analysts had foreseen.
The second quarter decrease in real gross
national product, at an annual rate of about 9 percent according to the
Commerce Department's preliminary estimate, was considerably sharper than in
the initial quarters of other postwar recessions.
The slump in activity has been most pronounced in the housing and
auto industries—the latter sector being adversely affected by structural
problems as well as by general cyclical pressures.
been limited to these sectors.
But the decline has not
Retail sales excluding autos have dropped
considerably since January, and business outlays for equipment and new construction also have fallen.
The very sharp curtailment of spending on houses and consumer goods
and services in the current downturn probably is attributable in large 'part to
the cumulative effect of inflation on consumers' financial well-being. Real
disposable personal income was virtually flat in 1979 and has declined appreciably this year. Earlier, consumers had reduced their rate of saving in
the face of shortfalls in real income in an effort to maintain consumption
standards and in anticipation of inflation. This was accomplished by further
rapid growth in installment and mortgage credit in the late stages of the
recent expansion, but with the result that debt service burdens—which already
were at high levels historically—continued to climb.
Sharply higher interest
rates and generally more stringent credit terms in late 1979 and early 1980
acted as additional deterrents to spending, encouraging households in their
efforts to reduce debt and to rebuild savings.
32
The falloff in final sales has caused businessmen to spend more
cautiously.
This tendency has been reinforced by financial factors as well.
The liquidity position of businesses had deteriorated appreciably during the
expansion, particularly in the latter stages when there was a surge in shortterm borrowing; many firms now are making strong efforts to restructure
balance sheets.
The unexpected rapidity of the current downturn thus far has led
analysts to reassess their view of the prospects for economic activity in the
period ahead.
Significant disagreement has arisen with regard to whether
recovery will be prompt and strong, with the recent relaxation of credit market conditions encouraging a resumption of normal spending patterns, or whether
the cyclical adjustment will be prolonged and the subsequent upturn possibly
sluggish.
The experience of the past year or so has demonstrated the hazards
of forecasting, and the uncertainties at the present time clearly are substantial.
Much will depend, for example, on the perceptions of businessmen
about the longer-range prospects for demand and the attractiveness of investment, the response of consumers to the 1981 model-year automobiles, and the
strength of the rebound in housing that may develop in the wake of the recent
easing in mortgage market conditions.
There are signs that the contraction in some sectors may be nearing
an end, but these are far from conclusive. Retail sales in June turned up
slightly after four months of sharp decline; in the first ten days of July auto
sales were at the strongest pace in three months.
Housing starts and sales of
new homes strengthened in the most recent months for which data are available.
33
In reflection of the prevailing uncertainties, there is a considerable range of views among the members of the Federal Open Market Committee regarding the movement of major economic variables over the remainder of the
year. Most of the members believe that the recession probably will persist
into the fourth quarter, with a cumulative net drop in real GNP less than that
in the downslide of 1973-75. Although the decline should slow in the months
ahead, employment may be cut back further, and the unemployment rate could rise
beyond 8-1/2 percent by year-end.
The increasing slack in labor markets and in
industrial capacity utilization should at the same time help to moderate inflationary pressures*
The table below presents ranges for key economic variables that generally encompass the judgments of the individual FOMC members about the probable performance of the economy this year and in 1981.
Actual
1979
Projected
1980
1981
Change from fourth quarter to
fourth quarter, percent
Nominal GNP
Real GNP
Implicit GNP deflator
9.9
1.0
8.9
5 to 7-1/2
-5 to -2-1/2
9 to 10
8-1/2 to 11-1/2
1/2 to 3
7-3/4 to 9-1/2
Average level in fourth quarter
Unemployment Rate (percent)
5.9
8-1/2 to 9-1/4
8 to 9-1/4
The outlook for 1981 is especially uncertain at the current time.
Economic and financial developments over the next six months should lay the
groundwork for the recovery anticipated in 1981.
But, in addition, any
34
actions taken in the fiscal arena would have an impact on the path of recovery. The projections presented in the table, which do not assume a tax
cut in the next year, indicate a turnaround in economic activity—although
there is a considerable range of views concerning the potential strength of
the recovery. On balance, the forecast is for a moderate rebound in real
GNP, accompanied by some further slackening in the pace of Inflation.
Unem-
ployment, however, is likely to remain high throughout the year.
Should there be a tax cut in 1981, the impact on economic performance will, of course, depend on its timing and composition.
There is the
distinct—and very troubling—possibility that a poorly designed tax reduction, or one not coupled with adequate restraint on the expenditure side,
might give rise to added inflationary and financial pressures that would in
time dissipate the beneficial short-term effects of the fiscal stimulus.
Any indication that the Congress and the Administration were moving away
from a commitment to rigorous fiscal discipline would run the risk of reinvigorating the inflationary expectations that have played such a major role
in the economy's difficulties.
The Committee thus feels it important that
the question of a tax cut be approached cautiously; if a tax cut ultimately
is enacted, it should be carefully structured to enhance the productive
potential of our economy and to yield the greatest relief from cost and
price pressures over the longer run.
35
SECTION 2.
MONETARY POLICY OBJECTIVES
The task for monetary policy—and for stabilization policy generally—in the current circumstances obviously is a difficult one. Recession
naturally summons forth calls for stimulus to aggregate demand.
The prevail-
ing high level of unemployment, and the exceptional weakness apparent in
particular industries and sectors of our economy, certainly must be given
careful consideration in the formulation of public policy.
But caution must
be exercised In the application of any broad countercyclical stimulus, especially in the present environment of persistent Inflationary pressures.
Indeed, there is no clearer lesson from the experience of the past decade
and a half than that excessive stimulus is detrimental to the objective of
achieving and sustaining noninflationary, balanced growth.
A primary and continuing goal of monetary policy must be to curb the
accelerating Inflationary cycle.
ning to be made in that direction.
It now appears that some progress is,beginPrice increases have slowed considerably
from the pace of early in the year, in part reflecting some relief in the
food and energy sectors, but also as a result of the drop in demand pressures.
In addition, recent attitudinal surveys point to a reduction in inflationary
expectations.
The continuation of this trend in expectations will result
in a greatly improved economic and financial environment, one more conducive
to long-term growth.
inflationary fears:
We already have witnessed one benefit of an easing of
a substantial decline in long-term Interest rates from
their highs earlier this year and a revitalization of the bond markets.
The
Federal Reserve's pursuit of a policy of monetary restraint-—evidenced this
year by a moderation of money growth—has been an important factor in this
36
turn in expectations; a sustained commitment to the attainment of noninflationary rates of money and credit growth is essential if this progress is to
be extended.
Despite the improvement that has occurred, however, inflationary
forces are far from subdued. The past years have left a legacy of adverse
cost trends that will not be reversed quickly.
tionary expectations easily could be reignlted.
Moreover, more extreme inflaIn establishing its plans
for growth in the monetary aggregates, the Federal Reserve will continue to
place high priority on reducing inflation, believing that this is essential
to fostering a sound and sustained recovery. Over the long term, a reduction
in the underlying rate of inflation is essential for a strong U.S. economy,
for encouraging the saving we will need to finance adequate capital investment,
and for maintaining the position of the dollar in international markets.
But It is clear also that if inflation is to be restrained without
undue disruption of economic activity we cannot rely solely on monetary
policies. For example, fiscal discipline Is essential to ensure that excessive
pressure is not placed on the financial and real resources of the economy.
The
structure of our tax system should be examined with an eye to the incentives
it provides for productivity-expanding research and capital formation. And
the full range of governmental policies should be reviewed to ensure that
they do not add needlessly to costs and do not stunt innovation and competition.
37
SECTION 3.
MONEY AND CREDIT GROWTH IN 1980 AND 1981
In February the Federal Reserve reported to the Congress ranges
of growth for the monetary aggregates in 1980 that it believed to be consistent with the continuing objective of reducing inflationary pressures
over time while providing for sustainable growth in the nation's production
of goods and services.
These ranges anticipated a substantial deceleration
in monetary growth in 1980 from the pace of the preceding year.
Measured
from the fourth quarter of 1979 to the fourth quarter of 1980, the ranges
adopted were:
for M-1A, 3-1/2 to 6 percent; for M-1B, 4 to 6-1/2 percent;
for M-2, 6 to 9 percent; and for M-3, 6-1/2 to 9-1/2 percent.
The associated
range for bank credit expansion was 6 to 9 percent.
During the first half of 1980, growth of the monetary aggregates
slowed considerably from the 1979 pace.
The deceleration was particularly
marked for the narrower aggregates, M-1A and M-1B, which grew at ratesfbelow
the lower limits of their longer-run ranges—at annual rates of about 1/2 and
and 1-3/4 percent, respectively, from the fourth quarter of 1979 to the second
quarter of 1980.
(M-1A is currency and demand deposits held by the public,
while M-1B includes checkable interest-bearing deposits as well.) At the same
time, the broader aggregates, M-2 and M-3, grew at annual rates of 6-1/2 and
6-3/4 percent, respectively, which is somewhat above the lower limits of their
ranges.
In fact, by June, as the accompanying charts show, M-2—which includes
money market fund shares and all deposits except large CDs at banks and thrift
institutions—was around the midpoint of its longer-run range, and M-3 slightly
below, while the narrower aggregates were moving back toward their ranges,
following an unusually sharp drop in early spring*
38
Growth Ranges and Actual Monetary Growth
M-1A
Billions of dollars
Range adopted by FOMC for
1979Q4to 1980Q4
6%
3!/2%
380
360
Annual Rate of Growth
1978
7.4 Percent
1979
5.0 Percent
350
1980H1 0.4 Percent
I
I
I
I
1
I
I
I
I
I
I
I
I
I
1980
M-1B
Billions of dollars
Actual
Range adopted by FOMC for
1979 Q4 to 1980 Q4
—
4%
400
390
380
Annual Rate of Growth
1978
8.2 Percent
1979
7.6 Percent
1980 H1 1.8 Percent
I
I
I
i
I
I
1979
I
i
I
I
I
I
I
II
I
I
I
1980
i
39
Growth Ranges and Actual Monetary Growth
M-2
Billions of dollars
Actual
~~
Range adopted by FOMC for
1979Q4to 1980Q4
1700
9%
^**
6%
1600
1500
Annual Rate of Growth
1978
8.4 Percent
1979
8.9 Percent
1980H1 6.4 Percent
1980
M-3
Billions of dollars
Actual
~~
Range adopted by FOMC for
1979Q4to 1980Q4
9 1 /2%
6 1 /2%
1800
Annual Rate of Growth
1978
11.3 Percent
1979
9.8 Percent
1980H1 6.8 Percent
1979
—
40
The contraction in the narrower aggregates during the second quarter
was much greater than would be expected on the basis of the historical relationships among money, income, and interest rates. This unusual weakness may
have reflected exceptional efforts by the public to pare cash balances, such
as have characterized some other periods following a sharp upward adjustment
in market interest rates to new record levels.
There may also have been an
impact from the surge in debt repayments, especially at banks, after the imposition of the credit control program in mid-March, with some of the funds
apparently coming out of cash balances. In light of these special circumstances affecting the public's demand for transactions balances, and given
the relative strength of the broader aggregates and the usual lags between
changes in credit conditions and growth in the narrow aggregates, the FOMC
believed it appropriate to foster a more gradual return of M-l growth to the
ranges established earlier.
In connection with reserve targeting procedures, System open market
operations supplied a large volume of nonborrowed reserves over the course of
the second quarter. Given the weak demand for money and bank credit, most
of the added nonborrowed reserves were used by banks to repay borrowings
from the Federal Reserve discount window. Borrowings fell from a high of $2.8
billion on average in March to minimal levels recently, and the easing of bank
reserve positions was reflected in a sharp decline in the federal funds rate.
From their peaks of late March or early April, short-term interest rates have
declined 7 to 9 percentage points and long-term rates by roughly 2 to 3 percentage points.
41
Expansion in the broader aggregates over the first half of the year
reflected the very rapid growth for much of the time in money market mutual
fund shares, 6 month money market certificates, and 2-1/2 year small saver
certificates, instruments that pay market rates of interest. Late in the
period, as short-term market interest rates declined sharply, the contraction
in savings deposits at banks and other depository institutions halted, and
the outstanding amount of those deposits began to rise.
For part of the
period, growth in M-3 was sustained also by continued issuance of large time
deposits by commercial banks and thrift institutions, which are included in
M-3 but not in M-2; however, large time deposits began to contract in late
spring as credit demands weakened substantially.
Bank credit growth greatly exceeded the FOMC's range in the first
quarter of the year. The second quarter, however, saw a sharp contraction
in this measure, and credit growth was well below the FOMC-specified range as
of midyear. Demands for bank loans by households and businesses dropped
abruptly in the second quarter, while the banks—concerned about the possible
erosion of profit margins by high cost funds obtained earlier and seeking to
conform to the guidelines of the March 14 special credit restraint program—
pursued relatively tight lending policies. Businesses, meanwhile, have met
a substantial portion of their credit needs through issuance of commercial
paper (which serves as a close substitute for bank credit for many large
firms), by borrowing in bond markets, and by reducing holdings of liquid
assets*
Over the half year, the total of credit advanced by banks and in
the private short-term money markets rose at an annual rate of around 7-1/2
percent.
42
Growth Ranges and Actual Bank Credit Growth
Bank Credit
Billions of dollars
Actual
9%
Range adopted by FOMC for
1979Q4to 1980Q4
1220
6%
Annual Rate of Growth
1978
13.5 Percent
1979
12.3 Percent
1980H1 4.6 Percent
I
.
.
I
1980
,
i
43
At its meeting in July, the Federal Open Market Committee reassessed
the ranges it had adopted for monetary growth in 1980 and formulated preliminary goals for 1981.
The Committee elected to retain the previously estab-
lished ranges for the aggregates over the remainder of 1980.
This decision
by the Committee took into consideration the recent behavior of the money
stock measures as well as emerging economic conditions. In this regard it
was recognized that, if the public continues to economize on cash balances
to an unusual degree in the second half of the year, growth in the narrower
aggregates would likely fall toward the lower end of the established ranges.
With respect to the broader aggregates, growth in the second half
is likely to place them nearer the midpoints of their respective ranges, and
in the case of M-2 quite possibly in the upper half of its range.
Recent
trends suggest that a continued substantial expansion in the interest-bearing
nontransactions component of M-2 is likely. In the current cyclical environment, consumers have begun to reevaluate their financial positions and have
reduced their borrowing and adjusted upward their rate of saving.
Thus, if
the recent lower level of interest rates persists, the outlook is for an
augmented flow of funds to depository institutions along with continued,
though slower, growth in money market mutual funds.
The Committee also noted that the recent sharp contraction in bank
credit makes it quite likely that this measure will fall below the 6 to 9
percent growth range specified in February. A resumption of bank credit
expansion during the second half is anticipated, but the strength of that
move will depend to a,considerable extent on patterns of corporate finance.
The desire for balance sheet restructuring may well continue to mute business
44
loan demands, although weaker corporate cash flows and a narrowing of the
spread of the prime rate over commercial paper rates likely will prompt some
borrowing at banks. Mortgage loan demands also should begin to recover as
the year progresses, and the runoff in consumer loans is expected to abate.
One factor that contributed to the recent weakness in bank lending
was the Board's special credit restraint program. As announced earlier, the
program is being phased out this month because there is now no evident need
for extraordinary measures to hold bank lending within reasonable bounds.
In removing the special controls, the Board has emphasized its intention to
continue to maintain aggregate growth in money and credit at rates consistent
with a reduction in inflationary pressures.
With regard to monetary policy over the longer run, the FOMC reiterates its intent to seek reduced rates of monetary expansion over coming
years, consistent with a return to price stability. While there is broad
agreement in the Committee that it is appropriate to plan for some further
progress in 1981 toward reduction of the targeted ranges, most members believe
it would be premature at this time to set forth precise ranges for each monetary aggregate for next year, given the uncertainty of the economic outlook
and institutional changes affecting the relationships among the aggregates.
The extent and timing of adjustments in the targets will depend upon an
appraisal of the outlook at the end of the year.
The appropriate money growth
in 1981 relative to 1980 of course will depend to some extent on the outcome
in this year—that is, on exactly where in the present ranges the various
aggregates fall at year-end.
45
In addition, the various measures of money will be affected in 1981
by shifts in the demand for different types of financial assets.
The intro-
duction of NOW accounts on a nationwide basis in January will accelerate the
shift from regular demand deposits into interest-earning transactions balances,
thereby depressing M-1A growth next year.
On the other hand, M-1B probably
will be boosted somewhat next year by shifts from savings deposits and other
interest-bearing assets into NOW accounts.
The range for M-1B thus may have
to accommodate a period of abnormal growth as the public adjusts to the
availability of a new instrument.
The experience of the past year and a
half with ATS accounts has indicated the difficulty of estimating in advance
the public's demand for such balances. Although growth in M-2 and M-3 will
not be affected by NOW account movements, these broader aggregates include
other relatively new financial instruments, the demand for which is still
subject to uncertainty.
The behavior of these instruments in coming months
will aid the FOMC in determining appropriate growth ranges for the broader
aggregates in the 1981 period.
46
SECTION 4.
THE ADMINISTRATION'S SHORT-TERM ECONOMIC GOALS AND THE
RELATIONSHIP OF FEDERAL RESERVE OBJECTIVES TO THESE GOALS
The Administration, in association with its midyear budget review
has updated its forecast of the behavior of major economic variables for 1980
and 1981. The revised figures are shown below.
The Administration's Forecast
1980
1981
Change from fourth quarter
to fourth quarter, percent
Nominal GNP
Real GNP
Implicit price deflator
6-3/4
-3
10
12-1/2
2-1/2
9-3/4
8-1/2
8-1/2
Average level in fourth quarter
Unemployment rate (percent)
These estimates, which the Administration has indicated should be
viewed as forecasts rather than as goals, show a considerably greater decline in real activity in 1980 than had been anticipated in the January
Economic Report of the President. The outlook for nominal GNP growth through
year-end has been lowered by a smaller amount, owing to a somewhat higher
anticipated rate of inflation for the four quarters of 1980. The Administration's projections for this year fall within the ranges expected by the members of the FOMC.
47
The Administration has projected a resumption of output growth next
year that places real GNP near the upper end of the range encompassed by the
forecasts of the members of the FOMC. At the same time, the Administration's
estimates place the rate of inflation somewhat above the range of the FOMC
members' expectations.
(Like the FOMC members' projections, the Adminis-
tration's forecast does not include a tax cut provision for 1981.)
As indicated in the preceding section, the Federal Reserve intends
to set monetary growth ranges for 1981 that will help to restrain inflationary
pressures in the recovery period. As experience this year illustrates, considerable uncertainty attaches to any analysis of the relationships over relatively short periods among money, interest rates, and nominal GNP.
However,
a substantial expansion in demands for goods and services, accompanied by a
lack of progress on the inflation front—or worse, an actual increase in
inflation or inflationary expectations—would raise the possibility of a considerable firming of conditions in financial markets. Large and prolonged
federal deficits would increase that risk. This highlights the urgency of
concerted effort by the public and private sectors to reduce the rate of
advance in costs and prices and the need to focus any discussions of fiscal
action on approaches that would serve to alleviate cost pressures and bolster
productivity.
48
CHAPTER 2
A REVIEW OF RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
SECTION 1.
ECONOMIC ACTIVITY DURING THE FIRST HALF OF 1980
Economic activity turned down early this year following almost
five years of expansion.
Between January and June, industrial production
fell 7-1/2 percent, employment declined by about 1-1/4 million, and the
unemployment rate jumped 1-1/2 percentage points. Real gross national
product is estimated to have fallen at an annual rate of 9.1 percent in the
second quarter, with the decline in activity widespread among major sectors
of the economy. Retail sales have decreased substantially since January,
housing starts have dropped to near-record postwar lows, and business outlays for equipment and new construction have declined. Although businesses
were cautious in building inventories during the expansion, the severity of the
recent decline in final sales has led to some involuntary stock accumulation;
as in past cycles, the resulting efforts to curb inventory growth have
played a significant role in the weakening of orders and production.
Recent reductions in aggregate demand, coupled with a slower rise
of energy prices, meanwhile have brought some moderation in the overall pace
of Inflation. The producer and consumer price Indexes have risen at much less
rapid rates in the past few months than they did earlier in the year.
Moreover,
there are indications from consumer surveys that inflationary expectations
have been lowered.
Nevertheless, inflation still possesses a strong momentum,
with unit labor costs continuing on a steep upward trend.
Personal Consumption Expenditures
Personal consumption expenditures fell sharply in real terms during
the first half. A number of adverse trends had characterized household finances
for some time prior to the beginning of 1980. Real disposable income had stagnated after 1978, household liquidity positions had weakened as liabilities
49
Current Indicators of Economic Activity
Real GNP and Final Sales
Industrial Production
Billions of 1972 dollars
Index, 1967=100
1350
1300
130
1250
1200
110
I
1974
1976
1978
1980
I
1974
I
I
1976
I
I
1978
1980
Capacity Utilization in
Manufacturing
Unemployment Rate
80
I
1974
1976
1978
1980
I
1974
I
1976
I
I
1978
I
1980
50
increased faster than financial assets after late 1976, and a near-record
proportion of disposable income had been committed to the servicing of debt.
Moreover, consumer confidence, as measured by opinion surveys, had deteriorated to levels last seen in the 1973-75 recession. In the light of these
trends, a downward adjustment of consumer outlays might have been expected
last year; the fact that it did not occur appears attributable in part to
growing expectations of inflation that fostered a buy-in-advance psychology.
Between January and May, retail sales fell 6-1/2 percent in nominal
terms and more than 9-1/2 percent in real terms—the sharpest four-month drop
in the postwar period. Preliminary estimates for June, however, indicate that
sales moved up somewhat.
As in past recessions, large decreases in sales this
year have occurred for the relatively discretionary items of consumer expenditure.
Automobile sales in June averaged only 7.6 million units at an annual
rate, close to the May pace, which was the slowest since late 1974. Furniture
and appliance sales also are down sharply this year, in part because of the
fall in housing sales. But weakness in consumer outlays has not been confined
to the durable goods sector. Purchases of nondurables in real terms also have
been falling since late last year, with sizable declines recorded for clothing
and general merchandise.
Since January, real disposable income has decreased substantially
as employment and hours worked have fallen and prices have continued upward at
a rapid pace; nonetheless, the retrenchment by consumers has lifted the saving
rate somewhat above the extraordinarily low level of the fourth quarter of last
year. It still remains low by historical standards, however, and uncertainty
51
Real Personal Consumption Expenditures and
Real Disposable Personal Income
Billions of 1972 dollars
Disposable Personal
Income
1000
Personal Consumption
Expenditures
i i I i i
Housing Starts
Annual rate, millions of units
1.4
Single-Family
1.0
0.6
0.2
1979
1980
Auto Sales
Annual rate, millions of units
1979
1980
52
about job and income prospects may well prompt households to enlarge precautionary savings, thereby contributing further to the weakness in personal
consumption expenditures*
Residential Construction
Homebuilding activity has experienced a severe decline.
Housing
starts, which averaged nearly 1-3/4 million units at an annual rate during
the first nine months of 1979, began to fall sharply last autumn.
By December,
starts were at a 1-1/2 million unit pace, and by May they had declined almost
to a 900,000 rate. June saw a pickup in starts to a 1-1/4 million annual rate.
In the single-family sector, starts dropped 45 percent between the
third quarter of 1979 and the second quarter of this year. Although demographic factors remained quite favorable during this period, the demand for
such dwellings was curtailed by the increased cost of homeownership associated
with higher house prices and the rapid rise in mortgage interest rates. The
monthly cost of interest and principal on an average-priced new home financed
with a conventional mortgage rose to $700 in May—a third higher than six
months earlier and 50 percent above the same month of 1979. Households probably were increasingly reluctant to undertake such heavy financial obligations,
especially as income and employment conditions weakened this year.
Home sales have dropped almost 40 percent from the pace of last
summer. Although production adjustments have reduced the number of unsold
new single-family dwellings on the market, these unsold units bulk larger relative to the recent slower rate of sales. At the May sales pace, which was up
sharply from April, there was almost a nine-month supply of unsold new singlefamily units on the market.
The pickup in sales in May is perhaps a sign of
53
some increased Interest on the part of homebuyers, prompted by the recent
easing in financial markets; however, the still large overhang of unsold
homes is likely to discourage a quick resumption of building in many localities.
Multifamily housing starts began declining sharply late last year
and in the second quarter were off about 35 percent from the already-reduced
pace of the third quarter of 1979.
The decline in this sector has been less
severe than in the 1973-75 period, as low vacancy rates in many areas and an
acceleration in rent increases beginning in late 1979 have given builders an
incentive to sustain a significant level of apartment construction in the
face of high construction costs and tight financial conditions.
In addition,
demands for condominiums—a lower-cost alternative to single-family homeownership—have provided support to multiunit activity.
Business Spending
Business spending on plant and equipment has slowed in recent months
as firms have sought to avoid expanding capacity at the onset of a recession.
Spending on nonresidential structures, which accounted for much of the gain in
investment during 1979, peaked in January and declined substantially in the
following months.
Business purchases of trucks and automobiles also have been
falling since early this year, as have outlays for other capital equipment.
Weakness in capital spending in the first half of the year—as well
as in forward-looking indicators of investment activity such as surveys, construction contracts, and equipment orders—probably reflected businessmen's
anticipations that sales may remain sluggish for a while. In addition, corporate cash flows are diminishing, and with liquidity positions already
54
Contracts and Orders for Plant and Equipment
Annual rate of change, percent*
1972 dollars
20
10
30
_|
I
I
1974
1976
1978
Inventories Relative to Sales
Ratio
1972 dollars
Total Manufacturing and Trade
I
I
1974
I
I
1976
I
J_
1978
* Annual changes are from Q4 to Q4; semi-annual change is from Q4 to the April-May average.
1980
55
strained in many instances, there may be a reluctance to undertake additional
projects requiring external financing.
Although interest rates have fallen
dramatically from the high levels reached earlier this year, growing excess
plant capacity suggests the likelihood of further decreases in real outlays,
while firms take advantage of lower long-term rates to restructure their
balance sheets.
Despite sizable cutbacks in production, some involuntary inventory
accumulation appears to have occurred this spring as a consequence of the
steep fall in sales. The stock-sales ratio for all manufacturing and trade
in real terms rose only moderately during the first quarter, but climbed
appreciably in April and May to near the level of late 1974.
Since the start
of the year, substantial Increases in the ratio have been registered in most
major industries with especially large rises for primary metals manufacturers,
furniture and appliance retailers, and the motor vehicle industry.
Auto sales
incentive programs and production adjustments in the first quarter of 1980
largely eliminated excessive stocks that had resulted from last summer's gasoline shortages.
However, beginning in mid-April, automobile sales plummeted
and, despite further curtailments of production, some overhang of stocks at
dealers reappeared.
Government
Spending at all levels of government has been restrained in recent
months.
Total federal expenditures, which grew rapidly in the early months of
the year, moderated in the second quarter largely as a result of the March budget cuts. Growth in receipts fell off much more, however, as weakness in
56
Public Sector Expenditures and Receipts
Federal Government
Annual rate of change, percent*
NIA Basis
£] Expenditures
—
Oil Receipts
20
10
i I HII i I HII i
1978
State and Local Governments
1980
Annual rate of change, percent*
NIA Basis
[""| Expenditures
—
16
HO Receipts
I I
1974
1976
*Annual changes are from Q4 to Q4: semi-annual changes are from Q4 to Q2.
Data for 1980 H1 are partially estimated by the Federal Reserve.
I I Illl I
1980
57
personal income and profits offset the impact of additional revenue from
the windfall profits tax on oil producers. As a result, the federal deficit
on a national income accounts basis probably deepened by about $30 billion,
at an annual rate, between the fourth quarter of 1979 and the second quarter
of 1980.
However, the high-employment budget, a better indicator of the
thrust of discretionary fiscal policy, showed a movement toward restraint
during this period.
State and local government spending fell in real terms during the
first half of 1980, as governmental units curtailed outlays in response to
the slower growth of revenues caused by tax cuts enacted in 1979, the weakening economy, and the March reductions of federal grants-in-aid. The reduced pace of spending was most pronounced for construction activity because
federal funding was cut back and municipal bond Issuance was constrained in
the first quarter by high interest rates. Despite the downward adjustments
of outlays, the aggregate operating deficit of the state and local government
sector apparently widened considerably in the spring.
International Trade and Payments
Real exports of goods and services continued to grow rapidly in the
first quarter of 1980, but the rise appears to have slowed somewhat in the
second quarter. The deceleration largely reflected the slowing of economic
expansion abroad and the fading of the impact of the 1977-78 real depreciation
of the dollar. All of the growth in the first half was concentrated in nonagricultural exports; agricultural shipments were reduced, partly because of the
58
Exports and Imports of Goods and Services
Seasonally adjusted, annual rate,
billions of 1972 dollars
NIA Basis
110
90
1974
1976
1978
Trade and Current Account Balances
1980
Seasonally adjusted, annual rate,
billions of dollars
Surplus
1974
1976
Data for 1980Q2 Merchandise Trade Balance are partially estimated.
1978
1980
59
embargo on additional grain sales to the Soviet Union imposed by the President
in January.
The volume of imports, meanwhile, began to fall off as U.S. economic
activity slackened and as higher prices and greater fuel efficiency acted to
restrain oil imports. The volume of non-oil imports rose slightly on balance
in the first half of 1980, but all of the increase was in the first quarter.
The quantity of oil imports fell, apparently reaching its lowest rate in four
years in the second quarter. Despite a declining volume of oil imports in
the first quarter, higher OPEC prices resulted in a continuation of the rapid
growth in the dollar value of oil imports.
The oil import bill nearly doubled
between the fourth quarter of 1978 and the first quarter of 1980; in the
second quarter the value of oil imports changed little as lower volume offset
a further rise in import prices.
The U.S. merchandise trade deficit increased about $6-1/2 billion,
at an annual rate, in the first quarter of this year from the rate in the
last quarter of 1979.
The current account moved from a deficit of about $7
billion at an annual rate in the fourth quarter, and near balance for the
year 1979, to a deficit of about $10 billion in the first quarter of 1980.
Higher foreign earnings of U.S. oil companies offset part of the rise in the
merchandise trade deficit. Partial data indicate that the trade and currentaccount deficits narrowed in the second quarter.
60
SECTION 2.
LABOR MARKETS AND CAPACITY UTILIZATION
Labor demand was relatively well-maintained early in the year, but
it fell off steeply in the spring as firms responded to the sharp declines
in sales by cutting their work forces and shortening workweeks. Between
January and June, the number of workers on the payrolls of nonfarm establishments fell almost 950,000; total employment, as measured by the household
survey, fell more than 1-1/4 million.
With layoffs rising, the nation's job-
less rate jumped from 6-1/4 percent in January to 7-3/4 percent in May and
June.
Much of the cutback in employment occurred in the construction sector and in durable goods manufacturing, especially motor vehicle and related
industries. By June, the number of auto workers on indefinite layoff was
nearly 250,000 (about 30 percent of total hourly workers in the industry),
and substantial layoffs had occurred in the steel and tire industries as well.
Construction employment began to drop early in the year, and subsequently suppliers of building materials also reduced their payrolls.
During the spring,
however, weakness in labor demand began to spread throughout the economy;
employment at trade establishments dropped 190,000 over the second quarter,
and in June payrolls in the service-producing sector registered the first
monthly decline since 1975.
In addition to trimming payrolls, employers have curtailed work
schedules in light of the weakening of sales. Since January, the average
workweek at manufacturing establishments has been shortened almost 1-1/4
hours. More generally, the number of workers on part-time schedules for
61
Nonfarm Payroll Employment
Annual rate of change, millions of persons *
i
[Him
i
i
i
1978
1980
Manufacturing Employment
Annual rate of change, millions of persons *
J
L
I
I
1978
L
1980
Unemployment Rates
1974
1976
* Annual changes are from Q4 to Q4; semi-annual changes are from Q4 to Q2.
1978
1980
62
economic reasons rose sharply in the second quarter, with former full-time
jobholders accounting for most of the increase.
The rise in joblessness has been widespread among demographic and
occupational groups, with especially large increases reported among adult
males.
Since December, the jobless rate among men has climbed almost 2-1/2
percentage points, compared with an increase of 3/4 percentage point for
adult women, and June marked the first time in two decades that the rate for
men was higher than that for women.
Unemployment among blue-collar workers
rose sharply to an 11-1/2 percent rate in June, the highest since September
1975.
In contrast, unemployment rates among white-collar workers have in-
creased only marginally since the end of 1979.
The adjustments in output by firms, especially in the second quarter, were reflected in a sharp decline in the index of industrial production.
Between January and June, industrial production fell nearly 7-1/2 percent.
Production declines in auto-related industries and in industries supplying
construction materials began early in the year, but by late spring cutbacks
were occurring in most other industries as well.
Among manufacturing firms,
capacity utilization in June dropped to 76 percent, almost 11 percentage
points below its 1979 peak.
63
SECTION 3.
PRICES, WAGES AND PRODUCTIVITY
After exploding upward in the early months of the year, rates of
price increase moderated significantly in the second quarter. The improvement resulted primarily from a stabilizing of energy prices and from declines
in the prices of nonferrous metals, after a flurry of speculative activity
earlier in the year.
Increases in the prices of construction materials and
components also slowed noticeably in the second quarter with the decline in
activity in the housing sector.
In the energy area, retail prices surged in January and February,
in large part the result of the hike in OPEC prices that occurred in late
1979, but the pace of increase then slowed noticeably in the spring, as
inventories reached near-record levels and demand continued to drop. The
Increase in energy prices also moderated at the producer level.
Nonetheless,
indirect effects of earlier increases in the prices of fuels and petroleum
feedstocks were still evident through the end of June in items such as
plastics and rubber products, industrial chemicals, and household supplies.
Moreover, a number of factors—including the latest increases in OPEC prices,
the curtailment of gasoline production, and the progressive decontrol of
crude oil prices—suggest that further relief in the energy area is not to
be expected.
Food prices generally have exerted a moderating Influence on aggregate price measures since the beginning of the year.
At the producer level,
finished food prices fell at about a 4-1/2 percent annual rate between December
and June. Steep drops in wholesale prices through May—particularly for livestock—alleviated cost pressures at the retail level, contributing to relatively
64
Prices and Labor Costs
Change from year earlier,
annual rate, percent
Gross Domestic Product"
Fixed Weight Deflator
I
I
I
I
i CPI Food
I
I
10
I
I
I
1978
I
1980
65
stable retail food prices since the end of last year.
However, recent devel-
opments in the markets for livestock and fresh produce indicate that food
prices also are likely to rise more rapidly in the second half of the year.
Inflationary pressures have persisted in sectors outside food and
energy since the beginning of the year.
In the consumer price index, in-
creases in the homeownership component have been particularly large, as the
measures of mortgage rates and home purchase prices both advanced rapidly in
the first half of this year; the recent easing of mortgage rates will likely
hold down increases in the CPI during the next few months.
In the producer
price index, prices of capital equipment accelerated in the first half of
1980 from the already rapid pace of 1979.
Labor cost pressures remained intense in the first half of 1980,
as compensation increases were substantial while productivity declined
further.
Output per hour in the private nonfarm business sector dropped at
about a 1-1/2 percent annual rate in the first quarter, after falling 2 percent over the preceding year. At the same time, hourly compensation accelerated to a 10-1/4 percent annual rate, so that the unit labor costs of
nonfarm businesses rose at about an 11-3/4 percent rate in the first quarter.
Preliminary data for the second quarter suggest that unit labor costs continued to rise rapidly, as productivity contracted further.
Although cyclical
reductions in overtime and the changing employment mix may restrain the growth
in total compensation somewhat in coming months, wage demands are likely to
remain strong, especially in light of past increases in consumer prices.
Thus, upward pressures on unit labor costs will probably remain substantial
over the near term.
66
SECTION 4.
FINANCIAL DEVELOPMENTS DURING THE FIRST HALF OF 1980
Interest Rates
Market rates of interest moved sharply higher in the early months
of 1980, exceeding previous record levels and peaking around the end of the
first quarter. These increases were largely reversed in the second quarter
amid a substantial downslide in economic activity and contracting demands for
money and credit. The upward pressure on yields at the turn of the year resulted from a combination of factors, including a deterioration in inflationary
expectations as actual price increases accelerated in January and February, the
failure of incoming data to confirm the long-anticipated downturn in activity,
and international political developments that raised the likelihood of an increase in federal deficit spending. In February, moreover, growth in money
and credit surged, creating demands for bank reserves well in excess of the
provision of nonborrowed reserves consistent with the Federal Reserve's target ranges for growth in the monetary aggregates.
In the Treasury bill market,
in particular, the resulting rise in short-term interest rates was reinforced
by large sales of securities by foreign institutions to finance intervention
in foreign exchange markets.
On March 14, the Board of Governors took actions of a temporary
nature designed to reinforce the effectiveness of the measures announced in
October 1979 and thus to provide greater assurance that the monetary goals
reported to the Congress in February would be met. These actions, some of
which were taken under the authority of the Credit Control Act as part of a
broad government effort aimed at reducing inflationary pressures, included:
67
Interest Rates
Short-term
Percent
20
16
12
4-6 Month
Prime Commercial Paper
3-Month
\
Treasury Bill
j
i
I
j
i
1980
Long-term
Percent
Municipal Bond
1974
68
(1) a special credit restraint program directed toward limiting the growth
in loans to U.S. customers by commercial banks and finance companies to
ranges consistent with the monetary and credit objectives of the Federal
Reserve; (2) a special deposit requirement for all types of lenders on increases in certain categories of consumer credit; (3) an increase in the
marginal reserve requirement on managed liabilities of large member banks
and U.S. branches and agencies of large foreign banks; (4) a special deposit
requirement on increases in managed liabilities of large nonmember banks;
(5) a special deposit requirement on increases in total assets of money
market mutual funds; (6) a surcharge of 3 percentage points on frequent
borrowing by large member banks from Federal Reserve Banks.
These measures hastened the movement toward reduced credit availability already in train at many lenders, and apparently increased the resolve
of consumers to curtail their use of credit.
In subsequent weeks, incoming
data revealed a substantial slackening in money and credit growth to well
within the Federal Reserved objectives.
In light of these developments, the
Board amended the special credit program: on May 6 the 3 percentage point surcharge on discount borrowing by large banks was eliminated, and on May 22
special deposit requirements were reduced by half and the special credit restraint guidelines were modified.
On July 3 the final phase-out of the pro-
gram was announced.
The rise in most interest rates came to a halt in late March and
early April, and yields began to move down as demands for money and credit
dropped abruptly in response to developing slack in the economy. Most private
short-term rates fell 7 to 9 percentage points, to their lowest levels since
69
the spring of 1978.
In long-term securities markets, bond yields retraced most
or all of the Increases recorded earlier in the year, as market participants
appear to have lowered their expectations of inflation. The restraining posture
of monetary and fiscal policy, as well as moderating rates of price increase
in the cyclical downturn, has contributed to this improved outlook for price
changes.
Foreign Exchange Markets and the Dollar
Movements in U.S. interest rates greatly influenced fluctuations
in the foreign exchange value of the dollar over the first half of 1980.
The
dollar was in strong demand early in the year when U.S. interest rates rose
sharply. The growing perception by market participants of accelerating inflation and worsening payments deficits abroad gave added impetus to the dollar's
rise over this period, as did the announcement of credit control measures on
March 14. Authorities in a number of foreign countries also moved to tighten
monetary conditions, but the resulting increase in foreign interest rates lagged
well behind that of U.S. rates. The strengthening in the foreign exchange value
of the dollar in February and March was moderated somewhat by substantial intervention activities by U.S. and foreign monetary authorities.
The peaking and subsequent steep decline in U.S. interest rates in
early April triggered heavy selling pressure on the dollar in international
markets, and its foreign exchange value fell in the April to June period.
Foreign and U.S. monetary authorities intervened to moderate this decline by
making net purchases of dollars. Even so, by the end of June earlier gains were
entirely erased, and the weighted-average exchange value of the dollar at midyear was little changed from its value at the beginning of the year.
70
Weighted Average Exchange Value of U.S. Dollar*
March 1973=100
95
i
1977
1978
3-Month Interest Rates
16
v
Weighted Average of
Foreign Interbank Rates*
JL
JL
1977
1978
1979
1980
Weighted average against or of G-10 countries plus Switzerland using total 1972-76 average trade of these countries.
71
Domestic Credit Flows
Net funds raised in credit markets by domestic nonfinancial sectors
of the U.S. economy totaled a sizable $391 billion at an annual rate in the
first quarter of 1980, but contracted sharply to an estimated $193 billion in
the second period.
This exceptionally large decline in borrowing reflected in
large part the recent sudden weakening in production and sales activity; in
addition, monetary restraint, supplemented by the special policy actions of midMarch, contributed to tauter credit terms and reduced availability of funds at
many lenders.
In the private sector, the volume of funds raised in the first
quarter was greatly enlarged by a surge in borrowing on the part of nonfinancial business firms.
Some of this increased borrowing reflected needs to
finance growth in inventories and fixed capital outlays, as the gap between
such expenditures and internally generated funds of nonfinancial corporations
widened.
But fears that unchecked inflation would lead to the imposition of
credit controls and a consequent reduction in credit availability apparently
led to a burst of anticipatory borrowing by firms as well.
As a result, corpo-
rations added substantially to their holdings of liquid assets in the first
quarter and appear to have drawn down these holdings in subsequent months.
As interest rates moved up rapidly early in the year, businesses
concentrated their credit demands in short- and intermediate-term markets,
with borrowing at banks and in the commercial paper markets especially heavy.
Corporate bond financing remained relatively low as businesses, especially
industrial firms, were reluctant to issue long-term debt at historically high
72
Net Funds Raised in Credit Markets
By Domestic Nonfinancial Sectors
Seasonally adjusted annual rate, billions of dollars
— 400
— 300
— 200
1973
1974
1975
1976
1977
1978
1979
lurce: Federal Reserve Board Flow of Funds Accounts. Data for 1980 Q2 are partially estimated.
1980
73
yields.
This pattern of corporate financing shifted dramatically, however,
when interest rates dropped rapidly in the spring.
Public offerings of longer-
term corporate bonds accelerated to unprecedented levels, with the proceeds
from many of these issues being used to pay down bank debt.
After March, commercial banks—concerned both about pressures on
their earnings margins as interest rates dropped and about meeting the loan
growth guidelines of the voluntary special credit restraint program—tended to
discourage business borrowers.
In particular, adjustments in the bank prime
lending rate lagged substantially behind downward movements in other market
rates, greatly increasing the relative cost of this source of financing.
As a
result of the relatively high cost of bank credit, coupled with a desire of businesses to adjust their balance sheets following the heavy reliance on short-term
debt in previous months, business loans at banks contracted markedly in the
second quarter. Although commercial paper issuance by firms remained very
large, total short- and intermediate-term business credit demands in the second
quarter moderated appreciably from the first-quarter pace. Late in the second
quarter, the prime rate began to move down, narrowing the gap with market rates
somewhat; survey data, furthermore, suggest that banks in May were making a large
share of short-term business loans at below-prime interest rates.
In the household sector, consumers greatly reduced their use of
installment credit during the first half. The large growth of consumer installment and mortgage debt in 1979—both in absolute terms and in relation to disposable income—had produced a marked deterioration in household liquidity.
The combination of resulting heavy debt burdens, high Interest rates, and, in
some states, restrictive usury ceilings acted to slow growth of installment
74
credit In late 1979 and the first quarter of 1980.
The volume of outstanding
installment credit contracted in the second quarter as consumers curtailed expenditures and repaid debt against a backdrop of rapidly declining real incomes
and rising unemployment. Credit-tightening measures by lenders after the
announcement of the credit-control package on March 14 and uncertainty on the
part of consumers about the effects of those controls contributed further to
the reduction in credit use.
Household borrowing in mortgage markets also slowed considerably
in the first half. Reduced deposit flows and pressures on earnings margins
from rising costs of funds constrained the lending activity of thrift institutions and pushed mortgage rates to record levels in March. Many would-be
homebuyers were deterred by the high cost of mortgage credit. More recently,
lower market interest rates have helped to reduce cost pressures for thrift
institutions and have contributed to a pickup in deposit flows. Sharp drops
in mortgage rates since early April and reports of some easing in nonrate terms
suggest that lending institutions have become more active in seeking mortgage
loans since early June.
But mortgage rates remain high by historical standards,
while demands for housing and housing credit continue to be damped by a weak
economy and by the liquidity concerns of households; consequently, mortgage
commitment activity apparently has remained relatively sluggish.
The Treasury borrowed heavily in credit markets in the first half
to finance the combined deficits of the federal government and off-budget agencies. Normal seasonal patterns in federal cash flows associated with the
timing of tax receipts led to a concentration of the Treasury's borrowing in
the first three months of the year. Although the first-quarter deficit was
75
further deepened this year by unusually large tax refunds associated with overwithholding in 1979, the Treasury was able to even out its borrowing pattern
somewhat by permitting its cash balance to drop over the first quarter and
then rebuilding it in the second.
In contrast to the federal sector, net borrowing by state and local
governments dropped off in the first quarter but accelerated appreciably in the
second.
Many municipal governments postponed or canceled scheduled bond issues
early in the year because of high interest rates; for some governmental units,
these actions were necessitated by the rise of interest rates above statutory
limitations.
But the volume of tax-exempt financing picked up considerably in
the second quarter when interest rates fell and many previously postponed bond
issues were brought to market.
The financing needs of state and local units
generally increased over the first half in response to slower growth of revenues
and a consequent widening of their operating deficits.
In addition, the volume
of tax-exempt securities issued continued to be boosted by offerings of mortgage
revenue bonds, designed to finance single-family housing.
The CHAIRMAN. Thank you very much, Mr. Volcker.
We will now proceed under the 5-minute rule.
As I have indicated to you in my letter of July 1, 1980 and in my
remarks this morning, I am persuaded that we need a comprehensive monetary policy, including active supervision of the uses of
credit. This point is driven home, I believe, by the experience of the
Great Silver Bubble of early 1980. Your letter to me of July 21,
responding to my inquiries of June 12, sheds important new light
on the bank role in supporting rampant speculation in silver. I
would like to review the main points with you and ask a few
additional questions.
First, it is clear now that banks were financing silver speculation
from the beginning, even while the market was rising and while
the Hunts were still acquiring silver. Direct bank loans to the
Hunts on the upside of the market totaled at least $150 million,
loans through brokers at least $50 million.
Second, none of the banks consulted with the Federal Reserve
between October and March, to see whether such loans contravened the Federal Reserve's anti-speculative lending directives of
October. Only three banks reported making such loans under the
special credit restraint program instituted in March.
Third, both the Hunts and their brokers had long-standing business relationships with the banks involved. These relationships
may have permitted the Hunts to obscure the massive scope of
their February-March raid on the credit markets, and they may
have seduced the banks into witting or unwitting collaboration.
With respect to the Hunts, you state: "It is not at all clear that the
banks individually knew the extent to which the Hunts' wealth
was tied up with silver/' With respect to the brokers, you state: "It
76
does appear that some of the banks were not as diligent as they
might have been concerning the precise utilization of the funds."
You argue that the banks played only a minor role in the development of this fiasco. Nevertheless, the facts show that the Hunt
involvement was a major factor of credit restraint. The banks
apparently give three excuses for this noncompliance: First, that
they made the loans under previous commitments, second, that
they were unware of the uses to which the money was being put,
and third, that the loans were needed for "damage control". The
first excuse is clearly a legalistic nonsense: In light of the Federal
Reserve's expressed concern, the banks could and should have renegotiated their commitments. The second merely shows the credulity of the bankers in their negotiations with the Hunts. The third
illustrates a fundamental fallacy: If, in fact, the Hunts had known
that massive loans would not be available on the downside, then
very likely the original speculation would never have occurred.
My specific questions follow:
First, how many banks were involved, in total, in lending directly or indirectly to the Hunts? Of these, how many now profess to
have been unaware of what they were doing? Who were they?
Would you provide for the record of these hearings, the statements
of the three large banks who attempted to justify their Hunt loans
under the special credit restraint program? As a matter of artistic
draftsmanship these will surely be of interest.
Second, do you believe that the terms of the bail-out loan from
the banks to the Hunts via Placid Oil adequately protect the public
from further speculation by the Hunts? If so, how do you square
the recent purchase of a silver mine by Bunker Hunt's daughter
with the assurance given in your interim report that there would
be no further silver acquisitions by the Hunts or "any related
entity"?
Third, you note that the October admonitions to the banks were
without the "force of regulation, law, or even formal reporting
requirements." In retrospect, isn't it clear that the banks fell down
on the job, and that the Nation would have been better served had
there been formal reporting requirements?
Could we hear from you on those points, and to the extent that
you don't have time fully to respond now, we would appreciate it
for the record.
Mr. VOLCKER. Let me make one general comment on this situation that I think is essential to the understanding of bank's involvement.
Let me say, first of all, that nobody is less happy about this
whole situation than the person before you, both because of its real
impacts, the questions that it raises in terms of public policy, and
the amount of time that is involved on my part.
The point I wanted to make to start with is that, I think it is not
correct to say that bank lending supported this speculative activity
during the period of the rising market. There was relatively little
bank financing during that time. There may have been only one
bank who was lending to the Hunts against silver at that time. The
amount was a tiny fraction of the Hunt ownership of silver during
the rising market. The big credit expansions, extensions, took place
during the declining phase of the market, in effect when specula-
77
tive venture was coming to an end, not when it was in the damaging stage at the beginning.
Nonetheless
The CHAIRMAN. If I can interrupt, but even this little $200 million direct-plus-indirect bank loan to the Hunts is not peanuts.
There is many a bedraggled home builder, consumer, small businessman, who would have loved to have had that credit channeled
to him rather than to Bunker Hunt.
Mr. VOLCKER. I have forgotten the exact amount; it may have
reached a peak of $200 million during that stage; I think it was
only one bank. I don't want to defend the episode, but $200 million
is, as you know, a tiny amount relative to the total amount of bank
loans outstanding. I just want to put it in perspective. These big
loans arose on the downside.
So far as supplying the exact number of banks, I haven't got that
figure right in my head at this stage. I think that is all in the
interim report we presented.
The CHAIRMAN. Would you provide that for the record?
Mr. VOLCKER. Yes.
[Chairman Volcker subsequently submitted the following for inclusion in the record of the hearing:]
At this point, we have identified 24 banks that extended credit to the Hunts,
either directly or indirectly, prior to restructuring of the Placid Oil loan. Another 4
banks initially extended credit to the Hunts when the $1.1 billion Placid Oil restructured loan was funded for a total of 28 banks.
The above figure does not represent all the bank credit the Hunts may have
received through brokers (indirect loans). We are aware that a number of other
brokers extended credit to the Hunts; however, we have not identified any specific
bank credit used to fund such loans. This is an area of continuing review.
Mr. VOLCKER. I feel reluctant to provide the exact statements
made by the banks to which you referred. I think there are three
banks that volunteered to report; it is unfair to the banks that
didn't volunteer to report.
The CHAIRMAN. Let's do this, then. Leave their names out of it,
but I am fascinated by the literary pyrotechnics. They did all this
but left out the name of Bunker Hunt. Let me see their prose, but
leave out the names.
Mr. VOLCKER. I might say that in reading these explanations I
had some of the same questions you raised. Let us say this: Simply
knowing the loan was secured by silver did not tell them it was a
Hunt long position; that referred basically to loans to brokers. The
banks in some instances—maybe in all instances—certainly knew
the loan was against silver; some apparently thought it was a
hedge silver position as part of the normal mechanism of the
market. Whether they should have known more or less is another
question.
The CHAIRMAN. Furnish us with their alibis. I think that the
trout in the milk does persist in the minds of many of us. We may
be doing an injustice to these bankers. If that is so, we will be the
first to apologize.
Mr. VOLCKER. All I am saying is that knowing the loan was
secured by silver doesn't answer that question.
Are we adequately protected? All I can say is we are a lot better
protected than we were before. The banks negotiated a loan agreement. They negotiated the loan agreement at their initiative. At
78
my insistence, but without their resistance, provisions were put in
to protect against renewed speculation to the best of their ability. I
am convinced that those provisions are as tight as lawyers can
reasonably make them.
You asked me whether that loan agreement with the Hunts
covers everything in the world; it doesn't.
The CHAIRMAN. How about his daughter, though?
Mr. VOLCKER. The term "related entities" in that loan agreement
technically means people and entities that were related, that somehow had participated with the Hunts in this particular episode,
whether they are companies or people.
Apparently, the daughter did not participate with them in the
loan agreement. It does not cover every member of the extensive
Hunt family; it would cover those who had been participating in
that silver episode.
The CHAIRMAN. Are you aware of the fact that the lady was into
soybean speculation heavily over a period of years?
Mr. VOLCKER. I am not aware of all the activities of every
member of the Hunt family over a period of years. I know that this
purchase of stock—it is a relatively small amount of stock, as I
understand it, by Hunt standards, a small piece of the company—
to the best of my knowledge—and I did look into it—certainly did
not involve any of the bank lenders who were involved in this loan
agreement.
As near as I can see, it didn't involve any bank credit at all. It
was a purchase of stock apparently by the Hunt daughter, a small
piece of a silver mining company. It didn't involve any bank credit,
to the best of my knowledge.
Your third question was, should there have been reporting earlier? Well, I don't know. One can always go back and try to replay
the tape. I don't feel strongly on that issue. I think there is an
implication—maybe a direct statement in what you read earlier—
that the banks paid no attention to what we had said either about
speculation or takeovers.
I don't think that is a fair comment at all. That does not say that
you cannot find instances that one would question, and I might
question, as to whether it was the most full-faith following of the
request as might have been hoped for. I don't think there is any
doubt that there was a good faith effort by a great number of
banks, and I
The CHAIRMAN. Let me be clear on that. My indignation on this
matter is principally because the many good bankers are made the
fall guys for the corner-cutters who are greedy for profits.
Mr. VOLCKER. That kind of problem arises in these programs. I
must say that when you get into particular instances the issue is
seldom black or white. When it is really black, I think the banks
cooperate. We have had, for instance, during this period—as one
kind of example of the problems that arise—a number of inquiries
from Congress and elsewhere as to whether banks should not be
permitted or even encouraged to finance a takeover in specific
instances. A couple arose when a foreign company was threatening
to take over an American company and the American company,
understandably, said, "How can we get our so-called white knight
if nobody can finance him?"
79
A number of people had sympathy with that argument. I only
bring that up to illustrate that it is very hard to say one type of
lending is bad, another type of lending is good. There are all sorts
of shades of gray. I don't think you can say, obviously, that all
activity in commodity markets is bad. Commodity markets serve a
very real economic purpose, and it requires a certain amount of
lending and borrowing to make those function, just in the normal
course of events.
The CHAIRMAN. Well, my 5 minutes approaches its end, but I
would say, with all of the force I can muster, that just as we look
to the judiciary to make microdistinctions, just as we listen to Mr.
Justice Potter Stewart say of pornography that he can't exactly
define it but he sure knows it when he sees it, just as we ask the
administration to exercise its fiscal power, not just to deal with
boxcar macroeconomic balanced budgets, deficits, or surpluses, but
to be concerned with their content and composition, we believe
that the Federal Reserve must, according to its lights, observe a
similar microeconomic emphasis.
The reason I have devoted my 5 minutes to silver is that this is
one of merely scores of examples where our current miseries, I
believe, are due to the flowing of credit to the wrong things instead
of to the right things.
Mr. VOLCKER. I have no reason to believe there are scores of
situations that in any way parallel this silver lending in terms of
magnitude or impact. I think our general philosophy and approach
at the Federal Reserve—not just as a matter of Federal Reserve
decision but as general philosophy in this area—has been that we
basically want those markets to operate in a competitive environment, on their own.
It is not our job to say this loan is a good loan or that loan is a
bad loan. That philosophy has guided us basically through history.
Of course, it is a philosophy that isn't confined simply to bank
lending.
The CHAIRMAN. Do you eschew the accolade I gave you before,
which I sincerely meant, relative to last October when you said
that commodity speculation and corporate raiding are not desirable
uses of the Nation's scarce credit, but that capital investment,
enhancing productivity, small business, farmers, consumers, and
housing are. Do you slough off the compliment I was paying you?
Mr. VOLCKER. Not if it is confined to that particular situation.
We did it and meant it. I am referring to what is a basic continuing policy. I don't think it has been our posture in the past, it is
not our posture now, and I, frankly, hope it is not our posture in
the future, to put ourselves in a position of deciding that one loan
is a good loan, another loan is a bad loan.
As I wrote to you recently, I think we can try—and we are
trying, although it is not an easy process—through changes in
either our examination or statistical procedures or both, to get a
better handle promptly on any unusual episodes of this sort that
might arise again and to, in effect, discourage banks or caution
banks about the problems of certain types of speculative lending.
The CHAIRMAN. A moment ago you said—and I agreed with
you—that many banks have been patriotic and public spirited in
their adherence to your list of goods and bads. To make that
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statement, you must have been capable of some intellectual judgment as to what they were doing.
I leave you, then, with the thought that you do have a continuing obligation, not to fool around with individual loans, but to
establish standards to which banks of goodwill can repair. Otherwise we are not going to escape, in my judgment, from the inflation/recession bind that we are in.
My time is up.
Mr. VOLCKER. If I may just add one very brief comment. The
kinds of problems that arose in the commodity market, I think, can
and should be attacked through a different avenue. What are the
proper rules and regulations, including margin requirements, borrowing requirements, all that sort of thing, on commodity markets?
We are working very hard in that area.
The CHAIRMAN. Well, if you slough off the Federal Reserve's duty
in these premises, I hope you will be as specific in telling us who
should carry out those duties as you are in telling us what tax
policy should be.
Mr. VOLCKER. We are aiming—in cooperation with other agencies—toward making very specific recommendations in this area,
which may include some Federal Reserve authority.
Mr. MINISH. Mr. Chairman, aren't we under the 5-minute rule?
The CHAIRMAN. Yes, we are. I am guilty of
Mr. MINISH. We are going on to 20 minutes right now.
The CHAIRMAN. Right.
Mr. Stanton?
Mr. STANTON. I certainly agree with the Member from New
Jersey that we should move along.
Mr. Chairman, two points: First, I was very pleased to see your
reference on page 6 to what I would assume were references to the
Credit Control Act of 1969. In that statement you said that credit
controls involve the kind of arbitrary intrusion into decisionmaking that should not be a part of monetary policy.
I have restrained from talking to you about this subject or corresponding with you on it because while it was in the process of
being implemented, on the actual books it, of course, was part of
the President's program on inflation.
Now that it is off the books, in the light of the broadness of that
legislation that took place December 17, 1969, I wonder what your
personal views would be on a sunset provision to the Credit Control
Act, perhaps 1 year from now?
Mr. ANNUNZIO. Will the gentleman from Ohio yield?
You made a statement that the Credit Control Act is off the
books.
Mr. STANTON. No. Its actual implementation.
Mr. ANNUNZIO. That is right. It is off the books. They are just
not using it now.
Mr. STANTON. It has been on the books since December 17, 1969.
My question is, Would you consider because of its hardness,
especially its rough treatment of consumers in our country, the
poor people, consider some kind of sunset legislation perhaps for 1
year from now which would force Congress to take a look at it,
perhaps curtail some of those controls, if not take them off? What
is your feeling on that?
81
Mr. VOLCKER. My personal feeling about that act is that it is,
indeed, a very sweeping piece of legislation with rather broad
criteria for its use, to put it kindly.
It is not really appropriate to have that sweeping grant of power,
in this case to the President and the Federal Reserve combined.
You have a protection in a sense that both sides have to act.
When I look at the language of that legislation on its face, I
share the feeling that it is extremely sweeping; it would permit, in
the last analysis, control of almost all transactions in the economy;
it makes me uneasy.
Mr. STANTON. The second question, Mr. Chairman. You made
yourself very clear on the subject of tax cuts next year, presumably
along the lines of a 10-percent, 15-percent, 20-percent individual
tax cut. I wonder, could you comment quickly: Would your objection also lend itself to such language that over 300 of us have
cosponsored called the Capital Cost Recovery Act, which would
limit itself strictly to a change in the method of accounting of the
actual depreciation schedules that we refer to as 10-5-3, known as
the Jones-Conable or Conable-Jones bill?
This type of legislation it seems to me is necessary to give
industry a leadtime. I am vitally interested. There is a plant in my
district, a steel plant. This means a good deal to it. It takes months
and years of planning ahead. Would your objection to specific tax
cuts also lend itself to something like that?
Mr. VOLCKER. I think it is clear in my statement—I hope it is—
that when one begins talking about tax reduction and rates, which
I think is a very good topic of discussion, that the effort ought to be
to maximize, among other things, the impact on the investment
saving process, and on enhanced productivity.
One of the leading contenders, obviously, in that area is some
kind of depreciation reform. There are other ways of going but I
have myself believed that the depreciation area is the best way to
do it; for the maximum kick for minimum revenue loss, particularly in the short run, it has a lot of appeal.
Whether the 10-5-3 proposal specifically—and I do not want to
pose as more of an expert than I am
Mr. STANTON. I am limiting the question specifically to that, not
to broaden it out as maybe the administration has.
Mr. VOLCKER. I am not familiar with the particular bill you are
referring to. I do not think I can make a sweeping comment in
opposition to measured response to the problems we know exist, on
the productivity-investment side, and with known revenue costs
that are tolerable, in light of everything we know now.
My comments refer to a total tax package. I think there is some
merit in putting things together in a package.
That is not my judgment to make in the end. I think all of these
things have to be gaged toward the general problems that I tried to
lay out here.
Mr. STANTON. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Moorhead.
Mr. MOORHEAD. Thank you, Mr. Chairman.
Mr. Volcker, I am going to follow up a little on Mr. Stanton's
comments about the Credit Control Act.
82
I think that having had experience with it, with the imposition,
with the removal of it, we ought to be thinking about the future. It
seems to me that the imposition had the very good effect of converting a blazing fire into some smoldering embers and that the
removal of the controls did not cause the fire to blaze up again, so
that it has some merit.
I do agree with you that some of the language is rather staggeringly broad. Would not, in your opinion, the better approach be—
based on your experience in administering the act—to have the
Federal Reserve—since it is the primary accounting agency—propose amendments to the act based on your experience rather than,
in effect, a repeal outright or a delayed repeal?
Mr. VOLCKER. We could do that. I think my own basic feeling is
that our ordinary control powers, except in very exceptional circumstances, are going to be adequate. We do have some emergency
provisions in the act that you passed this year, dealing only with
the reserve requirement question.
Now the real debate, it seems to me, ought to be as to whether
there is some reason, on a very exceptional basis, to have a little
more clearly defined emergency power than granted by either the
Credit Control Act—because it is too sweeping—or by the Monetary Control Act because it is limited to one particular use of
reserve requirements.
I am sure you understand that when the Credit Control Act was
invoked, we used an instrument that was very parallel to our
ordinary instruments of monetary policy. We did that quite deliberately. We used
Mr. MOORHEAD. Mr. Volcker, why did you not use the existing
one rather than the Credit Control Act if you could have accomplished
Mr. VOLCKER. I do not think we could have accomplished precisely that purpose in the same way. I think we could look at that and
see whether the addition of some language to existing law would
make it just a bit more flexible. Maybe that would take care of the
problem.
Let me say that I do not feel bereft without this kind of legislation, that sat there for 10 years without being used—or rather it
was used for one brief, exceptional period—but I think it is a
reasonable question as to whether, with some modification of existing law, so to speak, the standby purpose might be served.
Mr. MOORHEAD. Thank you, Mr. Volcker.
Let me turn now to the questions of tax cuts. What if there are
proposals for an immediate across-the-board 10-percent tax cut? I
would like to ask you, first, what would happen, in your judgment,
to the now projected—$30 billion deficit for 1981? As I see it, we
have two ways of financing it. Either by printing money, which is
inflationary, or by borrowing, which removes money from the capital markets.
The implication for those who support a tax cut is that of stimulating income that will immediately rise and that the deficit would
not increase. Do you share that opinion, sir?
Mr. VOLCKER. No, not in the short run. You can make that
argument over a period of time, but certainly not in fiscal 1981.
83
Mr. MOORHEAD. If we come to considering a tax cut—and you
mentioned here an increase in the payroll taxes in 1981, and I
think you have also suggested a tax policy that would increase or
make more attractive investment possibilities—if we were to consider a tax cut, do you believe it should be directed to a combination of reducing or holding fast on the payroll taxes, which I think
are both inflationary and deflationary, and on stimulating investment which, frankly, would not have that immediate effect, but
would—in the long run—hopefully increase productivity?
Mr. VOLCKER. I think all the tax actions you take should be
taken toward the long-range need to deal with productivity and
costs and incentives. There are purchasing power implications, too,
but you should not just look at a purchasing-power tax reduction.
You should use this opportunity, if indeed it arises at all, to get the
maximum impact in terms of these long-term requirements.
On the particular question of the payroll tax, there are competing considerations. I would love to see the payroll tax not go into
effect or offset because it has a direct impact on costs and inflation.
Mr. MOORHEAD. It also takes money out of the worker's pocket.
Mr. VOLCKER. It has the purchasing-power implication.
On the other hand, social security, I think for good reason, in
this country is financed with a tax related to benefits. That link is
an important piece of philosophy that I hate to see broken. How
you can do both at the same time, relieve the impact of the payroll
tax and maintain the link with benefits at a time when the fund is
potentially running out of money, is obviously the dilemma.
I think it is worth a little thinking as to whether some way
cannot be found through that; I would love to see it done. On the
other hand, I hate to see the link broken.
Mr. MOORHEAD. I would not break it as far as retirement is
concerned. Maybe some other benefits.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Gonzalez.
Mr. GONZALEZ. Mr. Chairman, on page 4 of your statement, your
short statement, you say:
There is no doubt in my mind that these lower levels of interest rates can play a
constructive role in the process of restoring a better equilibrium and foster recovery.
It has been argued that the delicate position of the international
dollar makes it difficult to lower interest rates in our country, at
least as quickly as we might otherwise like to, as you infer.
Suppose we could get our major allies, Germany, Britain, to
lower their interest rates as we lower ours, while fighting inflation
with tighter fiscal policies, if necessary. Could we not then lower
our interest rates a little faster without having short-term capital
flow overseas and setting off an inflationary pressure on the
dollar?
Mr. VOLCKER. I have a couple of comments. Our general posture,
as you know, is not to, in a sense, manipulate the interest rates,
but to try to guide our operations with somewhat longer range
vision—if that is the right word to use—about the aggregates. The
interest rates fall out of that process.
With the economy slumping, interest rates have gone down. In
that context, I think they play this constructive role.
84
Now, these interest-rate movements can affect, let us say, the
dollar internationally, both because they may be misinterpreted as
a basic change in policy and the expectation about inflation and all
the rest, and also directly, because of the interest rate relationships
to which you refer. So that inherently there is another side of the
coin: What is going on abroad.
I have rather continuously evaluated this situation. We have
discussions about it internationally. You say, "Would it not be nice
for other countries to tighten up their fiscal policy and ease their
monetary policy?" Yes, it would be nice, from the standpoint of this
immediate situation we face. Whether that is feasible and desirable
from their standpoint, given all the problems they have in manipulating fiscal policy, their own evaluation of the economic outlook,
and all the rest, I don't know. It is not a flexible tool, let me put it
that way.
These countries come back to us and say why don't you do the
opposite?
I do not think we can expect to live in a world where everybody
is readily changing basic fiscal policy in response to all those
relatively short-term problems. But differing postures of the different countries are an important thing, a relevant consideration;
they are under more or less continuous observation and recurrent
discussion.
Mr. GONZALEZ. Well, but has there been any effort to exert
American leadership at any point? You have the emergence of
EMF and EMS without a whimper from us. It is obviously intended
as part of the forced policy that even U.N. conferences have accepted. They have done it to us. They have insisted on
Mr. VOLCKER. But the question you are referring to, Mr. Gonzalez, is a question that has arisen in literally the past 3 months. In
the previous 3 or 4 months, the shoe was very much on the other
foot. They, in fact, said why can't you do more on fiscal policy and
less on monetary policy, because the dollar is going up too much
and our currencies are going down. Our answer is that it is not all
that easy to change fiscal policy overnight. That is their question
at the moment.
I think we have been setting a basic structure for several years.
It is another thing to cope with what is a very short-term problem.
Indeed, I believe the major factor that will affect the dollar over
any reasonable period of time is the degree of conviction that is
generated about the prospects for the American economy generally,
for inflation in particular, and for the balance of payments. The
balance-of-payments side is rather favorable at the moment, relative to the unfavorable situation that most other industrialized
countries have.
The key element is whether there is, in fact, progress and an
appreciation of progress on the inflation front. In that circumstance, I do not think you have to worry so much about these
short-range wiggles—or more than wiggles—in the short-term interest rate.
I do not think you can expect that we can handle every one of
these basically cyclical problems through a basic change in fiscal
policy. It is just too hard to do in that time frame.
85
Mr. GONZALEZ. Well, when the pressure was on, though, it has
been done.
Mr. VOLCKER. I think it is reasonable to talk about it as a basis
for general strategy. But you cannot put it in the context of a
problem for the next 2 months, or 3 months; it has to be fit into a
longer term perspective.
Mr. GONZALEZ. I notice my time is up. I wanted to get into what
I call M3. That is groceries. And one of my predecessor Congressmen from my district, Maury Maverick, Sr., during the height of
the Depression when they were talking about constitutional crises
preventing remedial help for the people suffering, he said, well, he
was interested in preserving the Constitution, but also groceries. I
think that is the issue today in America.
I do not have time. We will get to that later.
The CHAIRMAN. Mr. Wylie.
Mr. WYLIE. Thank you very much, Mr. Chairman.
Mr. Volcker, I would like to followup on what Mr. Gonzalez was
into there. You have expressed some reluctance to allow interest
rates to fall any further at this time; and may I assume that this is
at least partly responsible for the money growth being below your
targets?
Mr. VOLCKER. I put it the other way around, I think. We felt we
should not push very hard to get reserves in and make up that
April drop just as fast as we possibly could for a variety of reasons.
Now that might have—probably would have in the short run
driven the short-term rates down. What it would have done to the
long-term rates is not at all clear to me. I am sure it would have
led to a lot of confusion about whether we were headed off on
another bout of inflation. You might have actually gotten a perverse effect on long-term rates. If we just shot the money supply up
again, that is a policy that would have lasted for a month or two;
we would have been back on target. But then you would say we
have to go back the other way again. That would have whipsawed
the market.
Mr. WYLIE. I understand what you are saying, but from my
standpoint, why would it not have been better to allow interest
rates to come down further vis-a-vis our own economy? Is it the
fear, as Mr. Gonzalez suggested, that the dollar might fall on
foreign exchanges and might that not be good for our economy?
Would that not be good for American exports such as automobiles?
Would that not be good for American imports or for foreign imports such as automobiles?
Mr. VOLCKER. We basically have stayed on a course of providing
reserves, and the interest rates are going to fall out of that.
You know, I am not happy—I would not be at all casual about—
the prospects of a real foreign exchange disturbance. We have not
had that. I do not think, on balance, it would be helpful at all. I
think it would be quite destructive of the kind of progress we want
to make over a period of time, because it generates inflationary
expectations; it is a problem in its own right for us and for other
countries. I am sure it would be temporary anyway in terms of our
competitive position. So on balance, I would not look at all casually
on that kind of foreign exchange situation, to take just that aspect
of the problem. Among other things, when you get that kind of
86
foreign exchange situation, it is not going to be a good climate for
domestic bargaining.
Mr. WYLIE. Mr. Stanton talked about the Capital Cost Recovery
Act a little while ago. You commented on that. I cosponsored that
bill, too. It brings up another question. That is a possible increase
in, and making permanent, an investment tax credit which Mr.
Miller suggested as preferable when he was here. Would you comment on the permanent investment tax credit? Are you more in
favor of that?
Mr. VOLCKER. I would just offer perhaps a helpful comment.
There are alternative ways of dealing with this investment problem. I support the idea that this is the key problem, that we have
to look at it.
Which technique is the best in getting the maximum favorable
impact with the minimum cost is an appropriate matter for debate.
I do not have a judgment for you in the last analysis as to whether
you should push an investment tax credit as compared to the
depreciation reform.
That answer obviously should be resolved not simply on the
merits—where the merits are very close between the two—but on
where the consensus lies, where it is easiest to move forward if,
indeed, the impacts are very similar.
Those two cases, I think, come pretty close to having a rather
similar impact, depending upon the specific design.
Mr. WYLIE. The capital cost recovery might go more to wages or
more to operating expenses rather than directing it to, it seems to
me, capital investment.
Mr. VOLCKER. If that is true; I am not familiar enough with it.
Mr. WYLIE. As you say, there are a lot of questions here which
are subject to legitimate debate which makes it all the more difficult for us in the final analysis.
As we know—I want to followup on your reluctance here to talk
about money targets for next year; 1980 is, of course, a Presidential
election year. This year's candidates, so far, differ rather sharply
on the question of whether or not there should be a tax cut for
fiscal 1981, although I noticed in the New York Times today—I
guess on Monday—that the President is talking about having some
sort of leadership conference to shape a tax reduction bill, which is
almost certain to pass Congress this year.
Does the iffyness of your projections relate to the iffyness of the
outcome of the election?
Mr. VOLCKER. It does not relate to the outcome of the election at
all.
Mr. WYLIE. That does not enter into the uncertainty of money
projections for next year or the difficulty in projecting money
targets?
Mr. VOLCKER. No. I think I can honestly say I do not remember
the word election or anything connoting that episode arising in our
discussions.
Mr. WYLIE. Would there be much difference in the projected
monetary and credit aggregates under an assumption of a 10-percent tax cut or whether there was no tax cut? That is really what I
am getting at.
87
Mr. VOLCKER. As a first approximation, I would say our longterm goal and objective is to get these monetary targets reduced.
The principal difference of whether or not you have a tax reduction will be in the impact on the credit markets.
One of the concerns that we have is that you get what I guess I
called yesterday a collision between t$fr provision of money and
credit at a reduced rate—which this committee supported; the committee in the Senate supported; and which has been general
policy—and other policies, if they are all inflationary; then you
have a problem. If deficits arise, wages rise, cost trends are exacerbated in other ways, and we are working, plugging away, at trying
to get the money supply reduced, you have a collision.
Mr. WYLIE. Let me say your reluctance to give money targets
adds to our confusion, of course. I think tli^t it can be projected.
Mr. VOLCKER. I am beginning to get the message that it adds to
confusion. My message was that it should not.
Mr. WYLIE. If you cannot guess what it is going to be like, how
can we?
Mr. VOLCKER. I indicated that the FOMC was very concerned
that the kind of figures that we would give would add to the
confusion rather than relieve the confusion. If we give figures, I
think they would have to be, in a sense, on the assumption that we
did not have institutional change; that this is what the targets
would be if we did not have to take account of NOW accounts,
money market funds, and so forth.
That may be the clearest way of expressing our objective.
Mr. WYLIE. Thank you very much.
The CHAIRMAN. Mr. Minish?
Mr. MINISH. Nice to have you before the committee.
I am not going to get involved in this technical language involving Mi, because M2, M3; before we are finished, we will be up to
Mi6. People will confuse it with guns and butter.
I want to ask a simple question. What is the outlook for the
economy?
Mr. VOLCKER. I have to preface that with my usual comment,
about which I feel rather strongly: We make a mistake in economic
policy to put too much money on any particular forecast. We have
been fooled too often in the past. You get yourself in more trouble
by saying, "I know what the economic outlook is; I am going to put
all policies in that basket for the short run/'
I think we ought to realize and recognize there is uncertainty
here. We ought to stay on a path.
That has real implications for monetary policy. As you can see,
that is happening: the economy went into a slump, interest rates
went down. That, in itself, is a contribution to economic recovery.
Interest rates went down faster in my judgment than if we had
been operating on the old technique and had to manipulate them
down.
It was in the chairman's statement; you have an automatic countercyclical force at work.
My own feeling, and the estimates of the FOMC, were summarized in our report. The range was fairly wide. They reflected a
general consensus that the recovery ought to begin in the latter
part of this year, during the fourth quarter sometime; that was the
central trend of the discussion, with a rather restrained recovery
next year based upon what we know now.
The most recent information—even since we had that discussion—strikes me as being somewhat more favorable. I don't want
to put too much weight on that, but we have had a bigger increase
in homebuilding than many people expected. There is some indication that the car industry will come back to some degree from a
very depressed level.
The last consumer buying figures suggested that normal patterns
may be returning, but those are, at this point, straws in the wind.
I wouldn't put a lot of weight on them, but they tended to be in
that direction.
Mr. MINISH. Mr. Chairman, we have received reports that some
financial institutions, are charging social security recipients $1.50
when their check is mailed for direct deposit to the institution.
How widespread is that?
Do you have an idea?
Mr. VOLCKER. I do not know. I will look into it.
Mr. MINISH. Frankly, it is outrageous as far as I am concerned. I
will appreciate if you can get us more detailed information.
Thank you, Mr. Chairman.
[Chairman Volcker subsequently submitted the following for inclusion in the record of the hearing:]
This is the first instance that has come to our attention in which a financial
institution is imposing a service charge for direct deposits. Other institutions that
have communicated with our staff from time to time have all indicated that they do
not impose a charge. I should add, however, that many institutions believe the
Electronic Fund Transfer Act and the resulting regulation impose an undue burden
on institutions that are subject to Regulation E only because of their participation
in the federal recurring payments programs.
The situation you describe is illustrative of a general problem that, unfortunately
and all too frequently, arises in the implementation of statutes designed to benefit
consumers. While the regulations do protect the majority of individuals and groups,
they can also cause unintended hardships on others—despite conscientious efforts to
impose only those requirements necessary under the statutes.
In the case that you brought to our attention, the action taken by the New Jersey
bank was the result of its efforts to conform to Regulation E. The regulation
requires, among other things, that financial institutions offering EFT services provide customers with documentation of electronic fund transfers, including preauthorized credits. Financial institutions that receive direct deposits of social security
benefits, for example, have the choice of sending a notice of receipt or of giving
customers a telephone number that they can call to verify whether a deposit of
funds has been received by the institution. For some institutions, sending a notice
each time (though costly) is more feasible than responding to telephone calls from
customers.
Although there is no prohibition against charging for EFT transfers, so long as
disclosures are given, we are surprised that a charge would be imposed for direct
deposits made via the automated clearing house network. Direct deposits, like the
electronic handling of many other transactions, are cheaper in the long run than
making transfers by paper check. We understand, however, that this particular
bank has relatively few direct deposit customers, and it may be unable to realize
economies of scale sufficient to offset the added costs imposed by the Act and
regulation.
The CHAIRMAN. Mr. Annunzio.
Mr. ANNUNZIO. Mr. Volcker, I just have one compliment. You
would make a very good Congressman. You do answer the mail.
My mail is also answered.
You would make a very excellent prisoner of war because you
wouldn't tell the enemy a thing.
89
Mr. Chairman, there is a feeling in the savings and loan industry
and the building industry that there is a move on in the Federal
Reserve Board and that fake deregulation committee that I didn't
vote for to kill the savings and loan business, and in fact it has
been suggested that you are the triggerman.
Quite frankly, from the recent actions of the Fed and the DIDC,
it would appear that these feelings are well founded. As we know,
despite a small increase in housing starts last month, housing
starts are at a 10-year low and may well reach the lowest level
since the 1930's.
What I would like to know is, what you, as the chief monetary
officials of this country, plan to do to make certain that the housing industry does not disappear, just like our TV industry, our shoe
industry, the disaster that hit the auto industry? I could go on and
recite the litany of what is happening.
I also would like your views on the savings differential which—it
is no secret to you—I favor that very much because it hasn't cost
the taxpayers one cent—between the savings and loans and the
banks.
What is wrong with allowing S. & L.'s to pay more so that we
can have a sound industry in the housing field? In that regard,
does the DIDC plan to abolish the differential prior to the 6-year
cutoff date mandated by the Congress?
Under the reserve setting authority granted by H.R. 4986, your
agency was granted broad new powers with setting reserves for all
financial institutions. In that regard do you or does the Board have
any plans to expand these powers to further regulate savings and
loan, credit unions, or to try to examine these institutions?
Mr. VOLCKER. You have suggested a direct answer, and I will try
to give you a direct answer.
Mr. ANNUNZIO. I am a very direct guy. I would appreciate a
direct answer.
Mr. VOLCKER. I am delighted you raised the question.
Mr. ANNUNZIO. If you are against the differential, just say so.
Mr. VOLCKER. Let me go through this in order, if I can remember
all the parts of the question. I really appreciate the chance to put a
little different perspective on some of these questions.
I think the first question was whether I am masterminding the
demise of the savings and loans?
The answer to that question is
Mr. ANNUNZIO. And the housing industry?
Mr. VOLCKER. The answer to that question is that it is a ridiculous thought. Nothing could be further from the truth. Could I be
more explicit than that?
Mr. ANNUNZIO. Go ahead. I am listening.
Mr. VOLCKER. So far as the decisions of the DIDC are concerned
with respect to the differential, obviously the general answer is, we
are going to follow the law. The law, I think, requires that a
differential on any instrument in existence before some date in
1967, as I remember it, be maintained for this period.
The committee will follow the law and maintain the differential
on all those instruments that were in existence and are covered by
the act.
Let me, if I may—the final question was what?
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Mr. ANNUNZIO. The final question was if you are planning to
expand
Mr. VOLCKER. The answer to that question is no. If I can return
to the middle question and explain the nature of the decision that
was made by the DIDC, I would appreciate it, because I think it
was a constructive decision in the interests of this country.
We had several purposes in mind in making the decisions that
were made in May I know it looks Complicated, because the structure that had been built up was inherently complicated. We
changed some aspects of a complicated structure and inevitably
that looks complicated.
I think the general purposes that we had in mind should be clear
enough. One of those purposes—in a sense the basic purpose, the
most significant purpose of those changes—was to put all the depository institutions, including the savings and loans, in a more
favorable competitive position vis-a-vis the rest of the market.
The money market funds
Mr. ANNUNZIO. You know there is no competition when the
banks have had 150 years to build up their business and their
checking accounts.
You have given people checking accounts that they don't want,
so that statement is
Mr. VOLCKER. I know there is enormous competition between all
these institutions and money market funds, which happened to be
by far the most rapidly growing institution and which don't put
any money into mortgages
Mr. ANNUNZIO. You are going to see more smalltown banks,
neighborhood banks, small thrift institutions out of business before
you get through.
Tell me what you have in mind for the housing industry. How do
you plan for us to come back so that the young people of this
country can buy a home at a reasonable interest rate?
That is what the people want to know.
Mr. VOLCKER. If I may finish describing what we had in mind
with this decision, one consideration, one important consideration,
was to put all these institutions, all of which provide money—not
only to housing, but so far as some of them are concerned to
agriculture, to automobile dealers, and to others that also urgently
need credit—in a better position to do that job.
Mr. ANNUNZIO. You put them in a difficult position.
Mr. VOLCKER. Their inflows of funds
Mr. ANNUNZIO. Companies with 75 years of business went out of
business.
Mr. VOLCKER. Their inflows would unquestionably be lower today
if we had not made the decisions that we made in May.
Second, we made a very modest step toward deregulation, which
is the name of the committee, and said that consistent with our
first objective, if market interest rates go low enough, these institutions can all compete more freely for money so that they can
channel it to housing and other vitally needed areas of credit
demand.
Finally, on the differential, if I may address myself to that: the
differential was not touched on the form of deposit which seems
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most suitable and most desirable and most stimulative of housing,
that is, the 2V2-year certificate.
On the money market certificate, the differential was kept in the
operative range with an exception for people who held already
deposits in commercial banks which they had obtained during a
time when there was no differential; there was a rollover privilege
provided.
We were, without question, concerned about the impact of sizable
drains of funds from small banks around the country that were
very heavily pressed in providing agricultural credit, in providing
credit to local small businesses, automobile dealers, and others.
I continue to believe it was a highly constructive decision made
by that committee, consistent with the intent of the Congress,
consistent with the interests of the homebuilding industry, and
consistent with the interests of the country as a whole.
Mr. ANNUNZIO. My 5 minutes are up. I want to end by saying
that the best favor you can do for this country—that all of us that
were involved in the creation of this committee—swallow our ego,
and come out and make some suggestions to get rid of the committee.
Your statements are good, Mr. Volcker. You make beautiful
statements, but they don't add up to action on what is going on.
Mr. VOLCKER I am willing to let that action stand. It can be
debated, and if someone else can tell me how to do it in the better
interests of the country, I will be glad to listen.
Mr. ANNUNZIO. Come up with a proposal to get rid of that
committee we created.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. Mr. Chairman, as you know, one of the pieces of
legislation now before this committee involves the creation of
export trading companies.
Mr. VOLCKER. Yes.
Mr. LEACH. The most contentious issue within that is whether
banks should be allowed to take involvements in these trading
companies.
Do you have a position on that issue?
Mr. VOLCKER. Yes. I have had some conversations and correspondence with Senator Stevenson who has been the chief sponsor
in the Senate, as you know. I was about to have some further
conversation with him today.
The remaining issue, as I understand it, is the question of bank
control. We approach that issue, generally, as saying that this
country has had a philosophy and a tradition of distinguishing
between banking and other businesses. That line has been maintained pretty much through thick and thin, so we have been reluctant and opposed to opening a large hole in that traditional approach and letting banks go into an export trading company that
could conduct a great variety of commercial activities.
The export trading company idea may be a very constructive
idea from the standpoint of the country. Our question is, Does it
require bank ownership? The bill permits—and we are not troubled
by this—bank participation in the ownership; the only issue is
control.
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The Board has felt rather strongly on maintaining this traditional distinction. Senator Stevenson has raised with me the issue of a
very limited purpose export trading company, perhaps put together
for one project or for a series of discrete projects, or a trading
corporation that is handling some specialized area of trading, not
the kind of thing that is likely to attract widespread ownership
interest.
I am prepared to indicate to him, if that is the concern—speaking personally now—that we may retain the presumption against
control, but perhaps make an exception where there is a showing
that in a particular case a limited purpose export trading corporation really cannot operate without a sponsor and it must be a bank.
But let's keep the banks out of the big multipurpose trading
corporation idea. I don't think we want to duplicate the Japanese
experience in that particular respect. It is contrary to the general
way we have organized our banking system. I would hope something can be worked out in that area.
The rest of the bill, as I understand, looks fine from our standpoint. I think it could be constructive.
Mr. LEACH. I would basically agree with you on that and just
want to pursue one other thing touched upon earlier. That is this
issue of growth in liquidity outside the banking system.
Domestically, a most notable example is the money market fund
phenomenon. Obviously there is an inequity here in tax policy
because reserve requirements are not applied in the same way as
they are on deposits in banks and other financial institutions. It
seems from a tax equity point of view one should either establish
reserve requirements in one area or take off certain reserve requirements in other areas.
Is the Fed prepared to utilize its authority or make a legislative
recommendation that will have an effect upon equalizing competition?
Mr. VOLCKER. Yes. It is an annoying issue that has substantive
repercussions over a period of time. It is partly the reason, I think,
the Eurodollar market has expanded so rapidly in recent years.
We have approached it from both directions. We have had extensive discussions with foreign countries and foreign central banks
about how competitive conditions might be equalized, approaching
it through the Eurodollar market. There were differing opinions
among foreign countries on that. By the nature of the problem, you
have to have widespread agreement where everybody moves to the
least common denominator.
Mr. LEACH. How about within our own country?
Mr. VOLCKER. Domestically you can approach it from the perspective of reducing reserve requirements.
There have been proposals made for domestic international
banking facilities, I guess that is the term. Board consideration of
that was deferred more than 1 year ago in light of the international discussions and in light of the Monetary Reform Act.
The Monetary Reform Act clarifies our legal ability to do that, so
I would expect it to come before the Board of Governors within the
next 2 months for a decision.
Mr. LEACH. Thank you. My time has expired. I would appreciate
your presenting something more specific in writing about the issue
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of money market funds and how to insure equitable competition as
well as the impact of money funds on small rural banks in particular.
Mr. VOLCKER. That is another matter; it is an issue. I haven't got
a magic answer. I will be glad to elaborate on it further.
Mr. LEACH. Thank you.
[In regard to the colloquy above, information submitted for the
record may be found in the appendix.]
The CHAIRMAN. Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman.
Mr. Chairman, on page 3 of the Board's report, the Blue Book,
dated July 22, 1980, you offer a table which presents ranges for key
economic variables, probable performance of the economy this year
and in 1981.
For the fourth quarter of 1980 to the fourth quarter of 1981,
percent changes projected are as follows:
For normal GNP, 8.5 to 11.5 percent; implicit GNP deflator, 7%
to 9.5 percent; real GNP, minus 5 to minus 2.5 percent in 1980 to .5
to 3 percent in 1981.
Mr. Chairman, you offer these projections. Yet you will offer us
no projections for money growth over the same period.
It seems simply inconceivable to me that you could begin to
consider these projections of economic activity without considering
money growth. It seems to me that you have done much to restore
some confidence in the fact that this country is serious about
fighting inflation. I am very concerned that if you will not focus,
especially on MiB, which I think would solve some of the problems
that you discussed earlier on this subject, and give us and those
that watch these figures, and this economy carefully, a clear projection of the intention of the Federal Reserve, most especially on
MiB, which is what people can spend, then I think you will undo
much of the good that you have done.
Mr. VOLCKER. Let me just state the other side. I now understand
that impression exists. We discussed this for hours, partly in connection with these projections. The clear consensus that emerged
from the committee was that in a conceptual sense—if I can put it
that way—we want to continue to make progress in 1981 toward
some reduction.
I will just illustrate the problem by reference to MiB. The transfer from demand deposits in MiA to MiB does not affect the MiB
total; it affects the MiA total, and from that standpoint the MiB
total looks good. The transfer of savings deposits to MiB artificially
inflates MiB. That will undoubtedly happen next year; we will have
an artificially inflated MiB figure. So if we had taken the view that
you expressed here we might have said,
Look, we really have to make some assumption on whether the rate of growth of
MiB is affected by savings deposits. It certainly will be. So let us assume—just for
technical reasons, nothing to do with policy—that whatever our projection would
otherwise be on M1B, we should add 2 percent to it, or 3 percent, or 4 percent.
Our fear of doing that was that that would yield a confusing
figure. You would think we were going wild.
That is the kind of problem we had in putting this in perspective.
You understand that at the same time we would be saying. "But
look, MiA is going down; and MiB is going down from its earlier
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target. It is a confusing business. I sense the confusion that is being
created. I am a little afraid of the prospect of creating still more
because of this technical, purely technical, problem. This is a transfer of existing money. It has nothing to do with policy or what the
growth rate should be over a period of time.
Mr. NEAL. Mr. Chairman, I understand that. I think though, if
you would set your targets and explain it as you have this morning, and on several other occasions, that it is the clear intent of the
Fed to follow a policy of gradual reduction over time, make it clear
that is a consistent policy you intend to stick with, and are dedicated to sticking with, and annotate it any way necessary to clarify
these technical concerns—that it would
Mr. VOLCKER. That is precisely what we tried to do. We apparently tried to do it in too brief a compass to make it fully comprehensible.
The wording was rather carefully chosen to, I think, reflect the
sense of what you are saying, which I understand. We have maybe,
unwittingly, raised some questions that we did not anticipate,
frankly because we thought we were putting it in the way that we
thought would be clearest.
Mr. NEAL. Would you attempt to help us with this? Make it
clear? Especially with the focus on MiB?
Mr. VOLCKER. I am worried about the focus on MiB; we have to
have a bigger context than that somehow.
Mr. NEAL. On another subject, there has been some discussion of
these money market funds. There was a period when it appeared
that a lot of money was flowing out of the small savings institutions, small banks, savings and loans into the big money market
funds.
I guess as interest rates come closer together, that trend would
be reduced somewhat. But even though it might not make sense to
require reserve requirements on all money market funds—because
they all do not behave like banks—would it not make sense to
require reserves on those money market funds that do behave like
banks: Those that offer checking privileges, for instance, so that we
might create a more level playing field, as I believe has been your
intent?
Mr. VOLCKER. There is that possible approach. It has its problems, like everything does. Again, we could kind of go the opposite
way. If anything is done at all, we could say they shouldn't act like
banks, they shouldn't have checkwriting privileges, make a clear
line of distinction between the banking business—the transactions
balance business in particular—and the liquid investment business
that is the basic business of money market funds.
One of the problems you run into, of course, is that money
market funds, while substantively providing virtually the same
service, are organized differently. They are mutual funds operating
under the investment laws, and that creates problems of its own.
There are varying degrees of urgency with which people approach
this problem, but this is an area in which I share the feelings that
that competitive position should be examined to see whether it
really is fair and sustainable over a long period of time.
Mr. NEAL. Doesn't it have some impact on your ability to control
the monetary aggregates also?
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Mr. VOLCKER. Yes. Not only to control, but !in reading M2. We are
always trying to find out what these aggregates are trying to tell
us when they move, and what the significance of a change is. Those
money market funds, I think, are quite properly in M2, but they
are growing so rapidly—partly at the expense not of other things
in M2, but of things outside of M2, that you have to at least have in
mind the question as to what extent, when they are growing so
rapidly, that biases the M2 figure.
If the world stood still and we didn't have these kinds of changes,
it would be easier. When the world changes in these respects, you
have to have some room for judgment as to the meaning of the
change.
Mr. NEAL. Are you sugesting a policy change of any kind?
Mr. VOLCKER. Regarding money market funds?
Mr. NEAL. Yes.
Mr. VOLCKER. I don't want to suggest a policy change at this
moment. I want to suggest that I think it is an area that ought to
be looked at, but I haven't got a conclusion so far.
Mr. NEAL. My time has expired.
The CHAIRMAN. Mr. D'Amours.
Mr. D'AMOURS. Thank you, Mr. Chairman.
Mr. Volcker, thank you for presenting your testimony. I have a
couple of observations and then a few quick questions.
In your dialog with Mr. Stanton, I got the very clear impression
that you are very concerned about the Credit Control Act, authority that you and the administration have. You are uneasy about it, I
think you said.
Mr, VOLCKER. Uneasy.
Mr. D'AMOURS. It seems this act has been on the books for 10
years and hasn't done anybody any harm. It did us, I think, a
considerable amount of good. If it ain't broke, why do you want to
fix it?
Mr. VOLCKER. I think the word is uneasy rather than gravely
disturbed.
When I look at that, it is just an extremely sweeping authority
and, in that sense, I suppose it doesn't conform with my basic
instinct about legislation, which is that it should be a little better
defined if it is going to be there at all.
Mr. D'AMOURS. Are you anticipating making any suggestions,
issuing any reports, doing anything to eliminate, change
Mr. VOLCKER. We have issued a first report. We will issue another report on our credit restraint program part of which was
made possible by use of that act. I haven't contemplated any particular action with respect to the Credit Control Act itself.
Mr. D'AMOURS. Another observation. I want to be sure I have
this straight. In response to your colloquy with Mr. Wylie earlier,
do I understand you were saying that the Kemp-Roth proposal is
inflationary and as such it would cut against our attempts to lower
interest rates?
Mr. VOLCKER. I said what I said in my statement rather carefully. I don't want to get drawn into anything that could resemble a
partisan comment here. I think the thrust of what I am trying to
say
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Mr. D'AMOURS. If you prefer, I won't refer to it by name, if that
changes anything.
Mr. VOLCKER. The thrust of what I am saying is that a tax
program of that type, or any type, has to be looked at in the
context of these other criteria that I tried to spell out or allude to.
Is it the most effective, practical package we can put together in
terms of the savings investment-incentive cost problem we have? Is
it really the most effective package you can make? Is the timing
right? Can we afford at this time the impact on the deficit?
We can't answer that question without asking what the expenditure trend is going to be. If you are talking about a 3-year tax
program, what is the expenditure trend going to be over 3 years? Is
the implication of that kind of approach that we are really going to
cut spending persistently and vigorously over a long period of
time? Or are we going to spend more?
I don't think you can answer the question that you raise without
going into those other questions, because the danger is if they are
not answered and if they are not answered affirmatively. You
might have the problem to which you alluded: That you don't get
any advantage out of the tax reduction, but rather what you may
have done is increased the Federal deficit, had an impact on the
credit markets, have done more damage in that direction than the
constructive intent of the bill. So the criteria have to be in place.
Mr. D'AMOURS. I just thought I heard you tell Mr. Wylie that
you didn't think that was the direction we ought to take.
Mr. VOLCKER. I don't think it is the direction we ought to take
now. I don't think those criteria are in place.
Mr. D'AMOURS. Under existing criteria, the answer to my question is yes.
Mr. VOLCKER. We should not go ahead? The answer is "Yes."
Mr. D'AMOURS. That it was inflationary?
Mr. VOLCKER. Yes. As the situation exists now, yes.
Mr. D'AMOURS. The answer is yes?
Thank you.
Does the Federal Reserve, Mr. Chairman, have any way of knowing pretty accurately at any given time how much speculative
lending is being engaged in by banks?
Mr. VOLCKER. No.
Mr. D'AMOURS. Wouldn't that be desirable to develop?
Mr. VOLCKER. Yes. In the abstract it is desirable. I have had
some correspondence with your chairman about this.
You run into the problem that one man's speculative loan is
another man's perfectly good investment.
But we are looking at and have action underway as part of the
regular examination process. Are there criteria, procedures that
the examiners can use to identify or discourage really excessive
speculative activity that might go to the safety and the soundness
of the bank?
We are also looking at the routine, statistical collection to see
whether there are some different subdivisions we can make that, in
effect, would give us a better clue to highly unusual speculative
activity. We are not going to pick up normal, continuing activity
which goes on all the time in support of the commodity markets.
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Mr. D'AMOURS. While the Credit Control Act was being enforced,
weren't you requiring some sort of reporting?
Mr. VOLCKER.
Yes.
Mr. D7AMOURS. Couldn't that be continued? Simply continue
what you were already doing?
Mr. VOLCKER. Theoretically, yes. We decided not to do that; we
had some cautionary words; we decided these other approaches
might be more promising. We have a real problem of definition: A
loan ordinarily doesn't jump out at you and say, "I am speculative."
Mr. D'AMOURS. I have one quick question remaining in my time.
All of the charges that have been built into the credit card industry to offset the cost effects of the Credit Control Act, is there
anything being done to monitor whether these charges are being
removed now that the Credit Control Act is no longer being applied?
Is anything being done to look into what could be done about
getting them removed?
Mr. VOLCKER. We followed that to some degree—and I am sure
we will follow more closely during this period than in the past—
and have had a flow of information about charges for credit and
charges for cards and all the rest.
I don't think you should relate that increase in costs in a substantive way to the Credit Control Act. The amount of extra cost
imposed by that provision that we introduced after the Credit
Control Act was triggered was minor. I think it did have a psychological impact, without any question. I am sure many lenders, in
effect, said:
If the Government is indicating official concern to this degree about the extension
of consumer credit, we have a favorable psychological climate for going ahead and
introducing cost increases we want to make anyway.
But I think the basic rates and charges for cards were charges
they wanted to make anyway, whether or not the Credit Control
Act was on. I think they took it as some kind of official imprimatur
on their ability to do so with minimum adverse repercussions on
the part of customers.
It wasn't a calculation that, "The Credit Control Act in itself cost
us x dollars which we have to recoup/7 It was that they were under
heavy cost pressure anyway. It is a little hard, many of them
found, to be making consumer loans at 12 percent or 18 percent
under the usury statutes when they have to pay 18 percent for
money.
Mr. D'AMOURS. Thank you very much, Mr. Chairman.
The CHAIRMAN. Mr. Green.
Mr. GREEN. Thank you, Mr. Chairman.
Mr. Vplcker, you remember last October there was the unfortunate incident when the financial markets were perturbed by incorrect monetary data from one of the major New York banks. When
we were looking into that at that time, I raised the question as to
whether there was an investigation as to trading in interest rate
sensitive securities by anyone involved with this data. In response
to my question, special counsel was appointed to investigate the
matter. I do not know whether it was the Federal Reserve System
or the New York bank that appointed special counsel. The staff
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advises me we have never had a report on the outcome of that
investigation.
Mr. VOLCKER. I have not yet had the final report of the special
counsel. I inquired myself recently and was told that it would be
with us very shortly. The general counsel just told me the final
draft is being reviewed. I have had an interim report which was
not disturbing in that connection.
Mr. GREEN. I hope we can have that.
Mr. VOLCKER. When we have the final report, we will send it up
here.
Mr. GREEN. Regarding the midyear monetary policy report, I was
struck by the first chart on page 26 which showed a remarkable
phenomenon in terms of the Federal Government spending, that
the rate of increase from 1978 to the first half of 1980 of the
annual rate of change was quite markedly up, whereas the rate of
increase in Federal Government receipts was quite markedly downward over that period.
Does not this one picture really tell us as much as thousands of
words as to why we have our economic problem today?
Mr. VOLCKER. It is certainly part of the problem. I would not
point entirely at 1 year. The deficits, the high expenditures—it is
precisely that trend which suggests to me that one of the criteria
about a tax reduction has not been resolved, not to my satisfaction,
anyway.
Mr. GREEN. If I can turn to page 31 of the report, you note a
sharper rate of adult male than adult female unemployment.
In the past there was an assumption that adult male unemployment is more painful in a sense because at that time it was
assumed that female employment was essentially secondary wageearner unemployment. I would not assume that in this day and
age, but I wondered if you care to comment?
Mr. VOLCKER. I have not examined that particular relationship
closely. It is an interesting contrast.
I assume it reflects what is going on in the chart immediately
above. It is manufacturing employment that has been hard hit;
that is predominantly male.
Mr. GREEN. I see.
Let me return to a question that Mr. Wylie raised. Do you feel
that the level of the dollar in the foreign exchange markets compared with other major foreign currencies is an appropriate one,
one that we should be comfortable with as a country?
Mr. VOLCKER. Oh, I am always happier to see the dollar rising
than falling, if you want an honest answer.
It is on a level which I think is certainly consistent with our
competitive position. I think we are in a reasonably good competitive position. One could raise the question whether it is not too low,
but it is within the range in which it has traded for roughly 2
years now.
Mr. GREEN. So you would not advocate a policy of trying to
reduce the value of the dollar?
Mr. VOLCKER. I certainly would not.
Mr. GREEN. Thank you, Mr. Chairman.
The CHAIRMAN. Thank you.
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Let me say, Chairman Volcker, in connection with the matter
that Mr. Green referred to, the statistical problem which gave rise
to your appointment of a special counsel, I have not seen the report
from the special counsel, but I commend you for doing what seems
to me exactly the right thing. There was a question, a cloud in
people's minds. The appointment of an outside counsel with a letthe-chips-fall-where-they-may mandate was the course I would have
thought best calculated to quiet things down. It certainly quieted
me down.
Mr. VOLCKER. I, of course, agree with that. It has taken a long
time, which is what inspired my comment the other day. I hope I
can associate the length of time with the thoroughness of the
report.
The CHAIRMAN. Fine.
Mr. Blanchard.
Mr. BLANCHARD. Thank you, Mr. Chairman.
I am curious. Your report indicates a possible unemployment
rate of up to 91A percent. It appears that the Fed's policies are to
continue present policies, holding the monetary growth to relatively slow rates.
I am wondering what it is you would recommend to help fight
unemployment; and if you are not so sure we ought to move in that
direction, what it is you would recommend we do to fight unemployment to counteract what may be a helter-skelter politically
panicked tax package on the Hill?
Mr. VOLCKER. This is the key question. In a sense, our own
policies are fighting unemployment now and they are consistent
with much easier money market conditions—not with an easier
monetary policy in terms of growth of the aggregates, but rather
consistent with conditions in the financial market that I think
themselves are now conducive to recovery. The real challenge is
how you get a program together that can move us ahead on the
recovery side and help support that and at the same time recognize
these inflationary problems.
That is why I think there is such a strong fundamental case for
moving on taxes. I say there is a strong fundamental case, but that
we better get these other conditions in place to make it a responsible and not a counterproductive policy.
I think over a period of time, that can be very helpful. I think
there has got to be some recognition, generally, that there is kind
of a tradeoff; there is a real tradeoff.
If we want to move toward getting rid of inflation—which I think
we must, in the interests of unemployment over time, if nothing
else—if it is essential as part of that program to achieve at least a
gradual reduction in the money supply, then we are going to have
to look at other policies that are consistent in that respect. The
more that prices go up, the more that cost trends go up—whether
social security taxes, wage bargaining—the more constrained you
are on the employment side. There is kind of a direct choice: The
higher wages are, the lower employment will be.
I am not sure that is fully understood. Of course, the wage
bargain is worked out as an individual bargain with a lot of other
considerations in every particular instance. But from the national
interest it is clear, and from the worker's interest it is clear that,
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with a given rate of decline in inflation and in the money supply,
the lower the wage settlement, the more employment there will be
the more real income there will be, and the better off everybody
will be.
That is fine in concept, and I think it is an important concept.
The question is how to get from here to there.
To put a small practical tinge on it, it makes a lot of sense under
these conditions that if you are going to have wage guidelines at
all, you do not raise them, because that works in the other direction.
Mr. BLANCHARD. Let me approach the issue a little differently. It
would appear that unemployment is and will be greater than was
anticipated by the administration; not necessarily you, although I
suspect by you as well.
Mr. VOLCKER. Yes, greater than they anticipated a few months
ago.
Mr. BLANCHARD. All evidence suggests that this country and its
political leadership does not have the stomach or the heart, I might
add, to watch this happen without trying to do something.
Even if you and the Secretary of the Treasury and the President
and his advisers resist the support of a tax cut, it may well be
forced upon you by the Congress. In that case, you are going to
have to have some alternative policy or we may well end up with
what we have had in recent years, a demand-side stimulus which
may encourage double-digit inflation into the future, exactly what
you began fighting.
I hope you have in your hip pocket somewhere a carefully developed alternate set of tax policies, because otherwise we are going to
have that again.
Mr. VOLCKER. In that connection, let me say that I do not resist
the tax cut at all; I would welcome a tax cut. All that I urge is that
you pay the necessary attention, in my judgment, to having the
other policies in place that will make that constructive and not
destructive. I think it is the No. 1 item on our agenda, getting that
act together as an agency. I am on the side of the Federal Reserve
now.
For the tax cut to go ahead without the conditions being in place
is not going to be productive. It is going to be counterproductive.
Mr. BLANCHARD. I tend to share your feeling. It is just that we
are awfully close to an election. It would appear that the President
is in the position of having to oppose a tax cut of any kind. For
purely symbolic reasons, he does not want to look like he is trying
to buy votes.
I hope there is something carefully worked out that can be
arranged with our Ways and Means Committee. God knows what
they will do.
Mr. VOLCKER. I understand your concern.
Mr. BLANCHARD. We are worrying about jobs in Michigan right
now. It is twice the national average.
Mr. VOLCKER. It just would be extremely unfortunate to go for
some quick fix that is not going to be constructive.
The CHAIRMAN. Mr. Cavanaugh.
Mr. CAVANAUGH. Thank you, Mr. Chairman.
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Mr. Chairman, I am also concerned about the failure—your failure to include in this report your monetary aggregate ranges,
numerical range for 1981; and I have listened to your explanation
several times and read your explanation several times. It would
lead me to conclude that in your report to us next February, you
also would find yourself not in a position to provide numerical
target ranges because the conditions which you cite will be the
same as they are today.
Mr. VOLCKER. Some of them.
Mr. CAVANAUGH. Then are you informing the Congress that we
will not again have numerical ranges?
Mr. VOLCKER. That was not part of our intention. I recognize
that some of the important problems to which I referred are still
going to be with us at that time. At that time—if we are using
anything like our present procedures, and we intend to be—we will
need the targets for operational purposes. We also thought at that
time we would have a better sense of how this might develop. Even
then, we recognize that these technical problems may contribute a
good deal of uncertainty. But other things will be a little more
clarified. We will, at that time, I think, be able to make a better
judgment as to the lasting significance of this short-lived April dip
in money supply in terms of the future trend. We will have further
evidence on the moneymarket fund-trend, whether that is continuing at the same rapid rate of growth.
But you are quite right; we will be left with some of these
problems. The intention was to face up to them then, and give the
explanation that was appropriate.
Mr. CAVANAUGH. So the February report will contain numerical
figures?
Mr. VOLCKER. Yes. Without any question.
Mr. CAVANAUGH. Let me ask you: Do you feel it is a requirement
of the law that the February report contain numerical targets?
Mr. VOLCKER. I do not want to pronounce a legal judgment. We
had not considered that in that context. We consider it necessary
from an operating point of view.
I think the law points very strongly in that direction, but I do
not want to pronounce a legal opinion.
Mr. CAVANAUGH. You do not feel, I take it, that it was in the
spirit of the law that the July report contain numerical targets?
Mr. VOLCKER. I read the law carefully at the time; I have read
some of the committee reports and other material more fully since
then. But as I indicated, I did inquire at the time. I read the law.
Speaking for myself, without profound consideration, it seemed
that there was not any real question about that; it was not a real
issue; we did not have a legal debate.
Mr. CAVANAUGH. The distinction between the requirements for
the February report and the July report, the distinction that you
made was, I take it, that the February report requires numerical
targets?
Mr. VOLCKER. I cannot honestly say that I was reading the law to
see whether there were any distinctions. I took it for granted. I
think all the members of the committee took it for granted that we
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would certainly have a numerical target. We did not discuss it; it
was just assumed; it was not an issue.
The committee was not dealing with the issue as to whether we
should have a target; that is taken for granted. The issue was
whether at this point it was confusing or undesirable to try to
make an explicit numerical target for 1981 amid all the uncertainties that I referred to. Nobody sat down and had a debate about
whether we should have targets or not.
Mr. CAVANAUGH. Mr. Chairman, I did not ask whether there was
a debate on whether or not there should be targets. It seems wholly
obvious that you must have targets in order to have goals and in
order to have objectives and in order to fulfill the functions of the
Fed. The Congress would be appropriately concerned with the fact
you are not supplying targets in spite of the fact that the language
of the requirements for the February report and the July report
are the same. The circumstances and justifications which you cite
for not supplying numerical targets in this July report can be
anticipated to be substantially similar in February; and so we could
be appropriately concerned that we would perhaps never again
have numerical targets or that the law does not adequately require
numerical targets.
Mr. VOLCKER. I think it is clear that inadvertently we raised a
question in some people's mind that was not in our mind, and we
did not realize we were raising it.
Mr. CAVANAUGH. In my mind, Mr. Chairman, you violated the
law. More serious than that, in my mind—and I have been an
optimistic and enthusiastic supporter and heralder of your leadership at the Fed—I think your February report to this committee
was among the most outstanding reports I have seen as a member
of this committee.
This report is nonsensical to me. I think it does great damage to
your personal reputation and to the confidence that you have
enjoyed with this committee, with the Congress, and with the
American people.
This Congress or anyone interested in monetary policy can not
hope to evaluate the goals and objectives of the Fed over the next
several months without numerical targets, even redefined and explained—and frankly, the distinctions and difficulties that you
make with the anticipated transitions from MiA to MiB I do not
find that obscuring and beyond the comprehension of this committee or interested members of the American public. I think that
your coyness in that regard unnecessarily diminishes the reputation for candor and for leadership that you have developed over the
initial months of your leadership of the Federal Reserve System.
I would hope that you can go back and supply this committee
and the Congress with the numerical targets as the law clearly
requires and rehabilitate what otherwise will be a serious and
lasting gap in the continuum of the ability of those of us in the
Congress and the country to evaluate the flow of monetary policy
in the country.
Mr. VOLCKER. To make an observation as a matter of judgment, I
dp not think the committee came to a different conclusion than you
did. This may amaze you, but I think the committee actually
thought that they were being more helpful and explicit than they
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were being 1 year ago when they said vaguely we are going to have
targets next year of such and such. We thought we were providing
a little more content than that. We are very conscious of the
problem. Many members of the committee were extremely reluctant to change a target once they had set it down because of the
kind of problem that you are raising in a different context here;
maybe it was a misjudgment on our part of what was the clearest
way to get the message across. I do not think the message was
meant to be obscure. We can try to do it better.
Mr. CAVANAUGH. Do I still have time?
In our discussion the last time that you appeared in February,
you made a statement regarding the dangers, the serious inflationary dangers that would be attendant upon a significant increase in
the defense expenditures above the President's budget which at
that time: when submitted to the Congress, was for 1981, $161.8
billion. I am looking for your quotation. You said at that time:
Let me say, for example, it must be recognized that any substantial increase in
defense spending beyond what is already contemplated in the administration budget
could significantly alter the economic outlook. The lag between authorization and
actual Federal outlays may be quite long in the case of military hardware, but its
exceptional impacts on employment, production, and private spending can emerge
fairly quickly.
Subsequent to that, of course, in the budget resolution currently
adopted, that increase has been significant to the authorizations for
1981. It has risen to $171 billion. Do the consequences which you
describe for the committee in February attend to the reality that
we have experienced?
Mr. VOLCKER. I have to state the context clearly. We are now in
a recession. I think that question is still relevant in terms of
looking at the tax cut prospect again; that is an important consideration.
How much is defense spending going up? I do not myself have at
this point a confident feel as to what the answer to that question
is. It is one of the relevant considerations in gauging the extent of
Government expenditures and, therefore, how much room you have
for a tax cut.
It is perhaps the principal uncertainty on the budgetary side.
The budget is being affected, I might say, by purely cyclical developments; I discount those a lot in making this judgment. There are
other things going on in the budget, specifically in defense spending, that color the appropriateness of the tax reduction.
Mr. CAVANAUGH. Do you think what the Congress has done this
year in defense spending mitigates against helpful tax policy? Antiinflationary tax policy?
Mr. VOLCKER. I simply do not at this point have a close enough
analysis of what the Congress has done and what its implications
are to give you a useful judgment this morning.
Mr. CAVANAUGH. Could you supply one for the record?
Mr. VOLCKER. I can attempt to supply something for the record,
yes.
Mr. CAVANAUGH. Thank you, Mr. Chairman.
[Chairman Volcker subsequently submitted the following information for the record:]
I don't feel that I can comment on what would be an appropriate level of the
defense outlays. But one thing is clear—the outlook is for more defense spending.
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Both the Congress and the administration have been specifying increases in the
defense budget in recent months. In the First Concurrent Budget resolution Congress targeted over $170 billion for budget authority in national defense for fiscal
year 1981, considerably more than had been requested by the administration in
January and in the March budget update. By July, in the mid-session budget
review, the administration estimate exceeded the congressional figure, partly on the
basis of incoming cost data. These developments suggest a trend of successive
upward revisions, that also is apparent in outlay estimates. The administration had
projected fiscal year 1981 defense outlays to amount to $146 billion in the January
budget, but this estimate was increased to almost $158 billion in the midsession
budget review. My point is that the defense sector is growing rapidly and its pace of
expansion is subject to further large revisions. A dollar spent on defense is not
necessarily much more inflationary than a dollar spent on many other types of
government programs. But the rising trend of defense spending must be taken into
account in formulating policies for nondefense outlays and in considering the possibility of tax reductions.
The CHAIRMAN. Mr. Paul?
Mr. PAUL. Mr. Volcker, welcome to the committee. I was delighted to hear your comments about the credit controls and that you
remain uneasy about them. You know I have been uneasy about
the Credit Control Act for a long time.
I, too, have been concerned about the power that is granted
under this act being too broad and too sweeping; so hopefully
someday we can settle this, possibly with some sunset legislation. I
hope we can get your support on that.
A few months ago, we had an economist in who stated that he
thought that the primary cause of inflation was related to the
many hundreds of billions of dollars of guaranteed loans that Government has granted. They total now over $400 billion. These are
guaranteed or subsidized loans, low-interest loans to special groups.
He did not indict business loans, even if they were construed as
speculative, as the primary cause. In this group of guaranteed
loans, we also have the Export-Import Bank where now, I believe,
they have lending authority up to $40 billion; and this is usually
below market, at 8 percent.
The borrowers have benefits where they do not have to pay back
quickly and may not have any payments for 5 years.
Since I do not believe anything is for free or anything is below
the market value unless somebody else pays, I am inclined to
believe that the average American taxpayer must subsidize these
loans; and if this is the case, I have several questions to follow up. I
have three questions.
One, do you believe it is fair to the American citizen who is
forced to subsidize this loan, this low-interest loan, in particular
those loans that may go to a foreign interest—and it may be
beneficial to a domestic industrial interest, but it is of necessity
beneficial to some foreign interest as well—is it fair to this American taxpayer who has to subsidize it against his will to then go out
and borrow in the marketplace, if he can find the money, and pay
12 to 14 percent for his house mortgage?
The second question I have is do you agree that the Governmentsubsidized loan is a significant factor in our inflationary forces, or
do you maintain that there is a great deal of danger in private
loans of an individual going out in the marketplace and—even if it
is construed as speculative—is he the principal cause of inflation?
Under this circumstance, I agree that the banker who is granting
this speculative loan has to be discreet in his ability to stay in
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business and to grant the loan with his own interest in mind as
well.
Third, would you agree that commodity speculation is more the
result of an uneasy economic climate, a result of inflation rather
than the cause?
Mr. VOLCKER. On your first question, as to fairness, I do not
think I would put it in those terms. I think it is a matter of
whether it is good public policy or bad public policy. That depends
upon the examination of the particular case. Is there some legitimate national interest being served in your case by export credit? I
am a supporter of the Export-Import Bank in general; I do not like
to see the subsidies in their loans. I think export credits in general—not just in the United States; more elsewhere than in the
United States—have tended to get into a kind of a competitive race
that does nobody any good. On the other hand, given that situation, it is hard for the United States, and may be counterproductive in terms of our national interest, to stay out. I think, particularly, the subsidy element has to be watched very carefully.
I would not just make a sweeping judgment that it is fair or
unfair. It is a useful instrument of public policy or it is not; it has
to be looked at on its merits.
I think it is hard to make a distinction whether a subsidized loan
is more inflationary than a private loan. In a sense, they both are;
in a sense, neither of them are. It all depends upon what else is
going on.
I think it is a futile chase to say that a particular loan is
inflationary, or another loan is not inflationary. The question is
what the total is, what else is going on in the economy. And I think
you have to recognize as one of the problems that the more subsidized loans you make, the less money there is for your home buyer;
it is making things harder for him, and that should be put in the
equation.
There has often been an attitude in the past—going back many
decades—about Government loan programs. They are off-budget;
we can forget about them; the credit markets will supply everything that is needed. I think in recent years we have found out
there are choices in the credit markets, too; the more that goes in
that direction, the less that will go someplace else. I think there
are those problems.
Finally, I would agree with your comment that speculative episodes in commodity markets—commodity markets very broadly defined—are I think, a part of the whole of mania we have for
creating new futures contracts, for increased speculative activity in
many directions. These are a symptom of inflation, rather than the
cause. Now particular speculative incidents like this silver market
episode can be very troublesome in themselves; but, in general, the
likelihood of that kind of thing arising or of a more general speculative atmosphere arising is a symptom of inflation and not the
cause. I agree with that.
Mr. CAVANAUGH [presiding]. Mr. Vento?
Mr. VENTO. Given the different lag we have in terms of unemployment and so forth, shouldn't the Federal Reserve Board immediately try to return to the midpoint of its target ranges much
faster and with much faster monetary growth in 1980?
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Mr. VOLCKER. When you say return to the midpoint in targets,
let me say that we are already above the midpoint in one of those
targets.
Mr. VENTO. I think since you were below the targets earlier, I am
suggesting maybe we should return to putting as many dollars in
circulation as had been initially intended.
Mr. VOLCKER. We are below and have been significantly below on
the Mi measure. The M2 measure, to which I attach some importance as well, is above the midpoint. By pushing up Mi, you also
push up M2.
Mr. VENTO. Given the dynamic
Mr. VOLCKER. Let me answer the question. We made the explicit
choice I reviewed in my statement, that it would be more constructive over a period of time not to push as hard as we possibly could
to get back on that target in the shortest possible period of time.
That judgment was made that on balance, over a period of time, it
would not be the most constructive approach.
In fact, Mi and M2 have been coming up fairly rapidly in the
past couple of months. The inclination is in the direction you
suggest, but we did not push as hard as we could have pushed.
Mr. VENTO. I thank you especially for your comments about the
fact you are trying to induce that. Let me just go a point further.
There has been great discussion today about missed targets and
the lack of targets in the Humphrey-Hawkins review that is before
us. In other words, one of the concerns is that you can't be held
accountable for what you don't say.
Mr. VOLCKER. Right.
Mr. VENTO. You can't be held accountable for what you don't
say.
Mr. VOLCKER. No, I understand that. I think that is part of the
whole philosophy of this targeting.
On the other hand, there is another side to that coin. We don't
want to be held accountable for a target that is distorted for
technological or other reasons. These are very difficult to estimate.
I think it is a trap for you as well as for us.
Mr. VENTO. Let me just carry this particular thought. The fact of
the matter is that we have a very dynamic economy; one for which
we do look to the Federal Reserve Board to provide some stability.
It is a question of us working with the fiscal side but needing a
responsible monetary policy in order to coordinate our planning.
In other words, what we want from you is a commitment. What
you want from us is some commitment so we can go forward.
My concern and I think the concern that is being expressed by
others, is that you seem to be hedging based on the fact you don't
know what Congress is going to do and you don't know what the
world economy is going to do.
Mr. VOLCKER. There is obviously confusion here. There is a sense
we were trying to hedge; I don't think we were trying to hedge.
The problem goes back to the point, I suspect, that there is no
definition of money that is perfect. We approximate it in our
statistics. You can talk theoretically about a concept of money and
what money is, but when you go out and look for it in the real
world, it is a marginal decision whether x is money or whether it
107
isn't money. Some things clearly are; some things clearly aren't.
There are a certain number of things on the borderline.
Now with that inevitable haziness at the borderline—and that
area of haziness is distorted when we have a lot of technological
change—we have a little problem of communication in what we
really mean.
Looking at it from different sides of the table, apparently, without any attempt to mislead, I understand what your concerns are. I
understand what our concerns are. We ended up confusing you. We
didn't mean to confuse you; we meant just the opposite.
Mr. VENTO. Let me go a step further for the purpose of what my
concerns are with the Federal Reserve Board. I am disappointed
and I hope the message is getting through.
Mr. VOLCKER. I believe the message there is considerable confusion.
Mr. VENTO. I think the Congress has been quick to respond in
terms of giving the Federal Reserve Board powers that are necessary to deal with the monetary policy. In fact, we are very concerned about, for instance, the nature of the large loans that
Chairman Reuss outlined, and the sad episode of silver speculation
you were involved in, if not engineering. We are also concerned
about the Fed's missed targets, their curious actions under the
Credit Control Act in which consumer needs were pushed aside, the
inability of the Federal Reserve Board to enforce prices, and the
highest profits in the bank history occurred recently. I expect you
will be writing back an answer to me on that.
We have tried to respond in terms of giving you the tools to deal
with this, new definitions of credit and so forth, but the Federal
Reserve Board is obviously not able to use these new and old tools
to come to grips with providing the strong leadership we would
expect from them.
We all know about the pressure in the financial community, but
we don't expect the Federal Reserve Board to leave the monetary
ship of policy at sea without a rudder and perhaps without a
captain.
Your actions show more than your rhetoric, yours and the FRB's
willingness the public responsibility and authority slip to other
private economic circles and foreign currency decisions. I am disappointed. I think this leaves our monetary policy unguarded and
unguided, subject to the battering, the ups and downs of the privately controlled foreign monetary forces the rhetorical question is
why the timidity? I just don't understand it.
I am disappointed that at a time when we need stability in this
area to protect the public interest, indeed it is a very substantial
thrust that you appear to have deserted or are afraid to exercise
forthrightness. I am concerned about it. I know there are a lot of
characterizations that have probably been made of your leadership,
but I didn't think timidity would be one of them, Mr. Volcker.
Mr. VOLCKER. I have a little difficulty in responding because I
must confess I don't recognize any accusation. Perhaps we could
have some discussion later.
Mr. CAVANAUGH. Not now.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. CAVANAUGH. Mr. Watkins?
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Mr. WATKINS. Mr. Volcker, I am glad to have you with us today.
Mr. Chairman, I think you are in a very enviable position to do
something in this country about the economy. When President
Carter came off his mountain from Camp David, he made a speech
that a lot of people snickered at. I was not one of those. He talked
about a crisis of confidence.
I do think we have a crisis of confidence in this country today.
Mainly because the families of this country have overextended
themselves with credit. One of the areas of jurisdiction you have as
Chairman of the Fed is over credit. For about 3 years, I was a lone
voice on this committee, talking about credit controls or credit
restraints as part of a solution for trying to get hold of inflation.
I am glad to see on pages 5 and 6 of your report that you discuss
credit controls as helping to get interest rates down, and to get
hold of this country's inflationary spiral.
On February 19 when you appeared before the committee, I
asked you if you had considered consumer credit. Your answer was
no, that you had not considered it.
Mr. VOLCKER. That was an accurate answer at the time.
Mr. WATKINS. I understand it was. You and I have had discussions on this subject since. On March 14, it became part of the
national policy. I was quite concerned whether this was just shooting from the hip or what, but I really think, Mr. Chairman, we
cannot dismiss credit as part of the monetary policy.
My constituents tell me, when I head back to Washington, "Quit
printing that money up there." Well, credit, consumer credit is
printing money. Sears, J.C. Penney's, banks, businesses that issue
credit cards, that is printing money. An increasing amount of the
families in America have as high as 25 percent of their disposable
income paying on consumer credit. That is when credit plays a
very significant part of our monetary system.
As a result, it also creates a confidence factor, I think, with
families. Ministers will tell us, when they counsel with married
people, the biggest problem causing family problems happens to be
financial difficulties. This is what I consider a crisis of confidence.
What I am saying is, I hope we don't take credit too lightly. In
the first quarter there was $391 billion worth of credit. It dropped
sharply to $193 billion the second quarter.
As a former homebuilder who has been out there on the whipping block, I know what it is like to face rising interest rates.
When interest rates went from 14 percent all the way to 20 percent, we put on the credit restraints, to try to slow consumer credit
and to get hold of inflation. I have been advocating credit restraints for 2 years because I believed it was a way to get hold of
inflation.
I have gone to the point of researching this issue of credit restraints and I have determined that perhaps a trigger point is
needed which would start consumer credit controls. That is a must
if interest rates go so high again. They went over the roof with 20percent figures before we decided to do something and go with
another mechanism such as consumer credit controls.
I am asking this committee and my colleagues to start looking at
a trigger. I would like to ask your opinion on this factor. Second, I
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think we have to put a limitation on what interest rate levels can
be charged on credit cards.
If I am a manufacturer and I am borrowing money for a lot less,
I will build my inventories. I will make a push to sell that inventory. If I can sell it on credit and charge 18 percent, 20, 24 percent,
they can make more money. Credit card issuers are putting the
families of America in a crisis because the more they can get them
to buy on credit, the more they can borrow.
If businesses can borrow more money at a lower rate, they will
build their inventory stock in order to then try to sell it on credit
at a higher rate. I think we need to suggest to them that they can't
charge more than 2 percent above prime for their consumer credit
rates. That will save them from operating on a lot of credit in
order to get the families to buy on credit.
What I am saying is, I think, we have placed the American
families into a dilemma by pushing them to purchase more under
credit which puts them under more of a strain. It puts more of a
question on the confidence factor in this country which creates a
much more negative attitude.
Maybe I am looking at a whole big problem. I really, truly
believe that. There are two things I am saying are needed: A
triggering formula to trigger consumer credit controls and second,
putting a limit on what interest rates businesses can charge on
consumer credit cards because they can well afford to go borrow
that money.
What do you think of those two ideas, Mr. Chairman?
Mr. VOLCKER. It turned out I had to consider it within a relatively few weeks after I was here in February. You are now asking a
longer range problem. My sense is that it is not moving in the
right direction. I think we are operating an economy where we, to
the extent possible, want to leave those choices on credit use to
American business, to home buyers, to homebuilders, and to the
consumer. It is not unreasonable that companies, banks, develop
credit packages to help with their sales or to make money. That is
the way the system works.
Now, imbalances can develop over a particular time. I think we
had an imbalance in the consumer area in the past year or two.
Consumer indebtedness became historically very heavy relative to
income, and a good part of this trauma we are going through at the
moment reflects a readjustment of that.
Apparently, people have decided they are not going to be so
deeply in debt at the moment. They have been trying to repay. In
fact, the amounts have gone down quite sharply. While these figures move sluggishly, you can already see improvement in income/
debt ratios, but it is very hard to say that the Government has the
wisdom or the Federal Reserve has the wisdom to say that a
certain level of credit usage is appropriate, a certain level is not
appropriate, and then to get involved in what would inevitably
become, I think, a rather elaborate control mechanism.
My own feeling, and I think it is consistent with our traditional
approach, is that that kind of thing really ought to be sorted out in
the market to the maximum extent.
Now the Government can make a major policy decision and say
we want to discourage the use of consumer credit. I think you are
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also saying you want to discourage consumer spending, because
presumably you want to stimulate investment and other things in
the economy. But that is a major philosophical as well as a narrow
economic policy decision. My own thinking is not along those lines.
Mr. WATKINS. My time has expired. Please just try to bring
people back to the conditions where they can live within their
means, not just live within their credit.
You asked me when we met with the Speaker, the majority
leader, and the Secretary of the Treasury, what the interest rate
would have to go down to for homebuilders to get back to building
their inventory?
I said, somewhere between 12, 13, 14 percent. I think that has
proven correct. You look at June. It had the largest jump in
homebuilding for many months. Who got interest rates down?
Builders started moving from their equity financing at the high
interest end to operating financing which definitely turned out
great. I commend you for that.
Mr. VOLCKER. One month, anyway.
Mr. WATKINS. At least 1 month.
Thank you, Mr. Chairman.
Mr. CAVANAUGH. Mr. Bethune?
Mr. BETHUNE. Thank you, Mr. Chairman.
I was very intrigued by your comments, Mr. Volcker, on the
comments about the tax cut. What it boils down to is you say we
need it, but go slow, let us wait, let us study it a little bit more.
In 1976, the tax collections by this Government were $300 billion.
In 1981, if our budget holds up with respect to revenue, it is going
to be somewhere in the neighborhood of, perhaps in excess of $613
billion. It is more than doubled just since the 1976 budget.
You express concern about let's don't cut taxes, let us wait, study
it, because we need to know about spending, budgetary controls, all
of that.
So, what is all this caution about a very small tax cut? It is
really a very small tax cut when you measure it against the
increase that has taken place since 1976 and the increase that is
going on right now as a result of bracket creep.
I wonder where was all this caution back on March 14 when you
and the administration, I think, dangerously invoked the Credit
Control Act and you got a reaction that you didn't expect? Did you
approach that decision with all of the caution and care that you
are now suggesting that we invoke in the enactment of a very
small return of the tax bill that is more than doubled since 1976?
Mr. VOLCKER. I approached that decision with a great deal of
caution.
Mr. BETHUNE. Did you have at your command all of these facts?
Couldn't the same thing be said—I mean, in your statement here
today when you talk about the tax cut, there is sort of an offhand
slap, in my judgment, at those of us who were advocating the tax
cut when you say it takes a brave man to project with confidence
the precise nature of the economic situation we will face at the end
of this year. Relatively little discussion about how the tax plans are
brought to bear upon the question of wage and price increases.
Mr. VOLCKER. I think you misinterpret my position. I would like
a tax cut. I want the tax cut in an environment that will promise
Ill
to bring about results that could be very constructive. My concern
is not slowing down on the tax cut for its own sake, but whether
that is in place. The quicker you can put that environment in
place, the quicker we can have the tax cut.
Mr. BETHUNE. Isn't it so that the tax cut that is being discussed
by those of us on the Republican side is much less likely to cause
an exaggerated response in the economy as did your action back on
March 14?
Mr. VOLCKER. The direction, the thrust, the philosophy of that
tax program as I understand it is in the direction that I think is
supported by common consensus, an emphasis on production, productivity. I still have a question in my mind about whether the
conditions are in place.
On March 14 we had a clear and present danger.
Mr. BETHUNE. What was the clear and present danger?
Mr. VOLCKER. The clear and present danger was exploding inflation and inflationary expectations, exploding credit and, in a more
moderate degree, money. I think that had to be coped with at that
time. The problems toward which this tax cut are correctly directed, in my judgment, are continuing, long term, central problems of
the economy. It can have constructive effects. I want to get the
conditions right so the short-term implications do not vitiate the
highly constructive effects it could have in the long run.
Mr. BETHUNE. But the setting that you had back on March 14,
you decided to do something about the high inflation rate by involving yourself into the credit market; isn't that the case?
Mr. VOLCKER. But I knew I could disinvolve myself in 3 months.
Mr. BETHUNE. But you did involve yourself in the credit market?
Mr. VOLCKER. That is correct.
Mr. BETHUNE. I think that was very risky. I don't think you, the
Treasury Secretary, and least of all President Carter has any
notion of what the credit market is all about. I say that not out of
any comment that you and those of you are experts and have a
great deal of education in this field. I say it because of what Mr.
Paul said a moment ago.
With respect to Federal credit assistance programs, $1 out of
every $6 now in the credit market is being sopped up by some sort
of subsidized program, lending program, insured program, guaranteed program, and the CBO has said that they don't know the
nature and extent of those programs, that is, they cannot, therefore, give an opinion about how it is impacting the credit market.
If they don't know that, then I don't think you do, and I don't
think anybody can predict with any certainty what is going on in
the world of credit. I think it was an extremely risky thing to do. I
think you have to admit you don't know what is going on out there
in the world of credit.
Mr. VOLCKER. I am not a great believer in credit controls. I
thought I made that clear this morning. Their use was justified by
the particular circumstances existing at that time. I don't want to
stay in that business.
Mr. BETHUNE. My time has expired. I could go on.
Mr. CAVANAUGH. Mr. Porter?
Mr. PORTER. Thank you, Mr. Chairman.
112
Mr. Volcker, you have been battered about by the committee a
great deal in the hearings this morning. In fact, Mr. Cavanaugh
even suggested that the Fed may have violated the law.
Mr. CAVANAUGH. I got promoted for that.
Mr. PORTER. I think myself that whether or not you have the
target ranges, you are going to be judged as to what the state of
the economy is and not whether you met some ranges or not. I
want to at least commend you for the discipline that you have
explicitly stated in your statement and have implicitly stated in
your comments today, that you will hold the line and provide a
steady growth for our economy with low inflation and a minimum
of unemployment.
I think if you can do that, you are going to be possibly thought of
as Presidential timber by either one of the parties, and at the very
least, except for the comments made earlier, I would suspect that
Representative Annunzio might be willing to give you a gold
medal.
Nevertheless, I think there are a couple of questions that I would
like to address.
One is the timing of a tax cut. In your statement you indicate
that there are tax increases that are coming along both through
bracket creep and through increases in social security taxes.
Let us call those nominal tax cuts. Why can't the Congress make
a present commitment, make a statement to the American people
right now that we are not going to allow taxes to increase next
year and put off, if it seems necessary to do so—as you indicated—
a commitment to real tax cuts at a later time.
Wouldn't that provide a good deal of confidence at a good point
in time?
Right now, for the American people to look ahead and say at
least we are not going to have our disposable incomes further
reduced by Government action as it appears we will now if the
Congress doesn't act at all?
Mr. VOLCKER. I suppose, in terms of my comments, you would
have to add a couple of other statements. If you could say we are
going to commit ourselves to that course of action—not just for
1981, but beyond—and we are also committed to a complementary
spending program that assures that the budget will come into an
appropriate relationship, you are a long ways toward making the
statement ring true in my ears. But without that kind of recognition, you can't talk about a tax cut in a complete vacuum. It does
depend upon what is happening to the other side of the budget.
If you could make a credible statement, "We have a tax cut that
will absolutely maximize the cost, production, incentive side"—and
I am not saying you can say that—then I can assure you that with
the complementary budget program you are a long ways toward
home.
I still have the reservation that was in my statement. I understand that explicit tax reduction offsets tax increases already on
the books. But is there some way we can use this process to get the
message through that this isn't a license for other inflationary,
cost-increasing kinds of actions, but instead part of the bargain to
wind down other sources of inflation to make this tax cut even
safer.
113
Put that all together, that is what I tried to say. I am not
opposed to a tax cut if you can do it as part of that process. I think
it will help the American economy.
Mr. PORTER. What you are saying is the Congress ought to make
room in the budget for the tax cut?
Mr. VOLCKER. Yes, precisely.
Mr. PORTER. And not add to the deficit?
Mr. VOLCKER. It is going to scare people, understandably. I can't
say the scares are wrong, if all you say is that you are going to
have tax reduction, but you are making no commitment on the
budget, and I don't care what else goes on. I think you are going to
get a bad reaction in the markets directly.
You know, that is not a question of my policy preferences. I am
now stating a forecast.
Mr. PORTER. Can I ask kind of a basic question? Do you believe
we can control inflation through monetary policy alone regardless
of the level of deficits that the Congress funds in a long-term
sense? Can we do that?
Mr. VOLCKER. I think in a theoretical sense, yes, but it is not a
theory you would like to see implemented in practice because it
involves so much strain and maladjustment and pressure on some
sectors of the economy or the market. It is not the best way to go.
What we need is help from other policy tools, particularly the
budget.
Mr. PORTER. Isn't it true that there are other countries that have
experienced the same kinds of oil price impact that we have experienced, for example, that have run substantial deficits, and still
held inflation to an acceptable level?
Mr. VOLCKER. I don't want to put the whole emphasis on the
deficit. That is one factor in the credit markets and how the
economy works.
But some of the countries that have the best record—let me take
Japan and Germany—happen to have substantial budgetary deficits at the moment, more substantial than ours in relation to the
GNP, but they also have an institutional setting that in other
respects I think has served them very well. It is a remarkable fact
that Japan—which went through an inflationary episode of some
size after the first oil price increase—achieved a consensus among
labor this year to have a rate-of-wage increase that is very little
above the rate of productivity increase. It is very substantial in
Japan, the rate-of-productivity increase. That was a rate-of-wage
increase well below what one might have thought of as a possible
inflation rate. They did this in the wake of the oil crisis. Their
price and cost trends are reflecting that.
We don't have a mechanism for arriving at that kind of consensus in the same way. The same process, to some degree, seems to be
at work in Germany, partly because they have such severe memories of past inflation. They have succeeded in getting a message
across that everybody has something to gain from a noninflationary policy; if you conduct your own affairs that way, it will help
the process.
In the United States, we have different patterns, different traditions and that is one of our great strengths, but it means we are
winding down the cost/price cycle.
114
Mr. PORTER. Thank you very much, Mr. Chairman.
Mr. CAVANAUGH. Thank you, Mr. Chairman. It appears my good
friend from Oklahoma would like to enter round 2. I would indulge
that with the consent of Mr. Volcker. I think he has been most
generous to the committee.
Mr. VOLCKER. I am perfectly happy to answer.
Mr. CAVANAUGH. I would express some hope it would be brief.
Mr. WATKINS. Be very brief.
I commend Mr. Volcker on his restraint.
I wish a couple of colleagues that were moving on you had dealt
with you like I have. I know you have held back. I thank you for
looking at the tax cut deal.
I would like to adhere. A couple of my colleagues questioned you
about the dollars reaching into the available credit. Again the
consumer credit, when it reached $400 billion roughly, we were
talking about a lot of money that was not being directed by the
Government, because we were talking about the paper money
being written by a lot of companies with the credit cards and other
things that were out there.
I would like to just encourage the Fed, in general, to take time to
set up time to look at it. I think we have to have a balance. That is
why I said we had to look at the triggers. When the interest rates
went to 20 percent, we got out of balance.
In 1973, 1968, when I was in the homebuilding business, interest
rates, top money, I crawled on my stomach to survive. When we
went to 20 percent on the investment capital, it really just—in the
automobile business, the President came out with an automobile
policy on the guaranteed loan. Really it was uncalled for if we
hadn't gone so far out of kilter or out of balance.
I would just like to say, encourage, ask, plead with the Fed to
look at trying to find a balance with the credit situation, the
interest rates so it will not put this investment category of homebuilding, automobiles, other areas on their knee as quickly as we
have done this past time.
I do think we cannot divorce credit, consumer credit, again, from
the monetary policy. I don't think there is any way we can do it.
I would like to encourage you to do that. That is why I wanted to
wait for these last few minutes to just encourge that and make
that comment to you.
Mr. VOLCKER. I don't question your basic premise about what is
going on in this credit area. It is of significance for monetary policy
and money. It is just a question of whether this leads one to the
idea of a direct control; I think that is the only difference we have.
Mr. WATKINS. I agree with you. Thank you.
Mr. CAVANAUGH. Mr. Volcker, on behalf of the committee I want
to express our great appreciation for your tremendous indulgence
and the great generosity of your time with us today.
With that, we will conclude this hearing and we are adjourned.
Mr. VOLCKER. Thank you.
[Whereupon, at 1:43 p.m., the committee was adjourned.]
APPENDIX
BDARD DF G O V E R N O R S
Or 'TH E
F E D E R A L R E S E R V E SYSTEM
W A S H I N G T O N , D.. C. 20551
July 29, 1980
The Honorable Henry S. Reuss
Chairman'
Committee on Banking, Finance
and Urban -Affairs
House of Representatives
Washington, D. C. 20515
Dear Chairman Reuss:
It is apparent to me from the questions and discussions
at the recent monetary policy oversight hearing before your Committee that confusion has unfortunately arisen over the intent of
the Federal Open Market Committee in characterizing monetary target
ranges for 1981 only in general terms. I was, for instance, disturbed that some members of the Committee apparently seriously
considered that the FOMC was somehow signaling a reluctance to
provide specific numerical targets for 1981 at an appropriate
time •-- a thought, I can confidently say, has never entered FOMC
discussion.
Our concern was quite different. We wanted to reiterate,
as clearly as possible, the intent of the FOMC "to seek reduced
rates of monetary expansion over coming years, consistent with a
return to price stability" and the :Ibroad, agreement in the Committee
that it is appropriate to plan for some further progress* ^Ln 1981
toward reduction of targeted ranges," We believed then, *and believe
now, that those general statements are the clearest and most useful
indication of intentions that we can make (and are responsive to
the requirements of P.L. 95-523, the Humphrey-Hawkins Act) and we
have been concerned that an attempt to set forth precise numerical
ranges for each target could well prove to be ultimately a source
of confusion rather than clarity. A major part of the reason is
that certain institutional changes are in train or in prospect —
in particular the introduction of NOW accounts on a nationwide
basis but also the possible continued development of money market
funds -- that will upset "normal" relationships among the various
aggregates and their relationship to economic activity, While we
know these institutional changes are under way, the magnitude of
their impact is (and for a time inevitably will remain) in substantial doubt. Moreover, the FOMC wished to appraise for a period of
time the lasting significance, if any, of the recent short-fall in
M-l relative to economic activity*
(115)
116
Unfortunately, our attempt to cut through the institutional uncertainty to describe the broad substance of our intent
with respect to monetary growth ranges seems to be subject to
misinterpretation. To attempt to clear up any misunderstanding,
let me indicate that, abstracting from the institutional influences
and questions cited above, the general intent of the FOMC at this
time can be summarized as looking toward a reduction in ranges for
M-1A, M-lB, and M-2 for 1981 on the order of 1/2 percentage point.
Converting that approach into specific numerical ranges for next
year requires making a number of technical judgments that involve
considerable uncertainty and necessarily, at this point, a degree
of arbitrariness. Specific ranges for each aggregate, and assumptions
behind their derivation, are shown in the attachment to this letter.
In accordance v/ith usual procedures, all of the ranges
will have to be reassessed in or before next February. The extent
of downward adjustments in t.l'C ranges not only will be influenced
by the various technical factors described in the attachment, but
also will be conditioned by the speed with which inflationary
biases in labor and product markets can be reduced, and by the
likelihood that the economy can make, an orderly adaptation to
curtailed money growth. The need for public policies, other than
monetary policy, to move in a complementary way to speed those
adjustments was, of course, the essence of my testimony before the
Committee.
The appropriate performance of money growth in 1981,
within the ranges adopted, relative to actual results in 1980
will also depend to some extent on the outcome this year — on
for instance, whether this year sees a very slow growth in narrow
money because the public has, for one reason or another, economized
sharply on cash balances.
The FOMC approaches the targeting process with a great
deal of care, and is frankly concerned that changes in numerical
targets, particularly once specified in detail as in the attachment to this letter, will give rise to confusion even when (perhaps
particularly when!) such changes are purely in response to a
technical, institutional change that has no real significance
for monetary policy. But I trust this additional information
will, despite those concerns, help further the greater public
understanding of monetary policy that we both wish to foster.
Sincerely,
Attachment
117
A number of: technical judgments need to be made in
deriving specific numerical monetary growth ranges for the aggregates in 1981 consistent with the intention to reduce ranges for
il-lA, n-lB, and M-2 on the order of 1/2 percentage point. These
.include:
(a) the ox tent to v;hich the public will shift from
demand deposits to MOW accounts next year; (b) the extent to
v;hich there will be shifts from savings accounts or other interestbearing as'sets to I\OV; accounts; (c) the degree to which money market
funds will continue their phenomenal growth (in the process drawing
funds that would otherwise have flowed both through institutions
whose liabi].itics arc in M-2 ani the open market) ; and (cl) the
extent to which the public will or will not tend to return* to
longer-run relationships between cash holdings, interest rates,
a.nu the nominal GXP -- in otl 01 words, assessment of factors
affecting shifts in the p u b l i c ' s desire over the longer run to
hold money balances in relation to income.
degree of shifting into :,'OU and ATS accounts will
aggressiveness with w h i c h banks and other depository
omolc the now accounts, as well as on public response.
basis of experience in various New England States
ated that in 19B1 shifts from demand deposits to
Uld low_c_r ri-lA growth by amounts ranging from 1
points. Similarly, such shifts from savings
accounts could ra_i_se M-lB growth 1/2 to 2-1/2 percentage points.
•d-points of those ranges are taken as "the best
c) c s t i. m a t c a v a i 1 a b 1 c a t t lie present time,
:- y - J A and ::-!]> would " e implied of 0 to" 2-1/2
7-1/2 'percent, r o spec lively . Tn essence, those
t a 1/2 point reduction in the ranges adopted for
arc 3-]/2 to G percent for M-lA and A to 6-1/2 percent for M-1L3 -- but with the downward adjustment noted above for
M-lA
to allow for the effect of shifts into newly introduced MOW
accounts from demand deposits and the upward adjustment for M-lB
to allow lor s h i f t s from other assets-. The target growth 'range
for Tl-lA would h,.ivo Lo be raised if shilts out of demand deposits
were less than assumed, and lowered if shifts were greater. Similar
reasoning would a p p l y to the range Tor H-lH with regard to shifts
out of savimis de-posits and other in I: ores l-boar ing assets.
The
ranges for I1-3.A and M-.lr, a.l:;o .imp].\r c o n t i n u e d efforts in general
by the public to ecopomizc on transactions-type cash balances,
118
Cons is lion L with a reduction in ranges on the order of
''2 percentage point, the growth range .Cor "A-2 for 1981 would be
1-1/2 to 8-1/2 percent unless money market funds, included in M-2,
!'~e judged to be drawing substantial new amounts of funds that in
hn past would have been lodged in open market instruments (which
•:c not in M-2) . Consistent with the indicated M-l and M-2 tarel r, , 11-3 and ban); credit ranges of growth for 1981 of 6-1/2 to
'•-1/2 percent and 6 to 9 percent, respectively, could be the same
.:; Cor 1980. Maintenance of these ranges relative to M-l and M-2
is related to the growth in housing, business, and other credit
i h a t would be a normal accompaniment of the expected recovery in
economic activity.
.'It should bo emphasized that the relationship among the
specific numerical ranges for the M-ls and M-2 are dependent at
this state o.n necessarily rough, and somewhat arbitrary, judgments
of the impact of institutional change and must be considered illustrative. These complications should not obscure the basic intent
of achieving a modest further reduction in monetary growth rates
next year, as the FOMC indicated earlier. That the range for M-1B
next year will, in all likelihood, be higher than this year needs
to be understood ar. 110 more than a technical adjustment to accommodate one-tinve shifts put of siivings accounts in response to the
introduction of r,"OW accounts on a nationwide basis. The reduction
in M-lA is exaggerated -downward tor comparable reasons. The basic
point is that these ranges, abstracting from such shifts, are expected to be lower 'than in the preceding year, and thus reflect a
further curtailme111 of money growth.
119
rue. OHIO
IDAHO
U.S. HOUSE OF REPRESENTATIVES
COMMITTEE ON B A N K I N G . F I N A N C E AND U R B A N AFFAIRS
NINETY-SIXTH CONGRESS
2129 RAYBURN HOUSE OFFICE BUILDING
WASHINGTON, D.C.
20515
WID W. EVANS. IND.
>HN J. CAVANAUGH, NEBFL
ARY ROSE DAKAR, OHIO
July 1, 1980
The Honorable Paul A. Volcker
Chair/nan
Board o.f Governors
Federal Reserve System
Washington, D. C.
Dear Mr. Chairman:
I have no doubt that the recent turn of the economy is as disturbing to you
as it is to the American public. Since January, we have entered a steep slump.
Housing, autos, steel, and other basic industries are in crisis. Unemployment,
already too high, is going higher. Bank lending is down sharply, signalling perhaps a retrenchment that will ens.ure a long recession and a slow recovery.
At the same time, inflation remains intolerably high. Inflation has dropped
sharply, but past experience and the current political environment suggest that
the recession has milked about as much out of the so-called "Phillips curve" as
it is going to do. Significant further reductions in inflation cannot be obtained
through prolonged recession. The outlook on both fronts is therefore very grim,
I do not wish to point the finger of blame at the Federal Reserve or anywhere
else. Nevertheless, I have been struck by the dissonance between the notions on
which recent policy has apparently been based, on one hand, and the actual course
of events on the other.
For years now, the Federal Reserve, the Administration and we in Congress
have labored under the belief that, properly done, monetary and fiscal policies
could steer a narrow course between excessive inflation and excessive unemployment.
In recent times, a particular variant of this view has.predominated: that monetary
policy, through careful contrpl-of the growth of the monetary aggregates, would
bring down the rate of inflation slowly, while avoiding a sharp short-run contraction of output.
This Committee has led in urging that such a policy be adopted. In each of
our three reports on monetary policy under the Humphrey-Hawkins law we have written,
with nearly unanimous support, that the Federal Reserve should "pursue monetary
restraint without precipitating recession". We have made clear that we believed
control of the aggregates was the appropriate policy tool. We assumed, in short,
that there did exist a feasible stable path, and that monetary policy could get
us on that path if properly conducted.
120
Last October 6th, the Federal Reserve made a decisive move to stable.monetary
control: it abandoned its federal funds target and shifted the emphasis of open
market policy to control of aggregate bank reserves. The stated purpose of this
change was "to support the objective of containing growth in the monetary aggregates." Monetarists applauded the move. Since then, the Federal Reserve has -no one can seriously question -- made every effort to implement the new policy.
This Committee's report of April 15, 1980 took note of this fact:
"Control of the money aggregates was finally attained after
the Federal Reserve, on October 6, started conducting daily
operations by targeting reserves instead of interest rates,
a change we applaud."
One cannot look at the results without dismay. Against the pressure of rapid
growth in bank loans and.strong inflationary pressure in the period from November
through February, the Federal Reserve drove interest rates to historic levels,
to the point, indeed, of financial crisis for mutual savings banks, savings and
loan associations, and some large commercial banks. Monetary expansion accelerated
nevertheless. Still more severe measures were applied in March. Monetary expansion halted as the economy collapsed underneEth-. Then, as the economy tumbled,
inflation tumbled rapidly toward, but not below, the high levels of last year.
The failure of monetary policy to control expansion'bf the aggregates from
November to February contradicted our expectation that a policy of steady deceleration could be implemented in the face of a strong surge of inflationary credit
demand. The sharp slump of March to May contradicted our expectation that a policy of steady deceleration could avert recession.
I am not suggesting a change in monetary rtrategy at this f»ne. The appropriate policy in a slump is to provide liquidity to the economy, letting interest
rates fall where they may. This objective is well-served by a policy of attempting to stabilize money growth.
But the experience of recent months demonstrates that monetary and fiscal
policies alone cannot by themselves offset the present instability of our domestic and international economic affairs. We need'urgently to develop comprehensive
stabilization policies, including an industries policy to revive our industrial
base and re-establish competitiveness in world markets, and an incomes policy to
get our underlying rate of "inflation under control. Restrained monetary expansion
is a necessary but wholly'insufficient tool.
I would appreciate your thoughts on this at our hearing July 23.
Sincerely,
»'(oo -^
Henry•S.
Chairman
121
BOARD OF GOVERNORS
F E D E R A L RESERVE S Y S T E M
W A S H I N G T O N , D. C. 2 0 5 5 1
CHAIRMAN
July 21, 1980
The Honorable Henry S. Reuss
Chairman
Committee on Banking, Finance
and Urban Affairs
House of Representatives
Washington, D.C. 20515
Dear Chairman Reuss:
I have read your letter about the silver situation and
related transactions very carefully and share many o.f the concerns
that are reflected in it. Even several months after the event,
I am not certain that all of the facts of the situation are known.
It is clear that the Hunts and related interests ha.d accumulated
massive positions in silver and that as a result of this and other
circumstances, a series of difficulties and problems emerged, as
broadly reviewed in your letter. But while the' general outline
of the train of events can be identified, the complexity of the
relationships among the many participants, and those who financed
them—whether brokers, banks or other interests—makes it extremely
difficult, if not impossible, to identify all of the elements,
contributing forces, and motivation of the participants.
Before commenting on the specific questions that you
have raised, there are several aspects of the silver situation
that I would like to clarify.
In your letter you referred to reports that
an earlier loan to the Placid Oil Company may have
been related to the silver situation. It is true
that Placid did negotiate a bank credit line for
$450 million in the fall, but we have looked into
this and I am satisfied that the proceeds were used
for normal business operations. Our best estimate
of the extent of Placid financing of the silver
activity of the Hunts prior to the initial restructuring of the Hunt indebtedness is still $115
million.
One area of concern has been the extent to
which bank financing was used on the upside of the
silver market in the fall of 1979 and early 1980.
122
In our "Interim Report" we indicated that "bank
credit was not a ma jor factor in connection with
the acquisition or maintenance of silver positions
by Hunt and Hunt-related interests during this
period." Considering the size of the Hunt positions, that remains a fair assessment. However,
on the basis of our continuing investigations, we
now know that the timing of credits in the amount
of $150 million to Hunt interests occurred in the
fall of 1979 rather than in early 1980 ;a^ we had
previously thought. The loans in question were
committed prior to October 6. We are also now aware
of approximately $50 million in credits to the Hunts
from brokers on the upside of the market that were
financed by bank borrowings. Furthermore, it also
appears that others on the short side during this
interval may have been forced to rely on bank lines
to meet variation margin calls. We are still
looking into this.
There is a reference in your letter to the
Commodity Futures 'Trading Commission report that we
.were alerted to the presence of potentially troublesome speculative concentrations in September 1979.
Because of press reports and market rumors of
irregularities in- the silver market, and because
of the potential damaging impact on inflationary
expectations and on inflation of a renewed outburst
of speculatively driven price increases in precious
metals, I initiated inquiries with the CFTC about
developments in the precious metals markets in
September and again in December, in the latter
instance with emphasis on the silver situation.
In the course of those discussions no information
other than that generally available was provided.
I later learned that other inquiries of a very
general nature were made by the CFTC staff about
our interest in silver market developments but these
were not brought to my attention. At no time prior
to March 26 did the CFTC inform the Federal Reserve
as to the extent of the emerging problem.
As to the first of your specific questions, none of the
banks involved in lending to the Hunts or their brokers consulted
with us during the fall of 1979 or early 1980 about the loans that
they made. The vast majority of the loans were, of course, made
123
prior to March 14. Thus, the operative Federal Reserve guideline
was my October 6, 1979, request that banks avoid making "speculative"
loans. That request was in the form of "moral suasion" and did
not have the force of regulation, law or even formal reporting
requirements. Basically, the subsequent explanations given by the
banks operating in the United States fell into three (sometimes
overlapping) categories. First, in some instances the banks
pointed out that the loans were made under lines of credit that
were committed prior to October 6, 1979. Second, in other instances
the lending banks have indicated that they were" unaware of the
fact that the loan proceeds were being used to finance unhedged
positions in silver by the Hunt interests. Finally, other lenders
clearly viewed the credits as "damage control" loans which were
not of a speculative nature, in part because the proceeds were not
being used to acquire additional silver.
Your second question concerned bank reporting under the
Special Credit Restraint Program of extensions of credit to Hunt
interests. In the March reports received in mid-April, three of
the largest lenders did acknowledge the loans in question,
describing them in detail (without, of course, identifying the
loans by customer name) citing earlier commitments or refinancing.
None of the other banks acknowledged their lending activity in
this area. In retrospect and after further discussion with the
banks, their failure to report may, at least in part, be related
to the inherent ambiguities in defining speculative activity. In
addition, I should mention that the detailed reporting under the
Special Credit Restraint Program focused on commercial and industrial lending. Consequently, some banks, rightly classifying loans
to the Hunts in other categories, may knowingly or unknowingly have
omitted reporting on the technical grounds they were not "commercial"
loans. In that sense, the nature of the detailed reporting forms
contributed to the error. Given all of the publicity about the
silver situation and the Special Credit Restraint Program, one
might nonetheless have expected the institutions to err on the
side of reporting rather than non-reporting.
In this connection, your third question related to -the
steps we were taking to insure that we have better and more timel-y
information at our disposal in regard to the behavior of banks in
financing speculative activity. The question is both relevant and
difficult—difficult because speculative lending permits no easy
definition. We are working along a number of lines. We are
exploring modifications in our regular reports on bank lending
with a view toward singling out categories of loans more apt to
be associated with "speculative" activity—i.e., those on
commodities. I must emphasize that this is not an easy task
since there is no simple category that can be described to
blanket "speculative" lending, much less identifying the kind
of speculation that is of specific concern. I have also asked
124
the bank examinations staff to look into what further changes in
bank examination procedures could be made to assist in identifying
and discouraging damaging speculative activity. I expect that
effort will, in the near future, result in the submission to the
Federal Financial Institutions Examination Council of new guidelines, procedures and instructions that will focus more attention
on this area in the examination process.
Potentially much more important, we are looking into the
larger issues involved by way of various studies-'^i-n cooperation
with the Treasury, the SEC and the CFTC—on "financial futures"
and related markets. In our work so far, it is clear that in
attempting to guard against a repetition of the recent silver
situation, bank surveillance and restraint alone, however diligent,
are not sufficient. Apart from the definitional problems, it appears
that the amount of bank credit supporting the Hunts on the upside
of the market was relatively small. The procedures and rules of
the organized exchanges may well have to be modified to reduce
the risks of individuals or groups obtaining significant speculative positions capable of disrupting the orderly functioning
of those markets.
In your fourth and fifth questions, you asked about the
relationships between the banks and the Hunts. In the case of the
largest lenders, there were long standing relationships with the
Hunts and/or Hunt-related companies for financing in a wide variety
of business areas. Past lending typically was well secured.
There is no evidence that the banks involved had assumed, from
their point of view, more than normal banking risks. We have
also noted that at the time most of the silver loans were made,
there were sizeable margins of excess collateral, and as is
illustrated by the ability of the Hunts to restructure their loans,
they had and have assets of their own, and of related companies'
and family-owned trusts, of considerable size. It is not at all
clear that the banks individually knew the extent to which the
Hunts1 wealth was tied up with silver and it is possible that
this might have influenced their lending judgment.
In your last two questions you expressed concern about
the relationship of the banks with the brokers. Our study of
broker financing arrangements is still incomplete; however, we
do know that the vast majority of the bank loans to brokers, the
proceeds of which were in.turn made available to the Hunts, were
made under long-standing credit lines and banking relationships.
Indeed, under usual conditions, brokers utilize standing bank
credit lines and the distribution of broker extended credit to
customers would not be of concern to the bank on a day-by-day
basis. However, in retrospect it does appear" that some of the
banks were not as diligent as they might have been concerning the
125
precise utilization of the funds. I would emphasize, however,
that the matter of broker financing in the silver market is one
of the more complex areas of this whole episode and is still under
study.
While I share your concern in general about the role that
bank credit may have played in the silver episode, that credit '
appears to have been a minor part of the financing that allowed
the Hunts to increase their positions on the upside of the market.
Moreover, no one would, of course, argue that spe-qu^ation does
not have a legitimate and important economic role in the proper
functioning of the commodity markets. But clearly there are
potentials for market manipulation and the development of speculative fervor that can be exacerbated by excessive extensions of
credit. While only a portion of that credit—and perhaps typically
a small proportion—is provided by the banks, as I indicated
earlier, steps are being taken to improve our surveillance
capabilities. More importantly, our study of the broader relationships and functioning of the "financial futures" and related
markets will provide the basis for determining the nature and
extent of regulatory or legislative actions that are necessary
to discourage these speculative episodes.
I look forward to working with you as we move toward
the most effective solution to this problem.
Sincerely,
126
HENRY S, *EUS«, Wl«.. CHAIRMAN
7HCM.. i l_ ASHLEY. OHIO
WILLIAM S. MOORHCAO. PA.
PEKNAND J. St GERMAIN, R.I.
1. WILLIAM STANTON. OHIO
CHALMERS P. WYLIE, OHIO
STEWART «. MCKINNCY. CONK.
GEORGE KANSEN. IDAHO
?o7"rVo.M^~I~
FRANK ANNUNZIO. ILL,
U.S. HOUSE OF REPRESENTATIVES
PAnRlNMJHMiTCH^L^;YMD.
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
WALTER E, FAUNTROY. D.C.
ITwI^UAM 0!^"^""
RON PAUL, TEX.
STEPHEN L, NEAU N.C.
NINETY-SIXTH CONGRESS
• J E R R Y M. PATTERSON. CALIF.
JAMES' J. BLANCHARD. MICH.
. JIM
«"H\VDK£Y.'£X
'
LEACH. IOWA
CO BCTHUNE, ARK.
NORMAN B. SHOMWAY. CALIF.
•
^r^ALCc^--KV-
2129 RAYBURN HOUSE OFFICE BUILDING
WASHINGTON, D.C. 20515
CARROLL A. CAMPBELL, JR. S C,
E^ESt £«.
«S-««
12,
1980
BRUCE F. VENTO, MINN.
DOUG BARNARD. GA.
WES WATKINS. OKLA,
ROBERT GARCIA. N.Y.
The Honorable Paul A. Volcker
Chairman
Board of Governors
Federal Reserve System
-Washington, D.C.
Dear Chairman Volcker:
The silver bubble that burst on March 26-27 put the Federal Reserve's Special Credit Restraint Program .to an early and severe test.
Now that the initial excitement has
abated it is time, I believe,
for a thorough appraisal of the actions that the Federal Reserve took
§
during the crisis, and of the effectiveness of current procedures and
policies in meeting and thwarting speculative outrages in the future.
The Federal Reserve has made a significant contribution to such an appraisal already, both in your testimony of April 30 to the Subcommittee
on Commerce, Consumer and Monetary Affairs of the House Government Operations Committee, and in the "Interim Report" on silver that was -released on May 23. Nevertheless important questions remain. I am taking
this opportunity to set out my initial questions; after receiving your
written response I will look forward to taking up the matter with you
at the Banking Committee's hearings on the 'conduct of monetary policy
. next July.,
As you know, silver prices rose sharply over the last six months
of .1979, peaking near $50 per ounce in the third week of January, 1980.
In the nature of futures trading, the position of the Hunts during this
initial period of increasing prices was financed without bank credit.
After the week of January 18, prices subsided to about $33 per ounce,
and remained at about that level until the end of the first week in
March. Thirty-three dollars represented the highest price at which
the Hunts had purchased silver futures. However, in early February
higher margin requirements forced the Hunts to borrow $350 million from
U.S. banks to maintain their positions at that price.
Then prices fell, from about $33 on March 1 to about $17 on March
17, with the biggest drops on March 10 and March 13-17. The Hunts were
hit with large margin calls, and were forced again to borrow from their
banks and their brokers in order to meet them -- about $250 million according to the "Interim Report". According to your testimony of April
127
-30, 1980, and according to the "Interim Report", the Hunts borrowed at
least $800 million from domestic banks in February and March. This
included $233 million from Bache Halsey Stuart Metals Co., which was
financed by ten large banks: First National of Oklahoma City, U.S.
Trust, Northern Trust, Irving Trust, Bankers Trust, First National
of Chicago, Marine Midland, Harris Trust, Barclay's, and Citizen
and Southern. In addition, there were direct loans to the Hunts
from foreign and domestic banks, loans through Placid Oil Company,
placed at $115 million by the Federal Reserve and at^-$400 million
by the Economist magazine, direct broker loans, indirect loans by
foreign and domestic banks through other brokers, and indirect
loans through the International Metals Investment Co., Ltd., as
detailed in the "Interim Report".
These loans temporarily rescued the Hunts' silver speculation. They
.helped forestall the liquidation of the Hunts' silver futures positions,
and hence helped sustain the silver price. The loans through Bache,
plus some of the direct.U.S. and foreign bank loans, and most of the
indirect foreign bank loans, the direct broker loans and the, IMIC loans
were collateralized with silver bullion, and hence clearly depended
for their continued viability on the success of the rescue operation.
These silver bars constitute a "smoking revolver" pointing to guilty
participation in silver speculation. The temporary effect of these
loans can perhaps be seen in the rise of the silve.r price from $17
to $20 on March 19.
On March 26-27 this round of speculation collapsed. Silver spot
futures prices on.the COMEX fell from $20.20 on the 25th to $10.80
on the 27th. . The. Hunts were hit with further margin calls which they
could not meet, forcing liquidation of their silver futures positions,
and-the value of the silver bullion posted as collateral for the firstround speculative, bail-out declined sharply, forcing the.Hunts to seek
a restructuring of their debts. The eventual-result was the negotiation
of a $1.1 billion loan to a partnership consisting of Placid Oil
Company and the three Hunt brothers, about which you were questioned
"intensively on April 30, and which the "Interim Report" describes and
defends in detail.
The April restructuring through Placid Oil was, as you have
testified, a recuperative effort rather than a new speculation -- a
bail-out of the banks rather than of the Hunts. It is extremely
important, of course, that it be done in a way that ensures the
orderly liquidation of the Hunts' silver holdings and that precludes
further speculation of any kind by the Hunts. Recent press reports
have cast some doubt on whether this has been achieved. I hope that
you will be able to assure me that it has. But beyond this
necessary rearguard action, few significant issues of public policy
have so far been posed by the efforts since March 30 to dig out from
under the silver collapse.
128
Far more serious, it would appear, was the readiness with which
the banks and brokers rushed in to validate and sustain the Hunts'
futures positions in the first, and undeniably speculative, round
of lending.. Placid Oil began to build up liquidity for an eventual
rescue in November; the syndicate which lent to Bache made its
commitments in March. As noted above, nearly $800 million, or 8.6 percent of lending by the nation's 14,000 banks and 12.9 percent of all
bank business lending, flowed to the Hunts against silver in February
and March. This, at a time when general credit conditions were very
tight and when lending for small business, housing, consumers,
farmers, and productive capital investment was being severely squeezed.
These loans were made despite the Federal Reserve's vigorous
campaign against bank lending -for speculative purposes, which have been
in full swing since October. On October 6th, the Federal Reserve had
imposed marginal reserve requirements on managed liabilities of member
banks, stating,
The purpose of this action is to better control the expansion of bank credit, help curb speculative excesses
in financial, foreign exchange and commodity markets
and thereby serve to dampen inflationary forces.
On October
letters to
requesting
poses. On
10th and October 23rd, the Federal Reserve Board circulated
the chief executive officers of member banks, specifically
that they refrain from extending loans for speculative purOctober 10th, for instance, you wrote,
...the Board of Governors has .stressed its particular
concern that banks should take care to avoid financing
essentially speculative transactions, in commodity, gold,
and foreign exchange markets. I have no doubt that your
bank knows what loans best serve the continuing needs,
of your business and personal customers and of the nation.
On October 17th, in addition, you testified as follows to the Joint
Economic Committee:
...our immediate objective is to forestall speculative excesses and anticipations of a new inflationary
' outburst that could only complicate, and ultimately
make more severe, the process of economic adjustment
that is underway. ...In that connection, we have asked
the banks to take special care to avoid lending to support speculative activity, while giving particular attention to the continuing needs of their established
customers for funds to maintain normal business operations. . . .
129
The Federal Reserve's attitude toward speculative lending was
clear and unambiguous.. Nevertheless, untold number of large banks
went ahead with loans in huge amounts to rescue two of the largest
speculators of all time. Why?
The procedures employed by the Federal Reserve to monitor commodity
speculation were, and are, plainly inadequate. A major upgrading of
your oversight function in this area is urgently required.
According to the records of the Commodity Futures Trading Commission, the Federal Reserve was first alerted to the presence of potentially troublesome speculative concentrations on the^'TLong side of the
silver market in September 1979. As you testified on April 30, 1980
the Federal Reserve monitored the silver market '-'as part of our normal
economic intelligence throughout the fall and winter." The "Interim
Report" states that the Federal Reserve did consult with the Commodity
Futures Trading Commission over the fall and winter.
Yet, it seems that the entire first round of bank loans to rescue
the Hunts occurred without the Federal Reserve's knowledge. The "Interim
Report" states that in February and March "the Federal Reserve had
no direct knowledge of the size of the Hunt positions or of the
fact that they were financing.margin calls by borrowings of any
kind." In your testimony of April 30 you stated that "the first
indication of ... any potentially serious financial consequences
arising from the sharp fall of the silver price" occurred at midday
on March 26, and that prior to that time you had '"no knowledge ...
of any bank lending against silver."
By March 26, the banks had already lent the Hunts over $800
million — nearly 13- percent of all bank business lending — to
shore up their positions, collateralized in large- part by silver
bullion. The fact that the Federal Reserve did not know this, either
from its examiners, from its regular monitoring of events in the
financial and commodity markets, or from the banks themselves, suggests
something is seriously wrong with your market intelligence. Moreover,
• it. would appear that the Federal Reserve does not have the independent
-early-warning capability that would enable it to predict such crises,
and has not secured the kind of voluntary cooperation from bankers
that would make up for this deficiency. Finally, it would appear
very doubtful that the reporting requirements of the Special Credit
Restraint Program effectively enable the Federal Reserve to monitor
and discourage such speculative episodes.
My specific questions follow. First, with respect to the Federal
Reserve's market surveillance capability:
1) Did any of the banks involved at any time before March 26
attempt to consult with the Federal Reserve at the time of the
initial loans to ensure that such loans would not put them out of
130
compliance with the Federal Reserve's directives of October or with
the Special Credit Restraint Program? If so, what responses were
they given? If not, what explanation do they now give for their
behavior?
2) Did all of the banks involved directly or indirectly in the
speculative extension of credit to the Hunts in March so report under
the Special Credit Restraint Program? If not, was -their failure to
do so a dereliction on their part, or could the Program have been
construed as not requiring such reports? At what time did information
from the Special Credit Restraint Program become available to
permit assessment of the degree of speculative lending?
3) What steps have been taken to assure that any new speculative
.loans will be brought rapidly to the Federal Reserve's attention?
Specifically,
a) What steps have been taken to provide the Federal Reserve
with early warning of a massive raid on the nation's credit markets such
as that mounted in February and" March by the Hunts?
b) What steps have been taken to assure that the reports
required under the Special Credit Restraint Program are sufficient to
require a full accounting of speculative activity by banks, and hence
to deter banks from such activity?
Vigorous and effective surveillance is necessary but not
sufficient. .So long as high rollers like the.Hunts and their brokers
can write themselves their own loans at the bank, we will continue
to face the danger of a new outbreak of speculative fever. Therefore
I request that you address yourself to the following questions.
4) Were the direct loans from the banks to the Hunts part of
'.aw established relationship between the banks and the Hun.ts? Did the
'banks ask for and get from the Hunts a full and accurate account of
'the use to which the funds were to be put? Were the Hunts treated
any differently by the banks in this respect than ordinary personal
borrowers? In light of the Federal Reserve's October directives,
did the banks make any special effort to ascertain whether the funds
sought were part of a speculative venture? If not, why not?
5) If there was a special relationship between the Hunts and
their banks, what steps has the Federal Reserve taken to discourage
banks from permitting large customers to abuse such relationships
as the Hunts did? If there was no special relationship, why were
the loans made?
131
6) Were the loans that went through the brokers part of an
established relationship between the banks and the brokers? Did
the banks ask for and get a full and accurate account of the use to
which the money was to be put, including the fact that the ultimate
exposure was to the Hunts? Were the brokers treated any differently
from ordinary business borrowers in this respect?
7) If the banks and the brokers did have a cozy no-questionsasked relationship, what steps is the Federal Reser-v^ taking to
curb such potentially explosive speculative ties? Again, if there
was no such relationship, why were the loans made?
I look forward to your response, and to the July 23 hearing.
Sincerely,
Henry S. Reuss
Chairman
132
B O A R D DP G O V E R N O R S
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
July 17, 1980
The Honorable Henry S. Reuss
Chairman
Committee on Banking, Finance
and Urban Affairs
House of Representatives
Washington, D. C. 20515
Dear Chairman Reuss:
As earlier promised, I am enclosing a detailed staff study
of the data we collect on interest rates charged on short-term
business lending by banks over recent years.
The study clearly indicates that much of the explanation
for the phenomenon you noted of larger volumes of "below prime"
lending at New York City and other large banks during recent
quarters can be explained by very large loans of very short
maturity. The share of those loans in banks' lending activity
has increased in recent years as large banks have competed more
actively with the open market — particularly the commercial
paper market — to accommodate the very short-term financing
requirements of businesses; and interest rates on such loans
are therefore very closely related to money market rates. This
approach, dating back at least to 1977, was initially developed
to provide customers using commercial paper with transitional
facilities to bridge gaps of a few days in commercial paper
issuance.
Thus, the bulk of below-prime business at large banks is
related to a special market that does not involve smaller loans
or indeed large loans with maturities of more than a few days
or weeks. After allowing for this factor, experience among
banks of different size is much more comparable. Because these
particular below-prime loans have such short maturity, their
relative position in banks' portfolios is, of course, much less
than would be indicated by their share in the volume of new
extensions over any time interval.
I believe it is reasonable to, in effect, adjust the data
for this activity with large borrowers — borrowers which, in
any event, have access to the commercial paper market. The
question remains as to the situation with _respect to more usual
133
loans extending over longer periods. The study does not clearly
indicate a more favored position for large borrowers in the market
for credit at maturities that are more typically relied upon by
both large and small borrowers. In fact, the average cost of
short-term business loans maturing in more than a month has risen
more for large loans than for small loans over the last three years,
and at the peak rate period, rates for large loans appear to have
exceeded those for small.
Analysis of these data is necessarily obscured by lack of
information about precisely how many loans, and their distribution
by size, during rising rate periods may have been made under preexisting commitments having interest rate "caps." However, the
data appear consistent with other indications that special loan
programs for smaller businesses were one factor in moderating
increases for those borrowers during periods of peak rates.
In sum, the data you cited in your letter do not themselves
appear to justify sweeping charges of discrimination against
particular groups of borrowers. A more subtle question that
cannot be conclusively answered on the basis of available data
remains as to whether the prime rate is somewhat less indicative
of the minimum rate on the "best" ordinary business loans (i.e.,
those of more than a few days or weeks maturity) than the nomenclature implies. Moreover, I would note a lag in a reduction of
the prime rate relative to short-term market rates may work in
some instances to the relative disadvantage of customers that
do not have access to the open market for large short-term
business credit.
Sincerely yours,
Enclosure
134
July, 1980
Short-term Business Lending at Rates
Below the Prime Rate*
I.
Introduction and Summary
The cost of business credit, and interest rates generally,
increased throughout most of the period from 1977 through 1979 and continued to rise until the spring of 1980, reflecting the underlying strength
of demands for funds, boosted by accelerating inflation, and the efforts
of the Federal Reserve to restrain monetary growth.
As is illustrated in
chart 1, however, quarterly survey data indicate that the average rate on
new short-term business loans has increased less than the prime rate since
early 1977, while the prime rate itself—with the exception of the second
quarter of 1980—generally has stayed about 3/4 to 1-1/4 percentage points
above the commercial paper rate.—
In part, the relatively slower rise
in the average cost of short-term bank business credit reflects a growing
volume of short-term bank loans made at rates below the prime rate.
Below
prime lending initially became significant at money center banks, where the
spread between the average rate on these loans and the prime rate averaged
*
Prepared by the staff of the Board of Governors of the Federal Reserve
System.
I/ Beginning in the early 1970s, large banks began explicitly to link their
prime rates to money market rates. 'Citibank, which introduced this practice,
employs a formula that calls for a prime rate determined by a markup over a
three week average of money market rates. From mid-1973 through 1978 the money
market rate used was a measure of alternative costs of credit, the 90-day
commercial paper rate. Since 1979, the markup has been over a measure of the
bank's cost of funds, the 90-day certificate of deposit rate. The practice
has been to review the formula weekly and, generally, to adhere to it. As
money market rates plunged in the spring of this year, however, banks abandoned
such formulas, and the prime rate recently has declined comparatively slowly.
As a result, an unprecedented gap has opened between the prime rate and money
market rates.
Selected Measures of the Cost of Short-term Credit
WEIGHTED AVERAGE RATE ON
SHORT-TERM BUSINESS LOANS
136
between about one-half and one percentage point over the years 1977-1979.
This spread widened in 1980
(see table 1).
High percentages of short-term loan
extensions at rates below prime also have developed at medium and smaller banks,
generally at somewhat larger spreads below prime than at large banks.
Below prime lending at large money center banks mainly represents
very large extensions of credit for very short periods at -rates linked to
money market rates.
At large non-money center banks -and at medium sized
and smaller banks, below prime lending appears primarily to reflect several
other factors, including two-tier lending programs favoring small businesses
(which may also explain some of the below prime lending at money center
banks), the lesser reliance of many smaller banks on large denomination CDs
and other relatively costly purchased funds, and the interaction of rising
interest rates with the presence of cap provisions on the larger share of
below prime loans extended under commitment at these banks.—
Despite the
growth of below prime lending and the relatively restrained increase in the overall
cost of bank credit in recent years, the commercial bank share of outstanding short- and intermediate-term credit—comprising all business loans at
commercial banks, commercial paper issued by nonfinancial businesses, business
loans at finance companies, and bankers acceptances held outside banks—declined
from 70 percent at the end of 19-76 to 66r-1/2 percent at the end of 19-79.
\J Below prime lending also has been examined in "Changes in Bank Lending
Practices, 1977-79," Federal Reserve Bulletin, October 1979, pp. 797-815, and
in P. Boltz and T. Campbell, "Innovations in Bank Loan Contracting: Some
Recent Evidence," Staff study, Board of Governors of the Federal Reserve System.
2J Since the prime rate is a measure of the cost of short-term credit, this
report focuses on the relation between the prime rate and rates on shortterm (one-year-and-under) bank loans.
_3/ Also included in loans made at rates below prime at all sizes of banks is
an unknown, but probably quite small, volume of "restructured" loans that
have been renewed at reduced rates in order to prevent default.
Table 1
Short-term Business Lending Below the Prevailing Prime Rate By Selected Classes of Banks-
Class
of bank
48 Large
Percent of Gross Loan
Extensions Made at Rates Below Prime
1977
1978
1979
1980P
May
Feb.
Spread Between Prime Rate
and Weighted Average Rate on
Loans Made Below Prime (basis points)
1980P
1977
1978
1979
Feb.
May
8.8
16.1
32.6
50,0
58 .8
79
62
92
123
414
13 Money Center
12.2
17.5
38.3
55.2
67 ,5
77
67
84
116
431
Large Non-money
Center
4.2
14.5
22.7
40.5
31 ,8
95
53
114
142
309
15.7
22.6
43.3
67.0
67.0
69
68
88
118
419
134
410
Large New York City
Large Non-NYC
3.5
11.1
22.0
31.5
Medium and Smaller
3,0
10.5
33,4
32 8
51 .7
111
57
97
3
87
82
162
2/43
245 .
220 ?/
(211)2-7 (247)--'
p--preliminary
NOTE: Annual data are averages for the four survey weeks in each year.
I/
Short-term loans have a maturity of one year or less. The prevailing prime is that posted at a majority
of 31 large banks.
2_l
Calculated using actual prime rates posted by respondent banks on survey dates. This information became
~~
available beginning with the August 1979 survey. With the exception of May 1980, at 48 large banks actual
primes do not differ from the prevailing prime. For calculations using actual May primes, see appendix
table 1.
138
Survey data indicate that substantial volumes of gross loan
extensions at rates below prime appeared earlier and have remained more important at large money center banks.
However, the volume of below prime
lending reported by money center banks is importantly influenced by the
very short average maturity of these loans.
When this factor is taken into
account, 'there is nothing to suggest that the share of portfolios accounted
for by loans made at rates below prime differs substantially between money center
banks and other banks.
Finally, an examination of average rates paid on loans
of various sizes indicates that rates on small loans rose less than rates on
large loans between early 1977 and early 1980.
In fact, rates on small
loans were actually below those on very ..large loans in late 1979 and early
1980.
To the extent that size of borrower can be inferred from relative
size of loan, these findings suggest that, in the recent environment of
very rapid increases in nominal interest rates, the average cost of credit
to smaller borrowers has at times been below the average cost to
larger borrowers.
The survey data analyzed in this report provide information on
several characteristics of loans made by respondent banks during the first
full week of the middle month of each quarter.
A sample of 340 banks—selected
to represent all insured banks—reports the size of each loan (including renewals) made during this period, its term to maturity, its commitment
status, the interest rate charged and whether the rate is fixed or floating.
Beginning with the August 1979 survey, banks also report their prime rate in
effect an the survey dates.—
Reported interest rates on loans may be affected
If Data are from the Survey of Terms of Bank Lending (STBL). Forty eight
large banks report all loans made on certain specified days of the survey week,
while other respondents report all loans made on all days of the survey week.
The STBL is described in detail in the May 1977 Federal Reserve Bulletin.
pp. 442-445.
~
139
by a variety of unmeasured factors—for example, the presence and size of
compensating balances, the nature of the collateral if the loan is secured,
and other dealings between the bank and the borrower, such as cash management services.
Thus, survey rates may not accurately measure the overall
cost of the credit extended.
Nevertheless, the survey does provide a fairly
comprehensive, regularly collected scries on bank lending-sterms, and the general trends that it reveals appear to be broadly reflective of bank lending
developments.
II.
Below Prime Lending at 48 Large Banks—
As shown in table 2, the volume of short-term business loans
extended at rates below prime by 48 large banks, expressed as a percentage
of their total short-term business loans extended, has been rising since
1977, roughly doubling in 1978, 1979, and 1980.
Typically, loans made below
prime by these banks are far larger than their loans made at or above prime—
on the order of 5 to 10 times as large—and have considerably shorter maturities—well under a month, on average, compared
loans.
to 2 to 2-1/2 months for other
These size and maturity characteristics of below prime loans at large
banks primarily reflect lending activities at money center banks (compare.
tables 3 and 4.)
In most survey weeks, almost all below prime lending at money
center banks has been done at rates'above money market rates.
Lending at rates
tied to the money market had its genesis at agencies and branches of foreign
banks, which began around 1977 to make credit available at a markup over the
LIBOR "rate.
Below prime lending at large money center banks appears to be aimed
at countering both this development and competitive inroads also being
I/ As of December 31, 1979, the average assets of the 48 large banks were
$10-1/2 billion, and the smallest of these was $2 billion. For all insured
banks on that date, assets averaged $97 million.
Table 2
Selected Characteristics of Gross
Short-term C&I Loans Extended by 48 Large Banks
\
Nov.
5-10
1980P
Feb.
May
4-9
5-10
37.5
.8
18.7
5.6
50.0
1.1
58.8
.7
23.5
24.8
12.6
27.6
24.9
2.7
.7
2.2
.9
2.1
1.1
2.3
.5
2.5
.9
Feb.
1977 ,
May
Aug.
2-7
1-6
Nov.
7-12
Feb.
6-11
1978
May
Aug.
1-6
7-12
Nov.
6-11
Feb.
5-10
8.0
'.9
4.3
.2
13.6
.7
9.3
.2
15.4
.4
13.2
.2
16.0
.1
19.8
3.7
34.2
2.8
39.8
1.8
6.6
2.6
10.6
5.6
9.1' 7.6
8.6
10.6
20.8
2.1
.8
1.8
.7
2.4
1.5
2.2
1.0
2.3
.7
2.1
.4
2.3
.7
2.5
2.0
2.6
1.1
141
2,385
167
1,724
166
1,958
162
731
186
145
1,229 1,445
153
421
206
343
138
534
May
2-7
1979
Aug.
6-12
Percentage of gross loan
extensions accounted for
>y }.oans made at
rates below prime
rates below money
market rates I/
rates below prime and
not under commitment
Average maturity (months)
Loans above prime
Loans below prime
Average r,ize ($1,000)
Loans above prime
Loans below prime
H84
202 '
'994 1,011
361
237
227
208
1,115 1,233
p--preliminary
NOTE: Calculations are based on the prevailing prime rate. Actual primes, available since August 1979, are identical to the
I
prevailing prime except for May 1980.
See appendix table 1.
^/
The money market rate benchmark is the lower of the federal funds rate and the commercial paper rate.
Table 4
Selected Characteristics of Gross
Short-term C&I Loans Extended by Large Non-Money Center Banks
1977
May
Aug.
2-7
1-6
Nov.
7-12
Feb.
6-11
1978
May
Aug.
1-6
7-12
Nov.
6-11
Feb.
5-10
3.4
.0
3.9
.0
1.5
.5
7.9
.3
10.0
.1
14.8
.4
10.6
.1
22.5
4.3
24.2
2.1
35.1
1.5
22.8
.9
8.8
2.9
40.5
2.6
31.8
1.2
.1
.5
1.0
4.4
6.5
6.2
3.5
13.8
9.1
12.8
10.8
2.2
16.9
9.9
1.9
-1
1.7
.9
2.8
4.0
2.4
1.3
2.3
.8
2.3
.5
2.4
.7
2.7
2.9
2.4
1.3
2.7
.7
2.5
1.2
2.6
1.6
2.1
.6
2.7
1.1
HO
142
540 1,152
142
170
132
492
116
476
125
900
128
158
134
240
126
269
''540
140
338
225
64
184
437
154
274
May
2-7
1979
Aug.
6-12
198QP
Feb.
May
4-9
5-10
Feb.
7-12
Nov.
. 5-10
ercentage of gross loan
xtensions accounted for
y loans made at
rates below prime
rates below money
market rates \J
rates below prime and
not under commitment
Average maturity (months)
Loans above prime
Loans below prime
verage size ($1,000)
Loans above prime
Leans below prime
•--preliminary
IOTE: Calculations are based on the prevailing prime rate. Actual primes, available since August 1979, are' identical to the
prevailing prime except for May 1980. See appendix table 1.
I/
The money market rate benchmark is the lower of.the federal funds rate and the commercial paper rate.
Table 3
Selected Characteristics of Gross
Short-term C&I Loans Extended by 13 Money Center Banks
1977
1980P
Nov.
7-12
Feb.
6-11
1978
May Aug.
1-6 7-12
Nov.
6-11
1979
19.5 12.1 20.6
.0
.0
.1
17.8
3.2
42.3
3.3
42.4
1.9
44.7
.8
24.0
7.1
55.2
.3
67.5
.5
Percentage of gross loan
^tensions accounted for
•>y loans made at
rates below prime
rates below money
market rates _!/
rates below prime and
not under commitment
11.1
1.6
4.7
.5
22.6
1.0
10.6
.1
11.1
4.7
17.7
6.8
11.1
8.5
12.9
8.1
30.1
29.5
31.6
17.5
33.5
29.8
2.3
.9
1.9
.5
2.0
1.4
1.9
.7
2.4
.6
2.0
.4
2.2
.6
2.3
1.0
2.7
1.0
2.7
.7
1.9
.9
1.7
1.0
2.4
.5
2.4
.9
188
277
183
3,197 2,940 1,488
336
581
153
971
290
T246
1,634 2,015
585
498
Average maturity (months)
)-
Loans above prime
Loans below prime
'Average size ($1,000)
-
Loans above prime
Loans below prime
200
215
199
179
936 2,907 4,022 1,176
273 270
2,981 2,628
p—preliminary
NOTE: Calculations are based on the prevailing prime rate. Actual primes, available since August 1979, are identical to the
preyaillng prime except for May 1980, See appendix table 1,
I/ The money market rate benchmark is the lower of the federal funds rate and the commercial paper rate.
143
made by the commercial paper market and finance companies.
In 1977,
Morgan Guaranty announced a "commercial paper adjustment facility" designed
to provide large sums of credit for very short periods (usually no more than
10 daysj) to those of its customers having lines of credit used to secure
borrowings in the commercial paper market.
Similar credit facilities also
were made available by other large banks.
These programs, ^were designed to
allow customers to adjust the timing of their paper issuance in order to
obtain the best terms possible.
The price of these funds is set at a markup
over their cost to the bank, typically as measured by the federal funds rate.
Reports suggest that very short-term credit is also available in large volume
at rates marked up over the commercial paper rate itself.
The market for such short-term below prime loans is described as
very impersonal, with no sense of loyalty between lender and borrower.
Money
center banks make the funds available only if they cannot be more profitably
employed elsewhere, while borrowers tend to "shop around" from bank to bank,
and in the commercial paper market itself, in search of the cheapest source
of credit.
Generally less than a third of below prime lending at money.center
banks -is done under commitment.
The importance of this type of lending by money center banks is
illustrated by declines in the relative volume of their below prime lending
when money market rates approach the prime rate, as happened in the fall of
1978 and again a year later (see chart 1).
The surveys of November 1978 and
November 1979 show sharp declines in the percent of loans made at rates below
prime at money center banks.
Moreover, about a quarter of the below prime
loan made by these banks during these periods were priced below money
market rates.
Apparently, many of the "below prime" loans made
Table 5
Selected Characteristics of Gross
Short-term C&I Loans Extended by Large NYC Banks
\
Feb.
7-12
1977
May
Aug.
2-7
1-6
14.0
.0
7.7
.5
26.6
1.2
14.0
5.2
1.3
1.1
1.3
.7
231
284
Nov.
5-10
1980P
Feb. May
4-9
5-10
46.9
1.0
26.5
9.4
67.0 67.0
.2
.4
33.1
38.1
20.5
46.4
45.0
2.2
.6
1.5
.8
1.6
.9
1.7
.4
2.2
.9
1978
Feb. May
Aug.
6-11 1-6
7-12
Nov.
6-11
Feb.
5-10
14.4
• .0
24.7
.0
20.5
.0
25.9
.1
19.1
4.5
50.9
2.3
49.0
2.2
21.0
8.9
21.0
14.1
14.8
13.8
38.4
1.8
1.4
1.3
.6
1.7
.5
1.5
.3
1.8
.3
1.6
.8
1.5
.9
300' 310
3,752' 3,65?
269
607
329
641
182
1,229
Nov.
7-12
May
2-7
1979
Aug.
6-12
ercentage of gross loan
xtensions accounted for
y loans made at
rates below prime
rates below money
market rates JL/
rates below prime and
not under commitment
Average maturity (months)
Loans above prime
Loans below prime
(Average size ($1,000)
-
Loans above prime
Loans below prime
10, 760 4,622
261
251
4,428 2,061
£'347
365 ' 535
2,581 2,045 1,087
338 310
4,054 2,181
p—preliminary
NOTE: Calculations are based on the prevailing prime rate. Actual primes, available since August 1979, are identical to the
.prevailing prime except for May 19.80. See appendix table 1.
. . .
_!/
The money market rate benchmark is the lower of the federal funds rate and the commercial paper rate.
Table 6
Selected Characteristics of Gross
Short-term C&I Loans Extended by Large Non-NYC Banks
Feb.
1=12.
1977
May
Aug.
1-6
2-7
4.0
1.5
1.5
.0
1.8
Nov.
5-10
1980P
May
Feb.
5-10
4-9
25.0
.5
12.1
2.4
31.5
2.1
51.7
.9
11.9
7.0
^5.1
7.1
7.6
3.0
1.6
3.1
.9
2.9
1.4
2.4
1.5
2.6
.8
2.8
.1.0
124
273
PI
437
142
447
293
97
193
416
173
828
Nov.
7-12
Feb.
6-11
1978
Aug.
May
1-6
7-12
Nov.
6-11
1.8
.4
6.6
.3
8.7
.1
7.2
.3
8.4
.1
20.3
3.2
22.0
3.1
28.6
1.2
.5
1.2
3.8
.5
2.3
4.0
8.6
7.9
2.6
.1
2.2
.8
2.8
2.9
2.6
.1.4
2.7
1.1
2.6
.6
2.6
1.4
3.0
2.6
115
863
127
468
134
234
139
421
110
513
145
601
121
245
169
272
Feb.
5-10
May
2-7
1979
Aug.
6-12
E
rcentage of gross loan
tensions accounted for
loans made at
rates below prime
rates below money
market rates JL/
rates below prime and
not under commitment
jverage maturity (months)
Loans above prime
Loans below prime
verage size ($1,000)
Loans above prime
Loans below prime
--preliminary
OTE: Calculations are based on the prevailing prime rate. Actual primes, available since August 1979, are identical to the
prevailing prime except for May 1980. See appendix table 1.
I/
The money market rate benchmark is the lower of.the federal funds rate and the commercial paper rate.
146
by money center banks in November 1978 and November 1979 reflect the honoring
of previous loan commitments featuring cap provisions, as the prime rate had
been rising rapidly prior to both of-these surveys.
At large non-money center banks (table 4), the average size of
loans made below prime is only somewhat larger than other loans, and loans
generally are much smaller than at money center banks.
In addition, the dis-
parity between the maturities of loans made below prime and those made at or
above prime by these banks generally is not as pronounced as at money center
banks.
Finally, the share of below prime loans made under commitment is larger
at large non-money center banks than at money center banks.—
III.
Medium and Smaller Banks
Below prime lending at medium sized and smaller banks has been
substantial in all the surveys since November 1978.
In contrast to the
situation at large banks, a significant part of below prime lending at these
other banks has been done below money market rates Csee tahle 7).
This pricing
appears to reflect the tendency for loan rates at smaller banks, particularly
on smaller loans, to adjust to general upward rate pressures, much more slowly
than the prevailing prime rate and other money market rates.
In part, this
sluggishness may arise from cap provisions on the larger share of below prime
loans made under commitment by these banks.
Increases in the proportion of
loans made at rates below prime by medium and smaller banks in November 1978
and November 1979, for example, were likely due in part to the sharp upward
movements in interest rates that had been in train for some time before each
I/ Table 5 and 6 show similar patterns for large banks located in New York City
compared to large banks elsewhere. Of course, the similarities between the
large money center and large New York City bank categories is in part attributable to their overlapping coverage.
Table 7
Selected Characteristics of Gross
Short-term C&I Loans Extended by Medium Sized and Smaller Banks
Feb.
2lI2
May
1977
Aug.
1-6
Nov.
7-12
Feb.
6-11
1978
Aug.
May
1-6
7-12
1.8
.1
2.2
.0
3.2
.7
4.9
.7
3.7
1.1
7.0
.8
.5
'.8
1.1
2.4
1.5
2.7
1.0
2.3
1.0
2.1
2.0
2.4
1.1
27
195
28
447
35
78
30
59
Nov.
5-10
1980P
Feb.
May
4-9
5-10
32.9
17.8
45.5
26.0
32.8
11.9
43.3
2.3
17.6
22.5
32.7
25.7
27.0
2.6
2.7
2.3
2.9
2.2
2.7
2.3
3.0
2.5
2.5
2.7
2.8
41
20
*s
40
20
61
23
52
19
56
32
1979
Aug.
6-12
Nov.
6-11
Feb.
5-10
7.7
1.5
23.5
6.7
30.6
13.0
24.6
11.3
4.7
5.9
14.6
19.7
2.3
1.2
2.0
2.8
2.5
2.4
1.3
2.3
29
31
51
69
28
May
2-7
prcentage of gross loan
jctensions accounted for
v loans made at
rates below prime
rates below money
market rates I/
rates below prime and
not under commitment
fverage maturity (months)
Loans above prime
Loans below prime
.verage size ($1,000)
Loans above prime
Loans below prime
57
34
14
• --preliminary
iOTE: Calculations are based on the prevailing prime rate." For calculations using the actual prime, available since August
1979, see table 7a.
J[/
The money market rate benchmark is the lower of- the federal funds rate and the commercial paper rate.
Table 7a
Selected Characteristics of Gross
Short-term C&I Loans Extended by Medium Sized and Smaller Banks
Aug.
6-12
Nov.
5-10
Feb.
4-9
1980P
May
5-10
21.2
7.9
12.9
26.6
15.9
16.9
15.2
5.6
9.2
26.8
2.2
14.4
2
2
1979
Percentage 'of gross loan extensions
accounted for by loans made at
-
rates below prime
,,
rates below money market ratesrates below prime and not
under commitment
Average maturity (months)
-
Loans above prime
Loans below prime
£t
00
2
2
«*
-A
3
3
«
-*
2
5
«
-6
2
2
7
-7
Average size ($1,000)
-
Loans above prime
Loans below prime
34
22
36
33
36
23
p--preliminary
NOTE: These calculations reflect the actual prime rate in effect at respondent
banks on survey dates.
I/ The money market rate' benchmark is the lower of the federal funds rate and the
commercial paper rate.
40
46
149
of these survey weeks.
The increase in below prime lending during these
survey weeks contrasts with simultaneous declines in the share of loans made
below prime at money center banks.
As discussed above, the strong upward
rate pressures that characterized these periods had brought money market rates
into close proximity with the prime rate, causing the rate on loans tied to
money market rates to approach or exceed the prime rate.""
At medium and smaller banks, the average size and maturity characteristics of loans made below prime tend to be quite similar to those for loans made
at prime and a"bove.
Indeed, to the extent that they differ, below prime
loans iit these banks, tend to have longer maturities and smaller average sizes
than other loans—the opposite of the situation at large banks.
IV.
Implications of Relative Maturity
As already noted, gross loans made below prime by money center
banks have very short average maturities relative to their other short-term
loans and to short-term loans made at other banks.
This large disparity in
average loan maturities makes it difficult to use gross extensions data toinfer anything about the share of outstanding bank loans that were
rates below prime.
made at
Consider, for example, a bank whose outstanding loans are
equally divided between those made at rates of prime and above those made
at rates below prime.
If, in addition, the average maturity of loans made below
prime were half that of loans made at or above prime, then.gross loan extension data would show that the volume of loans made below prime was twice
the volume made at prime or above.
In general, since loans with shorter .
maturities tend to be made more often their importance in gross extensions data
will exaggerate the sharer of a bank's portfolios for which they account.
150
To obtain some indication of the proportion of outstanding bank
credit accounted for by loans made at rates below prime, the percentages
of loans made below prime were recalculated after adjusting the gross loan
extension data for differing loan maturities.
The results of this ad-
justment, presented in table 8, show substantially reduced proportions of loans
. **'«.•»,
made below prime at large bcnks—typically lower by a factor of about 1/2—
and generally higher proportions for medium and smaller banks, where average
maturities of below prime loans have tended to exceed somewhat average
maturities of loans made at or above prime in recent surveys.—
The adjusted
percentages suggest that lending at rates below prime did not reach
sizable proportions at large banks until late 1978, about the same time
as at smaller banks.
Removing the effect of maturity differences also
indicates that below prime lending was more extensive at medium sized and
small banks than at 48 large banks for every survey since that of May 1378,
calculated on the basis of the prevailing prime. When the prevailing prime
is replaced by the actual prime, below prime lending is more prevalent
at large banks than at medium and smaller banks in May 1980.
V. Loan Rates by Size of Loan
Many of the developments discussed above can also be seen in the
behavior of rates classified by size of loan.
The relative cost of credit
for various sizes of loans has changed considerably in recent years.
As
I/ The percentages calculated in table 8 are based on the volume of loans made
below prime adjusted to account for the difference between the average maturity
of these loans and that of all loans surveyed. Specifically, to adjust for the
contribution that the maturity of loans makes to the frequency with, which they
appear, on average, in gross loan extensions data, the ratio of a bank's gross
loan extensions made at rates below prime to total gross loan extensions (the unadjusted proportion of loans made below prime) was multiplied by the ratio of the
average maturity of loans made at rates below prime to the average maturity of
all loans made by the bank.
Table 8
The Percent of Gross Short-rterm C&I Loan Extensions
Made at Rates Below The Prevailing Prime By Selected Classes of Banks
(Adjusted for Maturity) I/
Class of
Bank
48 Large
Large Non-Money
Center
Mirr_
Feb . May
Aug.
7-12
2-7
1-6
Nov.
7-12
Feb.
6-11
May
1-6
9.1
4.4
5.1
6/1
3.0
2 /
6
3.9
3.8
3.5
3.1
1.7
191JA
.2
2.1
2.0
4.6
19_79_
Aug.
7-12
Nov.
6-11
5.1
16.2
7
8
C
23.9
FebV
5-10
May
2-7
Aug.
6-12
Nov.
5-10
18.8
14.7 20.6
10.8
n
1C
I C O
o
15.2
New York City
11.8
4.1
22.6
7.2
8.9
5.4
6.2
10.1
36.8
Large Non-NYC
.2
.5
1.9
3.7
3.5
1.9
4.6
18.1
12.9
Medium and Smaller
.6
.9
3.0
2.4
1.9
9.2
7.2
36.0
31.2
C
•)£.
f.
1980P
May
Feb.
4-9
\5-10
18.6
?n Q
f.
12.8 12.4
15.6
5.7
15.3
16.3
32.7 45.5
19.9 31.5
8.0
12.1
10.8 14.0
27.1
32.8 44.4
29.1 38.1
52 3
' 21 (15.8)-' (26.9P(21.8)^•'/ (35.0)^'
p—preliminary
I/ Percentages from row 1 of tables 2-7 were adjusted by multiplying them by the ratio of the average maturity of loans
made at rates below prime to the average maturity of all loans. See text, p. 7, for a fuller explanation.
2/ These percentages reflect the actual prime rate posted by respondent banks and are based on the data in table 7a.
~~ With the exception of May 1980, at 48 large banks actual primes do not differ from the prevailing prime. For calculations using the actual May 1980 prime at the several classes of large banks, see appendix table 1.
34.0
AO
C7!
152
shown in chart 2, the general increases in all interest rates from 1977 through
1979 were reflected least in rates on smaller denomination loans.- As a result,
the spreads between average rates on smaller loans and on the largest loans at
..all banks narrowed over-this period and actually reversed by late 1979. That
is, in November 1979 and February 1980, the average rate on the largest loans,
even including many below prime loans, exceeded the averag'e^rate on the smallest
loans.
To the extent that relative size of borrower can be inferred from rela-
tive size of loans, smaller borrowers, on average, acquired credit more cheaply
in late 1979 and early 1980 than large borrowers.—
This reversal occurred even
earlier if loans having a maturity of one month or less are excluded when calculating average rates by size of loan.
On this basis, the average rate on
very large loans was above that of small loans in three of the four survey weeks
in 19.79 and remained above through May 1980 (see chart 3) .
Several factors may have contributed to these changes in relative
rates on large and small loans.—
Borrowers of large amounts of funds typically
find the cost of bank credit moving in concert with rates generally, since banks
price larger loans—even -apart from those directly linked to money market rates—
competitively to reflect the cost of funds in money markets. The rate on large
loans moved fairly closely with the prime rate over the 1977-79 period.
Smaller
borrowers, on the other hand, often acquire funds from smaller banks, and for
many of these banks a relatively substantial share of their lendable funds
If Research based on a special 1972 survey indicates a strong average relationship between loan size and size of borrower, as measured by total assets. !'A
Model of Bank Lending to Business" by R. Puckett and M. Scanlon (mimeo , Board of
Governors).
2/ Smaller loans generally tend to have higher interest rates than large loans
owing to the higher per dollar expenses of origination and servicing they impose
on banks as well as to relative risk considerations.
-
The Average Cost of Short-term Business
Loans by Size of Loan, All Loan Maturities
Percent
20
18
16
14
1977
Source:
STBL
1978
1979
1980
H*
Chart 3
The Average Cost of Short-term Business
Loans by Size of Loan, Exclusive of Loans with
Maturities of One Month or Less
Percent
20
18
16
Under $100,000
—$100,000-$500,^
Over
~^
1977
Source;
STBL
1978
1979
1980
155
may be obtained from demand and savings deposits whose costs do not vary greatly
in the short run.
Sluggish movements in average rates on small loans also
likely reflect "two-tier" loan policies and other loan programs adopted by both
large and small banks to aid small borrowers.—
VI. Conclusions
Traditionally, a bank's prime rate has referred^to the"rate of
interest offered its most creditworthy customers, and banks appear to continue to use a base rate in pricing a large share of their lending activities.
However, the data examined in this report indicate that significant volumes
of short-term loans at both large and small banks have been made below the
prime rate since the second half of 1978.
In part, this development appears
to be related to the environment of high and rising interest rates in which
it appeared. If interest rates remain relatively:.low or continue, tq fall
during the recession, below prime lending at medium and smaller banks—
in part attributable to the establishment o.f special, losn programs for smaller
businesses, with base lending rates set below the prime rate, and to the
extension of loan commitments with maximum rates that were surpassed by the
rapidly rising prima rate—is likely to decline.
At large money center banks,
on the other hand, below prime lending is also traceable to the substantial
growth in very large, short-term loans tied to money market rates, suggesting
that below prime lending at these institutions may. remain important even as
interest rates stabilize.
An extended period of stable or declining rates
is also likely to see the reemergence of a more typical relation between rates
on large and small loans, and the average rate on very large loans, even
defined to exclude loans with maturities of a month or less, is likely to fall
below that for small loans.
I/ As of early 1979, the Small Business Administration had identified over"
100 banks—about a fifth of them very large banks—that had established twotier loan programs. Typically, these programs use a base rate of 1-1/4 to
1-1/2 percentage points below the prevailing prime to price loans to small
businesses. More recently, responses by large banks to surveys taken-under
the Special Credit Restraint Program indicated that about half of these
institutions had established a program to assist small businesses.
Appendix Table 1
Lending Characteristics For Selected Classes of Banks
Calculated on the Basis of Actual Prime Rates Posted, May 5-10,
1980
Class of Bank
Large NonMoney Center
Large NYC
48 Large
13 Money
Center
53.0
61.1
32.0
60.7
44.3
25.4
31.4
9.8
42.0
6.8
30.1
38.3
38.5
24.4
Large Non NYC
Percentage of gross loan
extensions accounted for
by loans made at
-
rates below prime
rates below prime and
not under commitment
rates below prime, and - ,
adjusted for maturity^-'
16.1
3
Average maturity (months)
-
Loans at or above prime
Loans below prime
2.5
1,0
2.4
.9
2.7
1.1
2.1
0.8
2.9
1.1
205
1,091
264
2,632
154
278
342
2,726
156
568
Average size ($1,000)
' - Loans at or above prime
- Loans below prime
\J See footnote 1, table 8,
157
3. WIU.IAM STAhTTOK. OHIO
CHALMCRS f. WYUC. OHIO
STEWART E. MCKIHNCY. CONK.
GEORGE HAMSEN. IDAHO
U.S. HOUSE OF REPRESENTATIVES
m«7«*!££.'Sx
JIM LEACH. IOWA
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
NINETY-SIXTH CONGRESS
2129 RAYBURN HOUSE OFFICE BUILDI
WASHINGTON, D.C. 20515
<•
EVAKS.VND.
May 23, 1980
E. D'AMOURS. N.H.
N. LOf^l
AUGK, NCBR.
£ DAKAR. OHIO
= «UCC F. VEKTTO. MINN.
X5UG BARNARD. CA,
VES WATKIKS. OW-A,
•S.IK.C LOWRY. WASH!
Honorable Paul A. Volcker
Chairman, Board of Governors
Federal Reserve System
Washington, D.C.
20551
Dear Mr. Chairman:
Information received from the Federal Reserve for the first
quarter of 1980 indicates that 66.96 percent of business loans
by "larg'e New York banks" were made at below the prime rate. This
compares with 28.85 percent below-prime loans made in the previous
quarter (4th quarter, 1979) , and with the 30.22 percent below-prime
rate average for all'previous quarters since the series started in
1977. For "44 large banks," whi'ch includes large banks in New York,
the first quarter of 19SO percentage of below-prime loans was 50
percent. This compared with 19.78-percent for the previous quarter,
and 21.4 percent average for all previous quarters.
The nation's' 14,500 other 'banks did not engage in comparable
below-prime lending. Their first quarter percentage of below-prime
business loans was a modest 15.18 percent, compared to 26.59 percent
for the previous quarter and 12.91 percentage for the average since
1977.
Information from published sources indicates that during this
period, large corporate borrowers were obtaining loans as,much as
6 percent under the prime rate.. Obviously the big banks were unfairly
discriminating against small business, farmers, home builders, and
others who were charged more than the posted prime rate.
Those who watch the prime rate as an indicator of what's going
on in the economy have been misled by the banks' posted rates. How
can bank examiners enforce such laws as The Equal Credit Opportunity
Act, which bans discrimination against women and minorities, if the
examiners have been flim-flammed on the real prime rate?
I would appreciate an investigation and report concerning this
entire situation.
Sincerely,
Henry S. Reuss
Chairman
158
B O A R D OF G O V E R N O R S
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
July 21, 1980
The Honorable Henry S. Reuss
Chairman
Committee on Banking, Finance
and Urban Affairs
House of Representatives
Washington, D.C.
20515
Dear Chairman Reuss:
The staff here and at the Reserve Banks have been looking
into the loan agreement that Mr. Stuart Tisdale of Sta-Rite
Industries, Inc. sent to you.
We have learned that the parties to the loan agreement
felt committed to the loan prior to my October 23 letter and that
there are indications that negotiations had been underway since
early in October. The October 23 letter was the first communication that specifically emphasized take-over loans. Nevertheless,
a question remains in my mind as to why the banks had not been
sensitive to the relevance of this commitment to earlier admonitions about financing purely financial and speculative activity'
that did not contribute to economic performance. In that
connection, I have noted the provision in the loan agreement
that the proceeds of the loan will be used to acquire an
unidentified "target." If the "target" was also unknown to
the lenders, it is difficult to see how they could show that
the loan was a transaction that would contribute to the economy's
performance.
The general request for restraint in this type of
lending—and before October 23 it was admittedly less explicit—
does not, of course, have the force of regulation. However, the
loan raises a question as to whether the banks consciously misconstrued or disregarded the spirit of the Federal Reserve's
efforts in this area. I have asked the Reserve Bank Presidents
to discuss this loan with the top officials of the banks involved,
emphasizing the nature of my concerns about the transaction and
making certain that the need for cooperation in such efforts is
understood.
Sincerely
159
P. WYUIE, OHIO
. McKINNEY. CONI
NCCN. IBAHO
U.S. HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
NINETY-SIXTH CONGRESS
WASHINGTON, D.C. 20515
June 26, 1980
* MATTOX. TEX.
:UG BARNARD. CA
Honorable Paul Volcker
Chairman, Board of Governors
Federal Reserve System
Washington, D.C. 20551
Dear Chairman Volcker:
Mr. Stuart Tisdale, Chairman and President of Sta-Rite
Industries, Inc., has called to my attention the enclosed
loan agreement, between five large banks and Nortek, Inc.,
in the amount of $40,000,000. The purpose of the loan, as
stated on page 3, is explicit:"(i) to purchase outstanding equity securities
and securities convertible into or rights to acquire
equity securities of a corporation (a 'Target') pursuant
to & solicitation by the Company or a subsidiary of
the Company of tenders of such securities, or in one
or more negotiated, block, market or other transactions
not involving a tender offer, or a combination of any of
the foregoing;
(ii) to make a Target a Subsidiary pursuant to a
merger, purchase of assets or other reorganization
providing for the issuance to the holders of the Target's
then outstanding equity and convertible securities, in
exchange for such securities, of cash or securities of
the Company or a Subsidiary, or a combination thereof;
(iii) to purchase the business or integral part of
the business of a Target; and
(iv) to pay fees and expenses related to any of the
foregoing."
This loan agreement is dated October 25, 1979, just two
weeks after your letter to large member banks of October 10, 1979 (
in which you stated,
"This is not the time to finance activities that have
little to do with the performance of the American economy."
160
Your letter of October 23 to all member banks made this point
even clearer:
"...credits for extraordinary financial transactions would
be viewed as questionable by the Board. Examples would include
loans ... for corporate takeovers that simply substitute one
source of financing for another and do not clearly promise improvement in economic performance."
Please provide this Committee, in advance of your appearance on
July 23rd, a written report that answers the following questions:
1) What, if anything, does the proposed Nortek takeover of StaRite contribute to the performance of the American economy?
2) Given your explicit injunctions of October 10 and 23, and the
unambiguous nature of this loan, why was it made?
3) At what time did the Federal Reserve become aware of this loan,
through the reporting requirements of the Special Credit Restraint Program or otherwise, and how?
4). What actions do you consider appropriate for the Federal Reserve to take under these circumstances, and
5)
What actions have you taken?
On a related matter, I am disturbed by news that Mr.. N... B.. Hunt's
daughter has. entered the silver business... Her purchase, of a. stake in
Goldfield Corp. silver exploration business suggests that the
Hunt brothers are determined to use 'their extensive, network of family
and other relationships- to carry on the speculative activities! that
they themselves are precluded from by their loan agreement stf.ith the
banks and with Placid Oil..
The 'Interim Report'- presented by the Federal Reserve to Congress
in May includes the following statement of the terms of the' bank loan
to Placid and the Hunts:
''The agreements relating to the partnership and the Hunt
guarantee provide that the Hunts, and all related entitles, cannot
make any new investments in securities (except appropriate money
market instruments1 or take any position in commodities or any
other futures position for any speculative purpose or otherwise
while the Placid loan is outstanding or the partnership is in
existence except investments necessary for the. prudent operation
of the farm, ranching and sugar businesses owned by the Hunts.
Furthermore, the Placid loan agreement prohibits Placid, while
the loan is outstanding, from engaging-in any similar __speculative
activity including using the proceeds of the loan to finance acquisitions that would be inconsistent with the intent and purpose
of the credit facility."
161
The banks should not permit the Hunts to engage in so transparent a circumvention of the terms of the loan. The Federal Reserve,
which has repeatedly assured the Congress that a watertight guarantee against new silver ventures would be included and enforced, should
not allow the banks to wink at this transgression.
Sincerely,
Henry £. Reuss
Chairman
162
FEDERAL RESERVE SYSTEM
V . ' A 5 H I N D 1 D I J , D. C. 20551
July 21,
1980
The Honorable Henry S. Reuss
Chairman
Committee on Banking, Finance
and Urban Affairs
House of Representatives
Washington, .D. C. 20515
Dear Chairman Reuss:
In reference to your earlier correspondence in which
you expressed interest in the Board's monitoring of the Special
Credit Restraint Program, I am pleased to enclose a staff interim re-port on that program. The report describes the program
and summarizes the statistical and other information, especially
that pertaining to bank lending to small businesses and loans
for purely financial or speculative purposes, provided in the
reports for March and April which certain large financial institutions wore required to file.' Reports for the month of June,
including the first reports from intermediate-size banks, are
nov; being reviewed and processed at each Federal Reserve Bank.
There arc also enclosed reports by the staff on the
other parts of the Federal Reserve Credit Restraint Program..
I hope you find these reports useful.
Sincerely,
Enclosures
EJS:JPD:vcd UV-155)bcc: Ms. Stockwoll
Mrs. Mallard! (2)
163
FEDERAL RESERVE CREDIT RESTRAINT PROGRAM
Interim reports by the staff
Board of Governors of the Federal Reserve System
THE SPECIAL CREDIT RESTRAINT PROGRAM
The Special Credit Restraint Program (SCRP) was one of several
credit restraint measures announced by the Board of Governors on March 14,
1980, In coordination with the overall anti-inflation program announced by
President Carter that day*
The purpose of these credit restraint measures,
which were adopted in part under authority given to the Board by the President's invocation of the Credit Control Act of 1969, was to supplement and
reinforce the more general measures of monetary and credit control.
They
were viewed as temporary measures, to be phased out as quickly as appropriate; accordingly, the restraints were relaxed on May 22, and on July 3
the Board announced their termination.
(See Appendix A for the Executive
Order and the Board's statements of March 14, May 22, and July 3.)
The Special Credit Restraint Program was designed to limit expansion in bank loans in 1980 to a rate consistent with the announced growth
ranges for money and credit, and to do so by discouraging certain types of
lending while putting no special restraint on others.
This report describes
its nature and administration, and summarizes the information collected in
connection with the program.
Experience with SCRP, though brief, may pro-
vide a basis for evaluating this general method of influencing the growth
in bank credit.
Background
Growth in bank loans outstanding, after slowing markedly in the
fourth quarter of 1979, increased sharply in January and February of this
year*
The acceleration was widespread.
Expansion in total loans to
164
domestic borrowers, at both large and small domestic banks, was about
three times as rapid in January-February as In the fourth quarter, and
at foreign-related institutions it Increased from a 20 percent seasonally
adjusted annual rate to 30 percent in January and to more than 40 percent
in February.
Data for large banks indicated a continuation of strong
growth in total loans through early March.
The rebound in loan expansion was especially pronounced for
business loans which increased at an annual rate of more than 20 percent
in both January and February, compared with 6 percent in the fourth quarter. Outstanding commercial paper of nonfinancial firms also increased
at rates substantially above those in the final quarter of last year.
Although business loans at finance companies actually declined during
this period, total short- and intermediate-term business credit, which
had increased at a 6-1/2 percent annual rate in the fourth quarter,
grew at almost a 25 percent rate during both January and February. Moreover, unused commitments for commercial and industrial loans at banks
expanded at a 40 percent annual rate from December to February, perhaps
reflecting anticipation of additional official actions to slow credit
growth but in any event creating the potential for substantial loan
growth in coming months.
Although the increases in real estate and consumer loans were
at about the same rate in January and February as in the last quarter of
1979, and security and nonbank financial loans showed almost no change
over the two months, the accelerated growth in total loans could not
continue without threatening achievement of the restrained growth in
165
money and credit In 1980 which was deemed necessary to help curb inflation.
In the circumstances then prevailing, longer-term competitive
considerations apparently made many banks reluctant to restrain new credits
or commitments (except by increasing interest rates) even though loan growth
raised questions about their ability to acquire the necessary funds within
the framework of the Federal Reserve's own targets for money and credit
expansion. In this environment, a supplemental program to restrain loan
growth seemed appropriate, so long as the burden of the restraint did
not fall on those classes of borrowers least able to bear it.
Nature of the Special Credit Restraint Program
The program which the Board adopted was directed primarily at
domestic lending by banks and finance companies, but other lenders were
requested to observe its guidelines. Under the program, banks were asked
to keep expansion of their total loans to U.S. borrowers in 1980 to a rate
which did not exceed 6 to 9 percent.
In order to avoid interfering with
1
banks own lending decisions so far as possible and to permit flexibility
in meeting customer requirements, the program included no quantitative
guidelines with respect to the allocation among classes of borrowers or
loan types of the total amount of credit that could be advanced under the
6 to 9 percent growth limitation.
Rather, qualitative guidelines were
provided; these were included in the March 14 announcement of the program.
"The Board does not intend to set forth numerical guidelines
for particular types of credit. However, banks are encouraged
particularly:
(1) To restrain unsecured lending to consumers, including credit cards and other revolving credits. Credit
for auto, home mortgage and home improvement loans
should not be subject to extraordinary restraint.
166
(2) To discourage financing of corporate takeovers or
mergers and the retirement of corporate stock, except
in those limited instances in which there is a clear
justification in terms of production or economic efficiency commensurate with the size of the loan.
(3) To avoid financing of purely speculative holdings
of commodities or precious metals or extraordinary
inventory accumulation out of keeping with business
operating needs.
(4) To maintain reasonable avallabllty of funds to small
businesses, farmers, and others without access to
other forms of financing.
(5) To restrain the growth in commitments for backup
lines in support of commercial paper.
(6) To maintain adequate flow of credit to smaller correspondent banks serving agricultural areas and small
business needs and thrift institutions.
The terms and pricing of bank loans are expected to reflect
the general circumstances of the marketplace. No specific guidelines or formulas are suggested. However, the Board does not
feel it appropriate that lending rates be calculated in a manner
that reflects the cost of relatively small amounts of marginal
funds subject to the marginal reserve requirements on managed
liabilities. Moreover, the Board expects that banks, as appropriate and possible, will adjust lending rates and other terms
to take account of the special needs of small businesses, including farmers and others."
As questions arose about the application of these guidelines, they
were further explained and developed in press releases or letters to all
respondents.
(See Appendix B.) For example, guidelines (4) and (6) above
reportedly were being interpreted too narrowly by many banks, while other
banks anticipated difficulties in observing them. Applications from certain types of borrowers apparently were being denied on the justification
that borrowers not specifically mentioned in guidelines (4) and (6) had no
preferred status in the program; there, were complaints, for instance, that
auto dealers were finding it impossible to obtain bank financing even
167
though most of them would qualify as small businesses. At the same time,
banks that specialize in lending to small businesses and/or farmers anticipated that they would be unable to meet the needs of these customers
without exceeding the 6 to 9 percent limitation.
In letters of April 17
and May 22 from Chairman Volcker to all banking institutions, it was made
clear that priority borrowers included auto dealers and buyers, homebuilders, and homebuyers (including home improvement and energy conservation loans), and banks were told that exceeding the 9 percent ceiling
would be acceptable if they could demonstrate that loan expansion was
essentially restricted to priority areas.
In order to assist in monitoring compliance of individual
lenders with the program guidelines, regular reports were required from
certain institutions. Monthly reports were required from U.S. commercial
banks with consolidated U.S. total assets of $1 billion or more, U.S.
branches and agencies of foreign banks with worldwide banking assets of
more than $1 billion, U.S. bank holding companies with U.S. consolidated
financial assets of $1 billion or more, and finance companies with total
business receivables of $1 billion or more. Reporting by these institutions changed to bi-monthly when the overall credit restraint program was
relaxed on May 22.
In order to assist in monitoring shifts to other sources of
financing when the ceiling on bank loan growth constrained availability
of bank loans to such borrowers, a group of large corporations was
required to file monthly reports which covered their borrowing in the
commercial paper market and from foreign sources. This reporting requirement was rescinded on May 22, effective with the report for April.
168
Finally, U.S. commercial banks with consolidated U.S. total assets of
$300 million or more but less than $1 billion were to file quarterly
reports; the first and only report for these banks covered activity
through June.
All reports were filed with and reviewed by the Federal Reserve
Bank in which the respondent was located*
The reporting forms were designed to impose as little additional
reporting burden on respondents as possible, even at the loss of some
desirable precision.
Information required from banking Institutions and
finance companies was largely qualitative in nature and primarily involved
check answers on the strength of credit demands and the proportion of loan
applications approved during the reporting month.
Several items of explan-
atory material were also required, including brief descriptions of smallbusiness loan programs and of any approvals or takedowns during the month
of loans for purely financial or speculative purposes.
The statistical information which the respondents had to provide
was for the most part identical in definition to data they provide regularly for other reports.
For example, most items of statistical information
on the reporting form for commercial banks were defined exactly as on the
quarterly Report of Condition and could be referenced to that report.
In some cases, however, data which respondents were asked to
supply either were not available from their records or were not available
on a timely basis. Although they were asked to provide their best estimate
if actual data were not available, a number of respondents were most
reluctant to do so, even when pressed, since they had no related or past
records on which to base such an estimate. As was anticipated, the item
169
on loans to smaller businesses—a very important item for assessing compliance with the program guidelines—was particularly difficult for
respondents to provide. (Since reporting of financial and speculative
loans would have been even more difficult, if not impossible, dollar
amounts for such lending were requested only for loan approvals and
takedowns during the reporting month.)
Other troublesome items were those involving data for foreign
offices.
Such information generally was not available either as of the
reporting date or by the date when the report was supposed to be filed;
this difficulty was resolved by adjustment of the reporting date, use of
preliminary estimates, or a moderate extension of the filing date. The
group of nonfinancial companies, which was asked for items of statistical
information only, reportedly found it quite burdensome to develop data on
their indebtedness to foreign entities, especially their net position with
their foreign subsidiaries.
Dissemination of Information about the Program
Detailed information about the Special Credit Restraint Program
was conveyed quickly by Reserve Banks to financial institutions, and by
them to their lending officers.
Immediately after announcement of the program, officials of
every Federal Reserve Bank began meeting with lenders and others in the
District to describe the program to them and answer their initial questions.
Subjects covered included: the need for such a program and the general
philosophy of this one; the qualitative and quantitative guidelines; reporting requirements; and plans for monitoring individual-lender performance.
170
The way in which lenders were informed about the program varied
from one Reserve Bank to another mainly in the extent to which lenders
were contacted individually or were invited to a group meeting. A fairly
typical procedure was for the president of the Bank to contact each of
the largest commercial banks in the District individually, by phone or
personal visit. This was followed by a series of group meetings with
the president and/or other officers of the Bank. Invitations to attend
were extended to lending institutions subject to the program's reporting
requirements and also to those that did not need to file reports but
were expected to observe the program guidelines—as well as to the large
nonfinancial corporations that were required to report on certain of
their borrowing activities. Meetings were held not only at the Reserve
Bank but also in cities throughout the District.
An equally important part of the dissemination process was the
adoption of procedures for providing prompt answers to questions about SCRP
and the other credit restraint measures, raised by lenders as they began
reexaminlng their lending policies, discussing the program within their
institution and preparing to file their first reports. Given the lack of
experience with these kinds of measures, the short lead time between
announcement of the program and the first SCRP reporting date, and the even
shorter lead time for Board staff to develop report forms, instructions and
definitions for the various parts of the program, it was inevitable that a
host of ambiguities, omissions and Inconsistencies would need to be resolved.
Some Reserve Banks received several thousand phone inquiries during the
early stages of the credit restraint program and assembled special teams
to respond to them. Coordination and guidance in resolving difficult
questions were provided by daily conference calls between Reserve Banks
and Board staff.
171
Reactions of lenders at their individual and group meetings with
Reserve Bank officials had been generally very cooperative. They had
expressed understanding of the overall intent of the SCRP program and had
indicated their willingness to comply with the guidelines, which many of
them felt would reinforce lending policies they already had in train. The
6 to 9 percent limitation was considered reasonable, even by those who
expected to have difficulty staying within it. These attitudes were
reflected in the guidelines institutions issued to their lending officers.
A question on the report form asked whether the institution had
transmitted the content of the Board's March 14 announcement to the appropriate lending officers at each of its U.S. offices. A second question
asked whether it had issued specific guidelines to these officers; if so,
a copy was to be enclosed with the institution's March report.
Examination of the responses by banks to these questions shows
that they moved quickly to inform loan officers of the content of the program and to develop guidelines to ensure achieving its goals.
The few
banks that had not issued specific guidelines by the end of March reported
that they were still in the process of developing appropriate ones.
Although the guidelines issued by many banks were simply paraphrases of those included in the Board's announcement, the more detailed
ones followed a general pattern. There was an emphasis at regional banks
on continuing to serve local and regional businesses and existing customers. Where changes from this policy were noted, most banks said that
no loans for speculative purposes would be considered, even if they had
been made in the past, and most placed restrictions on the types of
172
financial loans that would be made.
Particular consideration was to be
given to loans to support or finance acquisitions of local and regional
businesses that otherwise might fall. The guidelines Issued by many
banks reflected considerable concern over the impact of the recession on
their local economy, and placed increased emphasis on quality considerations in approving loans.
Most "families" of U.S. branches and agencies indicated that
they had informed loan officers of the contents of the Board's announcement, and most of the larger families had issued specific guidelines to
them—either by writing their own or simply sending a copy of the Board's
guidelines.
In many cases, the reporting institution noted that it did
not need to issue formal written guidelines—because it had a small
number of loan officers or only one office, because all commitments were
reviewed and controlled at one office, or because it had frequent meetings of loan officers at which compliance with the Board's guidelines
would be discussed.
Summary of Information Provided in SCRP Reports
SCRP reports were required for the months of March, April and
June. The reports for March, of course,—especially for banks which
reported as of the last Wednesday of the month—for the most part reflected
developments prior to announcement of the program.
Reports for June,
which were due by July 10 for most respondents, are now being reviewed
and processed at the Reserve Banks. Thus, the reports examined in this
summary are largely those for the month of April.
Information provided
173
by respondents with respect to lending to smaller businesses and loans
for purely financial and speculative purposes are discussed in separate
sections. (See Appendix C for statistical summaries of responses by each
type of reporter; additional tabulations, providing selected data by size
of institution and by Federal Reserve District, will be available shortly.)
Weekly data for large banks indicated a continuation of sharp
loan growth through early March, followed by much slower growth over the
remainder of the month which reduced total loan expansion in March to
a seasonally adjusted annual rate of only 2-1/2 percent compared with
growth rates of 15-20 percent in January and February.
In April, loans
outstanding declined at a 5 percent annual rate, and they dropped further in May and June.
It is difficult, if not impossible, to say how much of the
weakness in bank loans since early March has been due to the recession,
how much to reaction to fiscal announcements and general credit conditions (including expectational effects), how much to the cumulative
effects of earlier overall restraints, and how much to the credit
restraint programs.
But the timing and the abruptness of the change
in loan growth trends suggest that announcement of the programs played
a significant role.
Indeed the immediate effect of the programs on
bank lending may have been exaggerated by the initial reactions of
lenders to these
restraints, as they sought to evaluate what the
Federal Reserve actions—especially the 6 to 9 percent limitation—-would
mean in their particular case, and to obtain clarification on a number
of points.
174
As of mid-March, It appeared that loan growth at a number of
banks in the first quarter alone was already close to the 9 percent ceiling for the entire year, and that at many other banks it had been running
at an annual!zed (not seasonally adjusted) rate in excess of 9 percent.
By
the end of April, however, loan growth for the year to date exceeded 9 percent at only three banks.
Each had experienced rapid loan growth early in
the year; one had already greatly slowed its rate by loan expansion, one
was still showing rapid growth because of its large volume of prior binding
commitments but expected to be under the ceiling by year-end, and much of
the overage for the third In April reflected a temporary situation.
At 27 additional banks, loan expansion over the first four
months of the year amounted to more than 3 percent (annualized rate
of more than 9 percent) but, given the continuing weakness in loans, it
appeared unlikely that they would have had difficulty staying under the
ceiling.
For 78, or nearly half, of the reporting banks, total loans
declined over the first four months.
(Loans usually decline seasonally
in the early months of the year.)
Among the 139 U.S. branch and agency families that were
required to file reports, 62 reported declines in total loans to U.S*
borrowers through April, but 58 showed increases of more than 9 percent.
This apparent gross noncompliance needs to be viewed in the context of
the very rapid growth in their loans earlier in the year—more than 35 percent at a seasonally adjusted annual rate In January-February, compared
with about 15 percent for U.S.-chartered commercial banks.
Hie adjustments
they faced in reducing their loan growth to the 6 to 9 percent range by
year-end were bound to be difficult and costly.
Consultations were held
175
with families that reported significant excesses, and they assured the
Reserve Bank that they would do all they could to restrain their domestic
loan growth so as to show no more than a 9 percent increase by year-end.
The SCRP guidelines encouraged banks to maintain a reasonable
flow of credit to such borrowers as homebuyers and farmers. Whether
they did so is rather difficult to tell from the data available from
the SCRP reports filed by banks for March and April. Real estate loans
on residential properties increased slightly less in April than in the
same month of 1979, as they did in March, but their relative importance
in the banks' portfolios edged up—the only loan category to do so, of
those included on the SCRP reporting form, except for loans to smaller
businesses. Loans to farmers declined in April, in contrast to an
increase in the year-earlier month.
But loans to farmers account for
only 1 percent of the total loans of these banks—that is, banks with
assets of $1 billion or more—and for even less at well over half of the
group*
Thus the slight decline in agricultural loans which they reported
for April may be without significance. The bulk of residential mortgage
and particularly agricultural loans by banks are made by smaller banks
not covered in this report.
Examination of responses to qualitative questions on the
reporting form shows not only a decline in demands for bank credit in
April but also reduced willingness on the part of banks to approve
loan applications.
Respondents were asked to indicate whether total
private demands for credit from U.S. borrowers in the current month were
significantly greater, essentially unchanged, or significantly less,
176
as compared with the situation generally prevailing in February 1980
and taking account of seasonal patterns. For commercial and industrial
loans they were asked to provide the same classification of applications
for loans or loan commitments and of the proportion of such applications
approved, compared with the same month in recent years.
In both the March and April reports, most banks answered
"essentially unchanged" to all three questions.
But between March and
April, there were marked shifts toward answers of "significantly less."
In reporting for the month of March, 18 banks had characterized total
private credit demands in this way; for April, 61 did. Only five banks
(as compared with 26 in March) were still reporting total credit demands
as signficantly greater than usual.
Responses to the question about applications for commercial and
industrial loans showed a similar though less dramatic shift, but they
also indicated somewhat more strength in such loans than in total credit
demands. Nineteen banks in April and 63 in March reported that the number
of applications from commercial and Industrial borrowers was significantly
larger than usual. Loan applications from smaller business borrowers,
however, were reported by practically every bank as being unchanged to
significantly below normal. Only two banks in April and four in March
reported a signficantly larger than usual number of applications from
such borrowers. Fifty-two in April and 35 in March (a considerably higher
frequency than for all commercial and industrial loans or total credit
177
demands) reported the number of applications from smaller businesses as
being considerably smaller than usual.
Responses to the questions on loan approvals also differed for
smaller borrowers than for all business borrowers.
These questions, it
should be noted, applied to the proportion of loan applications approved,
not to the number.
Only three banks reported a significantly higher
than usual proportion in April (17 in March) for all commercial and industrial loan applications; for loans to smaller businesses the figures were
zero and two, respectively. But 34 banks in April (29 in March) reported
a significantly lower than normal proportion of approvals for all business
loans, while only 19 banks in April and 13 in March gave this response for
approvals of smaller-business loan applications.
Thus it appears that,
although an increased number of banks have reduced the proportion of
business loan applications they approve, the change in policy has affected
larger business borrowers more than smaller ones. Further discussion of
lending to smaller businesses appears in the next section.
Lending to Small Businesses
Each of the large U.S. commercial banks, bank holding companies,
and finance companies, and U.S. branches and agencies of large foreign
banks which was required to file monthly SCRP reports was asked to answer,
and explain, a general question as to whether it has developed a special
178
small-business loan program, and all except bank holding companies were
asked to provide statistical data on loans to smaller businesses.^
The summary of responses which follows relates primarily to commercial banks.
Branches and agencies of foreign banks, with only one or
two exceptions, do little lending to small, local businesses (or even to
regional ones); they are basically wholesale banks. Bank holding companies,
on the other hand, which were asked to report for those bank and nonbank
subsidiaries that were not required to file separate reports, indicated
that these smaller subsidiaries are generally regional institutions. As
such, they do not need to develop special small-business programs because
most of their business customers are small and lending officers are attuned
to their individual credit needs and problems. Finance company respondents
also reported that almost all of their business customers are local, or at
most regional, firms and are better served by flexible adjustment of lending terms rather than by establishment of a formal program.
Special Lending Programs
Roughly 60 percent of the reporting banks answered "yes" to the
question of whether they had "developed a special program to assist the
financing needs of smaller businesses." The distinction between "yes" and
"no" answers to this question was quite blurred, however; for example, some
banks that answered "yes"1 described their special program as active partlci1. With respect to the definition of smaller businesses, respondents were
instructed as follows: "As a general guideline, a smaller business might
be one whose activities are local, or at most regional, in scope; whose
loan takedowns normally do not exceed $500 thousand; and whose total loans
outstanding are less than $1-1/2 million. In the event that you cannot
classify borrowers according to this definition, use your best judgment as
to which of your business customers come closest to it."
179
pation In Small Business Administration programs, while some that answered
"no" gave such participation as the reason why they had not developed their
own program. For this reason, some of the descriptive responses need to be
considered together, regardless of whether they were submitted in explanation
of a "yes" or a "no" answer to the general question.
About half of the banks that reported having a special program for
loans to small businesses (and 29 percent of all reporting banks) said that
their program included a small-business base rate which was below the bank's
prime rate. (See table on page 18.) The spread below prime varied from 1/2
to 2-1/2 percentage points.
A few banks reported a cap on small-business
loan rates, but in some cases these caps exceeded 20 percent. Many respondents indicated that the special base rate would disappear if other Interest
rates fell below some specified levels—for example, if the large-business
prime was 12 percent or less. It is not possible to tell from the individual bank responses how many banks plan to make their small-business rate a
permanent feature of their lending policies, and how many have adopted
such a rate only to provide some relief to their smaller business customers
during a period of extraordinarily high Interest rates.
Only two banks had established programs designed to alleviate
short-term cash flow problems of small firms by maintaining a, level payment
of interest or interest plus principal.
Under such programs, interest lia-
bilities continue to accrue but payments are deferred until, for example,
>
interest rates decline or the principal is repaid. One bank allowed for the
possibility of extending the loan maturity in order to hold down periodic
payments. Among banks without a formal program of this tjype, several said
Commercial Bank Programs to Assist Small Business Financing Needs
Summary of Special Credit Restraint Program Reports
I/
Number of banks
All large reporting banks
YES, have special program
NO, do not have special program
Percent of Total
168
100
98
70
58
42
100
100
If "YES," program described as including:
a.
Small business base rate below prime
48 .
29
49
b.
Active participation in SBA or other government program
39
23
40
c.
Special small business department or community program
22
13
22
d.
Deferred interest payment
e.
Other
2
2
13
13
If "NO," reason given:
a.
I/
Most loans are to small business
21
13
30
5
11
b.
Participate in SBA program
8
c.
Wholesale bank, make BO or few small business loans
8
5
11
d.
In process of .formalizing special program
17
10
24
e.
Other
19
11
27
Sims are greater than 100 percent because some banks reported more than one characteristic or reason.
181
they had asked their lending officers to consult with regular customers
concerning potential cash flow problems.
Somewhat over one-fourth of all reporting banks cited participation
in SBA or other government-guaranteed assistance programs as either the primary feature, or one of several features, of their lending to small business.
About half that many indicated that they had special small-business loan
departments or community programs within the bank, or were active members of
local development groups.
A variety of statements about their small-business lending
activities, provided by nearly one-fifth of the respondent banks (either to
justify "yes" answers to the general question or to explain "no" answers)
have been classified as "other" in the table. Examples of such activities
are: seeking out new businesses or other small firms that may need credit,
rather than waiting for such businesses to come to them; assignment of a
senior vice-president to work with small businesses; establishment of a
"small-business loan team" within the commercial loan department; preparation
of advertisements and brochures on the kinds of available loan arrangements
and how to draw up a loan application; custom-tailoring of each loan agreement to the needs and repayment ability of the particular borrower; an
ongoing and aggressive marketing strategy to increase the bank's lending
to smaller businesses; willingness to accept higher than usual credit risks,
to be more lenient with the borrower's performance, or otherwise to give
preferential treatment to smaller businesses.
182
Ten percent of the banks reported that, while they have no formal
small-business loan program at present, they are in the process of developing
one. Another 13 percent said that they do not need a special program, since
they are small-business oriented and almost all the loans on their books have
been extended to such firms.
Finally, five percent of the banks characterized themselves as
wholesale banks, with no use for a special small-business lending policy
because they make virtually no loans to such businesses.
Only a very few
banks stated bluntly that no special program was needed since all legitimate
demands were being met.
In short, almost every bank reporting under the program claimed
that, in one way or another, it is making a serious effort to meet the credit
needs of the smaller businesses in its market area.
Only small businesses
themselves could say how effective these efforts really are. While other
Federal Reserve data suggest banks have extended significant amounts
of loans at'rates below prime, the volume of bank loans outstanding
to smaller firms appears to have increased less this year than loans to
larger businesses. It should be noted, however, that present bank records
seldom permit precise measurement of loan totals by size of borrower, and
thus the data summarized below rest primarily on good-faith estimates.
183
Volume of Small-Business Loans
The data that banks reported on loans outstanding suggest that,
despite the banks' own small-business programs and the guidelines of the
Special Credit Restraint Program with respect to loans to smaller businesses, growth in such loans has lagged the growth in loans to larger
firms.
It is possible, of course, that the shortfall has been primarily
demand-induced.
On a year-to-year basis, growth in loans to smaller businesses
in March and April was only half as large as the growth in commercial
and industrial loans to all U.S. addressees. (See table on page 22.) The
shortfall in February (not shown in the table) was somewhat smaller.
On
a month-to-month basis, differences in March and April between the change
in commercial and industrial loans to smaller businesses and in such loans
to all U.S. addressees were less uniform.
However, the data do Indicate
sharper cutbacks in lending to large businesses than to smaller ones in
April—the first full month of the Special Credit Restraint Program.
For the reporting banks as a group, loans to smaller businesses
have accounted for a slightly smaller proportion of total commercial and
industrial loans this year—the proportion was 20 to 20-1/2 percent in
February, March and April 1980, compared with 21-1/2 percent in each of
the same months last year. Median proportions, however, are running
a bit higher this year than last. It should be noted that all of these
proportions are understated to an unknown extent. A number of banks,
Including some with rather extensive small-bus!ness loan programs, said
they were unable to provide even an estimate of the volume of loans
184
Selected Data on Commercial and Industrial
Loans to Smaller Businesses and All U.S. Addressees
All Reporting Banks
March
1979
April
1980
1979
1980
Percent change from year earlier
Aggregate change
Smaller businesses
All U.S. addressees
n.a.
n.a.
8.9
18.1
n.a.
n.a.
7.1
14.2
n.a.
n.a.
6.5
11.5
n.a.
n.a.
4.9
9.4
Median change
Smaller businesses
All U.S. addressees
Percent change from preceding month
Aggregate change
Smaller businesses
All U.S. addressees
2.2
2.0
0.4
1.6
2.9
3.1
1.2
-0.2
1.3
2.3
0.4
1.0
1.9
2.6
-0.5
-0.3
Median change
Smaller businesses
All U.S. addressees
Percent of total commercial
and industrial loans
Aggregate
Smaller businesses
All U.S. addressees
21.5
93.7
20.0
94.4
21.5
94.0
20.6
96,0
29.3
98.3
30.0
98.1
28.9
98.1
30.8
98.3
Median
Smaller businesses
All U.S. addressees
Note:
For more detail, see tables in Appendix C.
185
outstanding to smaller businesses; some said they were revising their computer programs to enable them to provide such Information In the future.
For other reporters, the ratio of small-business loans to total
commercial and industrial loans has shown no change this year.
It has con-
tinued at less than 2 percent for U.S. branches and agencies as a group
and at over 60 percent for reporting finance companies. Bank holding
companies were not asked to provide data on loans outstanding to smaller
businesses.
Loans for Purely Financial or for Speculative Purposes
In October 1979, Chairman Volcker requested commercial banks to
refrain from financing corporate takeovers, except where fully justified
in terms of increased production or improved efficiency, and to refrain
also from financing speculative activities. These requests were repeated
in the SCRP guidelines, and the report forms for banks—as well as for
U.S. branches and agencies, bank holding companies, and finance companies—
asked a set of questions about such loans. Separately for each type of
purpose (purely financial and speculative), each respondent was to indicate whether, during the current month and with respect to commercial and
industrial loans, there had been any requests, any approvals, or any takedowns under prior (before March 1980) commitments.
A brief description
of the loan was required for each approval or takedown.
Two aspects of these questions are important in interpreting the
answers given:
the questions covered activity during the current month,
not outstandings; and they related to commercial and industrial loans
only, not to loans in other call report categories. This means that some
186
well-publicized takeover and speculative loans would not have been reported
if they were approved and disbursed prior to March 1980, or if the loan
would normally be classified elsewhere, for example, as a loan to an individual or financial institution, or as a security loan. On the other hand,
some banks apparently did include these other loan categories in answering
the question, thus overstating the number of approvals and takedowns of
commercial and industrial loans for financial and speculative purposes.
Loans for Purely Financial Purposes
Of the 170 large commercial banks reporting under the program,
71 indicated that they had received one or more requests or applications
in April for loans or loan commitments for this purpose.
Thirty-four
reported having approved such financings in April and 23 said there had
been takedowns under commitments made before March 1980.
Comparable
figures for March were somewhat higher—80, 38, and 32, respectively.
For U.S. branches and agencies of foreign banks, 13 of the 139
reporters indicated that they had received requests for this type of
financing in April, but only two reported approvals and two reported
takedowns on prior commitments.
Twenty-nine of the 161 bank holding
company respondents reported applications in April for loans for financial purposes, with 10 reporting approvals and 5 reporting takedowns.
Only 1 of the 15 large finance companies reported such a request and 1
reported an approval.
Commercial banks reported 45 separate approvals of loans for
purely financial purposes in April and 30 separate takedowns on prior
commitments. The average size of these loans was surprisingly small:
187
a significant proportion were for $500 thousand or less, and the median
size was $900 thousand for approvals and $800 thousand for takedowns.
Only five approvals and two takedowns were for more than $5 million.
Size of loan was not indicated for three approvals and four takedowns,
but only one of each seems likely to have been larger than $5 million.
Loans for Purely Financial Purposes
Size Distribution
Number of Loans, April, 1980
Takedowns on
Approvals
prior commitments
(Median size, thousands of dollars
900
$500 thousand or less
$500 thousand - $1 million
$1 million - $2 million
$2 million - $5 million
More than $5 million
Size not available
16
8
6
7
5
3
"45
800)
11
3
6
4
2
4
"30
Most of the approvals of loans for financial purposes reported
by commercial banks for April appear to have been for financings that were
consistent with the program guidelines.
As may be seen from the table on
page 26, the majority approved in April, as in March, were for acquistions
of one kind or another.
Eight were to finance purchases from retiring
owners (and thereby keep the firm in existence) or to acquire falling or
bankrupt businesses, and four were to provide the firm with new management
which the bank felt would improve its productive efficiency or better meet
the needs of the community.
Five were to finance the acquisition of a
bank by (generally) a new one-bank holding company.
Three were associated
188
Loans for Purely Financial Purposes
Nature of Loans Approved in April 1980
Number of Loans
Acquisition
To buy interest of retiring or deceased owners
To purchase failing or bankrupt firm
To improve efficiency or service to community
By present management or employees (ESOP)
By one-bank holding company
To complete prior purchase
, For expansion of own business line
Detail not provided
3J
6
2
4
2
5
2
3
8
Financial restructuring or debt refinancing
5
Purchase of own shares
From retiring shareholder or partner
Under contractual agreement with shareholder
To transfer ownership to ESOP
4
1
1
I
Other
2
To purchase stock from estate
To increase contribution to partnership
Nature not indicated
1
1
189
with transfer of ownership to the firm's current management or to its
employees through an employee stock ownership plan. None of the approvals
of loans to finance purchase of the company's own shares was for the sole
purpose of permitting the firm to retire the stock; retirement, if it in
fact occurred, was incidental to the primary reason for the repurchase.
However, some of the loans approved in April may have supported
financings which were not in compliance with the spirit of the program or
which could reasonably have been postponed. Acquisitions for expansion
purposes are an example, as are at least some of the loans for financial
restructuring or debt refinancing (although one of the latter—an advance
approval of part of the huge loan finalized later for refinancing of silver debts—was rather urgent). And the possibility exists that some of the
eight loans for vague acquisition purposes and the two loans to individuals
for unspecified purposes were contrary to the program guidelines.
Much less information was provided for takedowns on prior commitments than for loan approvals.
Of the 30 such takedowns in April reported
by commercial banks, 15 were for acquisition or merger financing and 11 of
these were not identified further. Six takedowns were to finance purchase
of own stock; in three cases, no further description of the purchase was
given, and in three the purchase was defined only as for retirement of the
stock. Seven of the remaining takedowns were loans for the purpose of purchasing securities or unidentified loans to individuals.
Although at least some of the acquisitions and stock repurchases
financed by these takedowns undoubtedly were for purposes that would not
have been justifiable under the program if the commitment had been made
after March 14, all of the takedowns reported here were under commitments
190
made before that date. It was recognized from the start of the program
that the need to honor pre-existing binding commitments would limit the
ability of many banks to take on new loans of the types favored in the
guidelines. Banks did pull back on some prior negotiations; borrower
complaints reaching the Federal Reserve after the program was announced
indicated that banks were refusing to honor some understandings with
respect to loans for relatively unproductive purposes if the commitment was
not legally or morally binding.
With respect to the binding commitments which had to be honored,
however, it may be noted that the reported date of the commitment underlying the actual takedowns in April of loans for purely financial purposes
was in late 1979 or early 1980 in almost every case—before announcement
of SCRP but after receipt of Chairman Volcker*a letters of last October
discouraging such loans. Negotiations on some of these commitments may
have been so far along by October that the bank felt obligated to carry
them through to completion. But it may also be that the more detailed
guidelines and the reporting requirements announced in March were more
effective deterrents than the earlier cautionary statements.
In any
event, the Federal Reserve Banks, in selected Instances, are reviewing
these situations with individual banks.
As the program continued, but before its termination, increasingly urgent questions arose concerning the appropriateness of particular
propositions for takeover loans. The question of "defensive" financing
of possible U.S. buyers arose in several instances where there were
potential foreign buyers. No affirmative indications were given, but
191
prolongation of the program would necessarily have entailed difficult
and potentially arbitrary decisions.
Loans for Speculative Purposes
Very few respondents reported approvals or takedowns of commercial and industrial loans or commitments for speculative purposes in
March or April. As suggested earlier, there may have been additional
disbursements for such purposes, which would not be classified as commercial and industrial loans.
Among reporting commercial banks, 41 indicated that in April
they had received requests or applications for commercial and Industrial
loans or commitments for speculative purposes, but only 5 reported approvals
for such requests and only 4 reported takedowns under commitments made before
March 1980; comparable figures for the month of March were 47 requests,
9 approvals, and 7 takedowns. Three U.S. branches and agencies reported
requests in April (5 in March) for such financings, but no approvals or
takedowns (2 takedowns in March were reported).
Requests were reported
by 26 bank holding^companies, approvals by 4, and takedowns by 3. No
finance company respondent reported any requests, approvals or takedowns
in either month.
Although, as noted above, five banks reported approvals in April
of commercial and Industrial loans or commitments for financing pf speculative activities, there is some question as to whether all of them should
have been so classified. Three banks included their participation in the
192
Placid Oil/Hunt silver refinancing.1
(Another bank had considered Its
participation to be a loan for a purely financial purpose.) Another April
approval was a small, very short-term loan to an Individual for a speculative commodity purchase. The remaining approvals reported were also for
relatively modest amounts.
They Included:
a loan to a developer to enable
him to acquire land adjacent to land he already owned; Inventory loans to
protect the business against an anticipated Interruption In the flow of
supplies or to take advantage of a reduced price for materials; and a loan
to a small-business customer to acquire land adjacent to its plant.
All takedowns under prior commitments for financing of speculative
activities reported by banks for the month of April involved relatively
small amounts—a few hundred thousand dollars at most. As was the case with
loans for financial purposes, less information was provided on the nature
of the prior commitment than on new approvals.
Two banks reported what
appear to be several very small takedowns, without identifying each one.
Another reported takedowns under several commitments for land banking, but
indicated that it was making no new commitments of this type. The fourth
classified as a speculative loan a takedown to finance an additional contribution of equity to the borrower1* company.
As with takeover loans, narrow distinctions are sometimes Involved
as to what is a speculative loan and what is not.
Distinctions of this kind
become increasingly difficult to handle in the context of a prolonged program.
1« In March, it may be noted, two U.S. banks and one U.S. branch of a
foreign bank had reported financings involving the related speculative
activities in the silver market-
193
APPENDIX A
Executive Order 12201
Principal Statement* on &*. Progrm
EXECUTIVE ORDER
CREDIT CONTROL
By the authority vested in me as President of the
United States of America by Section 205 of the Credit Control
Act (12 U.S.C. 1904)., and having determined that the regulation
and control of credit is necessary and appropriate for the
purpose of preventing and controlling inflation generated by
the extension of credit in an excessive volume, it is hereby
ordered as follows:
1-101. The Board of Governors of the Federal 'Reserve
System is authorized to exercise all the authority under
the Credit Control Act (12 U.S.C. 1901 et seq.) to regulate
and control consumer credit.
1-102. The Board of Governors of the Federal Reserve
System is authorized to exercise all the authority under the
Credit Control Act to regulate and control credit extended by
those financial intermediaries which are not subject, as of
the date hereof, to either the amendments of law effected by
Public Law 89-597, as amended, or Section 19 of the Federal
Reserve Act, as amended (12 U.S.C. 461), and which are primarily
engaged in the extension of short-term credit.
1-103. The Board of Governors of the Federal Reserve
System is authorized to exercise all the authority under the
Credit Control Act to regulate and control credit extended to
commercial banks that are not members of the Federal Reserve
System in the form of managed liabilities.
1-104. The.Board of Governors of the Federal Reserve
System is authorized to exercise the authority under
Section 206(4) of the Credit Control Act (12 U.S.C. 1905(4))
to prescribe appropriate requirements as to the keeping of
records with respect to all forms of credit.
1-105. For the purposes of this Order "consumer credit,"
"financial intermediaries," "short-term credit," "commercial
banks," and "managed liabilities" shall have such meaning as
may be reasonably prescribed by the regulations of the Board
of Governors of the Federal Reserve System.
1-106. The authorizations granted by this Order shall
remain in effect for an indefinite period of time and until
revoked by the President.
JIMMY CARTER
194
FEDERAL RESERVE press release
For immediate release
March 19, 1980
The following corrections should be made in the material distributed
in connection with the Federal Reserve Board's anti-inflation program announced
March 14:
1. Covering news release: Page A, third paragraph, fifth line, at
the beginning, read $1 billion (not $5 billion).
2. Part 204--Marginal Reserve Requirement amendments-Page 5 - Section 204.5<f)(3)(i)(B), fourth line, read "of
other institutions!!/ or institutions" omitting "to"; and
--Fifth line down in next paragraph read "balances due from
foreign offices of other inst{tutions!9-' or institutions"
omitting "to".
--Page 5 "- Fourth line from bottom, make line read:
"such differences shall be rounded to the next lowest
multiple of $2 million." (inserting "multiple of").
3. Credit Restraint (Subpart B) - Short Term Financial Intermediaries:
—rage H — Place a reference to footnote 1 at end of
second line (after word "instrument,") in Paragraph (c), Sec. 229.12.
-Page 5 — Place a reference to footnote 2 in 13th line
of Paragraph (d) after the word "less".
4. Part 229—Credit Restraint (Subpart C) -- Nonmember Commercial Banks:
—Page 1 — Effective Date, read dates in the first two
sentences as follows:
"The special deposit requirement is. effective
on marginal total managed liabilities outstanding
during the seven-day computation period beginning
March 20, 1980, and each seven-day period thereafter.
The non-interest bearing special- deposit for the
computation periods beginning March 20, 27 and April 3,
1980, must be held during the deposit maintenance
period beginning April 17, 1980."
—Page 5 -- Computation and Maintenance of Non-Interest
bearing Special Deposits, 16 lines from bottom,
read March 19 (not 12) and 10 lines from bottom
read March 20 (not 13).
—Page 8 — First sentence in Paragraph (a) read dates
April 17 in second line (not 10) and March 20, 27 and
April 3 in fifth line (not March 13, 20 and 27), and
April 24 in seventh line (not 17).
—Page 10 — Second line of paragraph (b) read date
March 20 (hot 13).
All these corrections will have been made as this material appears in
the Federal Register.
195
FEDERAL RESERVE press release
For immediate release
The Federal Reserve Board today announced a series of monetary and
credit actions as part of a general government program to help curb inflationary
pressures. The actions are:
1.
A voluntary Special Credit Restraint Program that will apply to all
domestic commercial banks, bank holding companies, business credit extended by
finance companies, and credit extended to U.S. residents by the U.5. agencies and
branches of foreign banks. The parents and affiliates of those foreign banks are urged
to cooperate in similarly restricting'their lending to U.S. companies. Special effort
will be made to maintain credit for farmers and small businessmen.
2.
A program of restraint on certain types of consumer credit, including
credit cards, check credit overdraft plans, unsecured personal loans and secured credit
where the proceeds are not used to finance the collateral. The Board has established a
special deposit requirement of 13 percent for all Renders on increases in covered types
of credit.
Automobile credit, credit specifically used to finance the purchase of
household goods such as furniture and appliances, home improvement loans and
mortgage credit are not covered by the program.
3.
An increase from 8 percent to 10 percent in the marginal reserve
requirement on the managed liabilities of large banks that was first imposed last
October 6, and a reduction in the base upon which the reserve requirement is
calculated.
*.
Restraint on the amount of credit raised; by large .non-member banks
by establishing a special deposit requirement of 10 percent on increases in their
managed liabilities.
5.
Restraint on the rapid expansion off money marker mutual funds by
establishing a special deposit requirement of. £5 percent on increases in their total
assets above the level of March 14.
196
6.
A surcharge on discount borrowings by3 large banks to discourage
frequent use of the discount window and to speed bank adjustments in
response to restraint on bank reserves. A surcharge of 3 percentage
points applies to borrowings by banks with deposits of $500 million or
more for more than one week in a row or more than four weeks in any
calendar quarter. The basic discount rate remains at 13 percent.
In making the announcement, the Board said:
"President Carter has announced a broad program of fiscal,
energy, credit and other measures designed to moderate and reduce
inflationary forces in a manner that can also lay the ground work for a
return to stable economic growth.
"Consistent with that objective and with the continuing intent
of the Federal Reserve to restrain growth in money and credit during 1980,
the Federal Reserve has at the same time taken certain further actions to
reinforce the effectiveness of the measures announced in October of 1979.
These actions include an increase in the marginal reserve requirements on
managed liabilities established on October 6 and a surcharge for large
banks on borrowings through the Federal Reserve discount window.
"The President has also provided the Federal Reserve, under the
terms of the Credit Control Act of 1969, with authority to exercise
particular restraint on the growth of certain types of consumer credit
extended by banks and others. That restraint will be achieved through the
imposition of a requirement for special deposits equivalent to 15 percent of
any expansion of credit provided by credit cards, other forms of unsecured
revolving credit, and personal loans.
"One consequence of strong demands for money and credit
generated in part by inflationary forces and expectations has been to bring
heavy pressure on credit and financial markets generally, with varying
impacts on particular sectors of the economy. At the same time, restraint
on growth in money and credit must be a fundamental part of the process
of restoring stability. That restraint is, and will continue to be, based
primarily on control of bank reserves and other traditional instruments of
monetary policy. However, the Federal Reserve Board also believes the
effectiveness and speed with which appropriate restraint can be achieved
without disruptive effects on credit markets will be facilitated by a more
formal program of voluntary restraint by important financial
.intermediaries, developing further the general criteria set forth in earlier
communications to member banks."
Special Credit Restraint Program
In adopting this program, the Board said increases in lending this year
should generally be consistent with the announced growth ranges for money and credit
197
reported to Congress on February 19. Although growth trends will vary among banks
and regions of the country, growth in bank loans should not generally exceed the upper
part of the range of 6-9 percent indicated for bank credit (that is, loans and
investments). Banks whose past lending patterns suggest relatively slow growth should
expect to confine their growth to the lower portion or even below the range for bank
credit.
The Board said the commercial paper market and finance companies—both
a growing source of business credit—will be monitored closely in the program. Since
activity in the commercial paper market is normally covered by bank credit lines,
banks are expected to avoid increases in commitments for credit lines to support such
borrowing out of keeping with normal business needs. Thrift institutions and credit
unions will not be covered by the special program in light of the reduced trend in their
asset growth.
No numerical guidelines for particular types of credit are planned but
banks are encouraged particularly:
—
To restrain unsecured lending to consumers, including credit cards
and other revolving credits. Credit for automobiles, home mortgage
and home improvement loans should be treated normally in the light
of general market conditions.
To discourage financing of corporate takeovers or mergers and the
retirement of corporate stock, except in those limited instances in
which there is a clear justification in terms of production or
economic efficiency commensurate with the size of the loan.
To avoid financing for purely speculative holdings of commodities or
precious metals or extraordinary inventory accumulation.
To maintain availability of funds to small business, farmers
nomebuyers and others without access to other forms of financing.
To restrain the growth in commitments for back-up lines in support
of commercial paper.
198
No specific guidelines will be issued on the terms and pricing of bank loans.
However, rates should not be calculated in a manner that reflects the cost of
relatively small amounts of marginal funds subject to the marginal reserve
requirement on managed liabilities. The Board also expects that banks, as appropriate
and possible, will adjust lending rates and other terms to take account of the special
needs of small business and others.
Lenders covered by the program are asked to supply certain data and
information. The President, in activating the Credit Control Act, has provided the
authority to require such reports.
Monthly reports are requested from domestic banks with assets in excess of
$1 billion and for branches and agencies of foreign banks that have worldwide assets in
excess of $1 billion.
Monthly reports are also requested on the business credit
activities of domestic affiliates of bank holding companies with total assets in excess
of $5 billion. Banks with assets between $300 million and $1 billion are asked to report
quarterly.
Smaller institutions need not report unless subsequent developments
warrant it.
Foreign banks will be asked to respect the substance and spirit of the
guidelines in their loans to U.S. borrowers or loans designed to support U.S. activity.
A panel of large corporations will be asked to report monthly on their
commercial paper issues and their borrowings abroad. Finance companies with more
than $1 billion in business loans outstanding will also be asked to report monthly on
their business credit outstanding.
Consumer Credit Restraint
The special deposit requirements of 15 percent on increases in some types
of consumer credit is designed to encourage particular restraint on such credit
extensions.
Methods used by lenders to achieve such restraint are a matter for
determination by the individual firms.
Increases in covered credit above the base
date—March 14—will be subject to the special deposit requirement.
199
Among lenders subject to the regulation are commercial banks, finance
companies, credit unions, savings and loan associations, mutual savings banks, retail
establishments, gasoline companies and travel and entertainment card companies—in
all instances where there is $2 million or more in covered credit.
Typical examples of credit that is covered are credit cards issued by
financial institutions, retailers and oil companies; overdraft and special check-type
credit plans; unsecured personal loans; loans for which the collateral is already owned
by the borrower; open account and 30-day credit without regard to whether a finance
charge is imposed; credit secured by financial assets when the collateral is not
purchased with the proceeds of the loan.
Examples of consumer credit not covered are:
Secured credit where the security is purchased with the proceeds of the
loan such as an automobile, mobile home, furniture or appliance; mortgage loans where
the proceeds are used to purchase the home or for home improvements; insurance
company policy loans, credit extended for utilities, health or educational services;
credit extended under State or Federal government guaranteed loan programs; and
savings passbook loans.
All creditors with $2 million or more of covered credit outstanding on
March 1* must file a base report by April 1 directly with the Federal Reserve or
through the Federal
Home Loan Bank Board or the Federal
Credit
Union
Administration. This report will state the amount of credit outstanding on March I'*
or a figure for the nearest available date.
Thereafter, these creditors must file a monthly report on the amount of
covered consumer credit outstanding during the month, based on the daily average
amount of covered credit if that data is available, or the amount outstanding on other
appropriate dates approved by the Federal Reserve. The first report—for the period
from March 15 through April 30—is due by May 12. The report for subsequent months
is due by the second Monday of the following month.
200
The first 13 percent deposit requirement must be maintained beginning
May 22 on increases in outstanding credit.
Marginal Reserve Requirement
On October 6, the Board established an 8 percent marginal reserve
requirement on increases in managed liabilities that had been actively used to finance
a rapid expansion in bank credit* The base for this reserve requirement was set at the
larger of $100 million or the average amount of managed liabilities held by a member
bank, an Edge corporation, or a family of U.S. agencies and branches of a foreign bank
as of September 13-26. Any increase in managed liabilities above that base period was
subject to the additional 8 percent reserve requirement.
Managed liabilities include large time deposits ($100,000 or more) with
maturities of less than a year, Eurodollar borrowings, repurchase agreements against
U.S. government and federal agency securities, and federal funds borrowed from a
nonmember institution.
In today's action, the Board increased the reserve requirement to 10
percent and lowered the base by (a) 7 percent or (b) the decrease in a bank's gross
loans to foreigners and gross balances due from foreign offices of other institutions
between the base period and the week ending March 12, whichever is greater. In
addition, the base will be reduced to the extent a bank's foreign loans continue to
decline. The minimum base amount remains at $100 million.
Nonreember Banks
The special deposit requirement for nonmemoer banks is designed to
restrain credit expansion in the same manner as the marginal reserve requirement on
the managed liabilities of member banks.
For nonmembers, the base is the two-week period that ended March 12 or
$100 million, whichever is greater. The 10 percent, special deposit will be maintained
201
at the Federal Reserve on increases in managed liabilities above the base amount. The
base will be reduced in subsequent periods to the extent that a nonmember bank
reduces its foreign loans.
Money Market Mutual Funds
Money market mutual funds and similar creditors must maintain a special
deposit with the Federal Reserve equal to 15 percent of the increase in their total
assets after March 1*.
A covered fund must file by April 1 a base report of its outstanding assets
as of March 1*. Thereafter, a monthly report on the daily average amount of its assets
must be filed by the 21st of the month. For example, a report on the first month's
assets—from March 15 to April 1*—must be filed by April 21 and the special deposit
requirement will be maintained beginning May 1.
A fund that registers as an
investment company with the Securities and Exchange Commission after March 1^
must file a base report within two weeks after it begins operations.
Discount Rate
In fixing the surcharge for large bank borrowing, the Board acted on
requests from the directors of all 12 Federal Reserve Banks. The action is effective
Monday. The discount rate is the interest rate that member banks are charged when
they borrow from their district Federal Reserve Bank.
The surcharge above the basic discount rate would generally be related to
market interest rates.
It is designed to discourage frequent use of the discount
window and to encourage banks with access to money markets to adjust their loans
and investments more promptly to changing market conditions. This should facilitate
the ability of the Federal Reserve to attain longer-run bank credit and money supply
objectives.
The surcharge will apply to banks with more than $500 million in deposits
on their borrowings for ordinary adjustment credit, when such borrowing occurs
successively in two statement weeks or more, or when the borrowing occurs in more
202
than four weeks in a calendar quarter.
There jviil be no other change in the
administration of the discount window with respect to adjustment credit. Such credit
will continue to be available to member banks only on a short-term basis to assist
them in meeting a temporary requirement for funds or to provide a cushion while
orderly adjustments are made in response to more subtained charges in a bank's
position.
The surcharge will not apply to borrowing under the seasonal loan program,
which will continue at the basic discount rate, nor to borrowing under the emergency
loan program.
Attached are copies of the following documents:
1.
2.
The Special Credit Restraint Program.
Regulation CC establishing a special deposit requirement on
increases in certain types of consumer credit.
3.
An amendment to Regulation 0 increasing the marginal reserve
requirement on managed liabilities to 10 percent and reducing
the base period.
4.
A subpart of Regulation CC establishing a special deposit
5.
A subpart of Regulation CC establishing a special deposit
requirement for nonmember banks.
requirement for money market mutual funds.
203
Special Credit Restraint Program
Background
President Carter has announced a broad program of fiscal, energy, credit,
and other measures designed to moderate and reduce inflationary forces in a manner
that can also lay the groundwork for a return to stable economic growth.
In connection with those actions, and consistent with the continuing
objective to restrain growth in money and credit during 1980, the Federal Reserve has
also taken certain further actions to reinforce the effectiveness of the measures
announced in October of 1979. These actions include an increase in the marginal
reserve requirements on managed liabilities established on October 6 and the
establishment of a surcharge on borrowings through the discount window by large
banks.
The President has also authorized the Federal Reserve, under the terms of
the Credit Control Act of 1969, to exercise particular restraint on certain types of
credit. The Board has determined to restrain the growth of certain types of consumer
credit through the imposition of a requirement for special deposits equivalent to 15%
of any expansion of consumer credit provided by any lender through credit cards, other
forms of unsecured revolving credit, and personal loans. Under the authority of the
Credit Control Act, the Federal Reserve has also (a) applied a special deposit
requirement on the growth of managed liabilities of large non-mernber banks and (b)
imposed a special deposit requirement on the growth in the net assets of money
market mutual funds and other similar entities.
One consequence of strong demands for money and credit generated in part
by inflationary forces and expectations has been to bring heavy pressure on credit and
financial markets generally, with varying impacts on particular sectors of the
economy. At the same time, restraint on growth in money and credit must be a
fundamental part of the process of restoring stability.
That restraint is, and will
continue to be, based primarily on control of bank reserves and other traditional
instruments of monetary policy. However, the Federal Reserve Board also believes
204
the effectiveness and speed with which appropriate restraint can be achieved without
unnecessarily disruptive effects on credit markets will be facilitated by a program of
voluntary credit restraint by important financial intermediaries. -The program set
forth here develops certain general criteria to help guide banks and others in their
lending policies during the period ahead.
Statement of Purpose
The purpose of the Special Credit Restraint Program is to encourage
lenders and borrowers, in their individual credit decisions, to take specific account of
the overall aims and quantitative objectives of the Federal Reserve in restraining
growth in money and credit generally. The guidelines set forth are consistent with the
continuing interest of the Federal Reserve and individual institutions to:
—
Meet the basic needs of established customers for normal
operations, particularly smaller businesses, farmers, thrift
institution bank customers,
and agriculturally-oriented
correspondent
homebuyers
banks,
and
with
limited
alternative sources of funds.
—
Avoid use of available
credit resources to support
essentially speculative uses of funds, including voluntary
buildup of inventories by businesses beyond operating
needs, or to finance transactions such as takeovers or
mergers that can resasonabiy be postponed, that do not
contribute to economic efficiency or productivity, or may
be financed from other sources of funds.
—
Limit overall loan growth so that adequate provision is
made for liquidity and acceptable capital ratios.
In requesting cooperation of individual institutional lenders in achieving the
general objectives of this program, the Federal Reserve Board is strongly conscious of
the fact that sound decisions concerning the distribution of credit and specific loans
205
can be made only by individual institutions dealing directly in financial markets and
intimately familiar with the needs and conditions of particular customers. We are also
aware, however, that in existing market circumstances, individual institutions may be
under competitive pressure to make loans or commitments that, in the aggregate,
cannot be sustained within our overall monetary and credit objectives or that, for
particular institutions, may exceed prudent limits.
By more clearly considering
individual lending and commitment decisions in the light of the national objectives
reflected in this program, undue market pressures and disturbances can be avoided and
available credit supplies be used to meet more urgent requirements.
Nature of the Program
Coverage
The Special Credit Restraint Program will be directed primarily toward the
domestic credit supplied by commercial banks and the domestic business credit
extended by finance companies. Surveillance will also be exercised over borrowing in
the commercial paper market and borrowings abroad by U.S. corporations.
With regard to domestic commercial banks, the program is designed to
cover credit extended to U.S. residents by both the domestic and overseas offices of
such banks. Credit extended to U.S. residents by agencies and branches of foreign
banks domiciled in the United States will be specifically covered. Affiliates abroad of
banks operating in the U.S. are expected to respect the substance and spirit of the
guidelines in their loans to U<5. borrowers or loans otherwise designed to support U.S.
activity.
In recent months, the commercial paper market and finance companies
have been a growing source of business credit. In recognition of this trend and to
assure comparable competitive treatment, finance companies (including subsidiaries of
bank holding companies) are asked to follow the general guidelines in their business
lending.
206
Activity in the commercial paper market is normally covered by bank
credit lines. That practice is strongly encouraged in the interest of continuing to
provide a sound base to that market.
But the use of commercial paper should be
restrained, and growth in the market and activity of the larger users of that market
wtll be closely monitored. For their part, banks are expected to give special attention
to avoiding increases in commitments for credit lines for purposes of supporting
commercial paper borrowing for other than normal business operating purposes.
Thrift institutions and credit unions are not specifically covered by the
Special Program in light of recent patterns in their asset growth.
Reporting arrangements are described below.
Quantitative Guidelines
The Federal Reserve has recently set forth growth ranges for the monetary
aggregates for 1980 as follows:
MIA
3K% -
6%
M1B
*%
•
6)4%
M2
6%
•
M3
6J4% -
9%
9*%
The growth ranges set forth for M3 encompass almost all the relatively
short-term liabilities of banks and other depository institutions. That liability growth
was broadly estimated to be consistent with growth in total bank credit (loans and
investments) of 6-9%. We are aware that in current market circumstances, banks may
be requested to carry a larger than normal share of growth in business and certain
other types of credit. However, prudent attention to liquidity and capital positions
will also be required, and liquidity of banks is already somewhat depleted. Taking
these factors into account, growth in bank loans,.consistent with the monetary growth
ranges and maintenance of prudent liquidity positions,should not generally exceed the
upper part of the indicated range of growth in total bank credit. That growth should
207
be spread out over time in an orderly fashion, taking account of normal seasonal
patterns.
Growth trends vary among banks and regions of the country. Individual
institutions will wish to appraise their own prospects and policies in that light. Banks
whose past patterns suggest relatively slow growth, and particularly those serving
more slowly growing areas, should expect to confine growth to the lower portion or
even below the indicated range for bank credit, particularly in instances where
liquidity or capital ratios are below average. More rapidly growing banks should also
evaluate their ability to support such growth without impairing liquidity or capital
ratios.
The Federal Reserve and other federal bank regulatory agencies will
carefully review patterns of loans and commitments at institutions that
are
experiencing growth in lending at or above the top of the range specified. Account
will be taken of their own past experience and regional trends as well as the banks'
capacity to finance their loan portfolios without straining capital or liquidity.
Increases in loans by banks resulting in lower capital or liquidity ratios, particularly
when the bank ratios are below peer groups, will be especially closely reviewed to
assure their position is not weakened. In that connection, other regulatory authorities
will be consulted as appropriate.
Individual institutions should adopt commitment policies that enable them
to maintain adequate control over growth in loan totals and to assure funds are
available to meet the priority needs specified below.
Qualitative Guidelines
The Board does not intend to set forth numerical guidelines for particular
types of credit. However, banks are encouraged particularly:
!' •
4fc) -:Td'> restrain unsecured lending to consumers, including
'fcpedit'-cards and other revolving credits. Credit for auto,
208
home mortgage and home improvement loans should not be
subject to extraordinary restraint.
(2) To discourage financing of corporate takeovers or mergers
and the retirement of corporate stock, except in those
limited instances in which there is a clear justification in
terms of production or economic efficiency commensurate
with the size of the loan.
(3) To avoid financing of purely speculative holdings of
commodities or precious metals or extraordinary inventory
accumulation out of keeping with business operating needs.
(ft) To maintain reasonable availability of funds to small
businesses, farmers, and others without access to other
forms of financing.
(5) To restrain the growth in commitments for backup lines in
support of commercial paper.
(6) To
maintain
adequate
flow
of
credit
to
smaller
correspondent banks serving agricultural areas and small
business needs and thrift institutions.
The terms and pricing of bank loans are expected to reflect the general
circumstances of the marketplace. No specific guidelines or formulas are suggested.
However, the Board does not feel it appropriate that lending rates be calculated in a
manner that reflects the cost of relatively small amounts of marginal funds subject to
the marginal reserve requirements on managed liabilities.
Moreover, the Bqard
expects that banks, as appropriate and possible, will adjust lending rates and other
terms to take account of the special needs of small businesses, including farmers, and
others.
209
Reporting
The Federal Reserve will closely monitor developments in all sectors of the
credit markets and will ask that certain data and information be supplied by banks and
others. The President, in activating the Credit Control Act of 1969, has provided
authority for requiring such reports.
In the case of domestic banks with assets in excess of $1 billion, and for
U.S. branches and agencies of foreign banks that have worldwide assets in excess of $1
billion, a monthly report will be requested. Monthly reports will also be requested on
the business credit activities of domestic affiliates of bank holding companies with
U.S. financial assets in excess of $1 billion. As will be noted, the bank reports include,
apart from qualitative information, certain data on the movements in broad categories
of loans and commitments, liquid asset holdings, and capital accounts. Certain data,
including that on capital and liquidity, will be requested on a consolidated worldwide
basis. Banks with less than $1 billion but more than $300 million in assets will report
quarterly. Smaller institutions, while requested to observe the program, will not have
special reporting requirements unless warranted by subsequent developments.
A group of large corporations will be requested to complete a brief
monthly form about their activities in the commercial paper market, including the
extent and usage of "backup" lines of credit at banks and their borrowing abroad.
Finally, finance companies — including subsidiaries of bank holding companies — with
more than $1 billion in loans outstanding to business borrowers will be requested to
provide monthly reports concerning their business lending activities.
Consultative Arrangements
In instances warranted by trends in loans and commitments, Federal
Reserve Bank officials in consultation with other federal bank regulatory agencies,
will review with individual banks and pthers their progress in achieving and
210
maintaining appropriate restraint on lending. In general, such consultations will be
sought if:
(1) Bank or finance company lending is occurring at a pace
that appears to be significantly in excess of the national
objective,
taking account of the
location or
past
experience of the bank or other institution.
(2) Commitment policies appear to suggest the possibility of
large subsequent increases
in lending or exceptional
expansion of commercial paper borrowing.
(3) Explanations of "takeover" or "speculative" financing
contained in regular reports raise significant questions.
(4) The distribution of credit at an institution generally
appears disproportionate in light of
the
qualitative
guidelines above.
(5) Liquidity positions or capital ratios reflect developing
strains, particularly in the case of institutions whose ratios
are below peer group averages.
In the case of nonbanks, the Federal Reserve may also wish to hold
informal discussions with such institutions if such discussions seem warranted by
developments.
211
FEDERAL RESERVE press release
For Immediate release
May 22, 1980
Evaluation of recent banking and other credit data, including trends in
consumer credit, indicate that current developments are well within the framework
of the basic monetary and credit objectives of the Federal Reserve and the special
measures of credit restraint established last March 14.
The Federal Reserve is
accordingly modifying and simplifying the administration of the special programs.
These actions do not represent any change in basic monetary policy as
reflected in the targets for restrained growth in money and credit over 1980 that
were developed early this year to help bring inflation under control.
The actions announced today are consistent with the intent to phase out
those special and extraordinary measures only as conditions clearly permit.
the basic framework of the special March measures remain.
Therefore,
These were established
in part in conjunction with the action of the President to invoke certain provisions
of the Credit Control Act of 1969.
Actions taken by the Board are:
—A reduction in the marginal reserve requirement on managed liabilities
of large member banks and agencies and branches of foreign banks from 10 percent to
5 percent, and an upward adjustment of 7-1/2 percent in the base upon which the
reserve requirement is calculated.
—A reduction in the special deposit requirement em managed liabilities
of large nonmember institutions from 10 percent to 5 percent, together with a
similar upward adjustment in their base.
—A decrease from 15 percent to 7-1/2 percent in the special deposit
requirement that applies to increases in covered consumer credit.
212
—A decrease from 15 percent to 7-1/2 percent in the special deposit
requirement that applies to increases in covered assets of money market mutual
funds and other similar institutions.
—Modification of the Special Credit Restraint Program to ensure that
more urgent credit needs are being met—such as those for small business, auto
dealers and buyers, the housing market, agriculture and energy products and
conservation—and to reduce reporting burdens as described in the attached letter
to the Chief Executive Officer of commercial banks.
The lower marginal reserve requirement on the managed liabilities of
member banks and foreign agencies and branches will apply to liabilities
effective with the statement week of May 29-June 5. Effective that
week also, the marginal reserve base will be increased by 7-1/2 percent above
the base used to calculate the marginal reserve in the statement week of May 1421. Declines in outstanding loans to foreigners will continue, as before, to
reduce the base in subsequent weeks. The upward adjustment does not apply to
the $100 million minimum base amount.
The same effective date and adjustment in base will apply to nonmember
banks subject to the special deposit requirement on increases in managed liabilities.
The new special deposit requirement on covered consumer credit will be
effective beginning with the average amount of credit outstanding in June, with
the special deposit due July 24. For money market funds, the new requirement
will be effective with assets in the week beginning June 16, and the deposit will
be maintained in the week beginning June 30.
Attachment
213
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 2O5SI
PAUL A- VOLCKER
CHAIRMAN
May 22, 1980
To the Chief Executive Officer of Banking Institutions;
Preliminary review of reports of large banks under the
Special Credit Restraint Program, together with analysis of
other banking data, now indicates that bank loans appear to
be running comfortably within the 6 to 9 percent guideline
set forth in the Special Credit Restraint Program. Moreover, the most recent data suggest the rate of growth has
been at a significantly reduced pace, and some categories
of loans, such as consumer loans, have actually been falling.
As you will recall, the 6-9 percent guideline was
directly related to the objectives and targets set by the
Federal Reserve to achieve restrained growth in the overall
supply of money and credit during 1980 for the nation as a
whole. While present trends appear fully consistent with
reaching those goals, we recognize individual banks, or
banks in some regions of the country, may face conditions
that make it particularly difficult to meet the quantitative
guidelines while fully respecting the qualitative guidelines.
In that-connection, the administration-of-the- program.will
henceforth reflect the following criteria. These criteria
are broadly consistent with the existing program, but are
designed to provide for individual banks facing local conditions that may inhibit their ability to meet the overall
objectives:
(1)
{
Lending by small banks as a group (those under $100
million of deposits) has clearly been within the
quantitative guidelines. Those banks should not
feel under any special restraint in meeting the
needs of their regular local customers, consistent
with their individual capital and liquidity requirements, in particular, the program is not designed
to exert restraint on agricultural, small business,
home construction and improvement (including energy
conservation), home mortgage, and auto-related credit.
Small banks that find their lending exceeding the
general guideline should refrain from extending
their normal lending area or participating in larger
credits to those with other potential sources of
funds.
214
2)
Larger banks, consistent with the program, are
also expected to treat loan requests from farmers,
small businessmen, homebuilders, homebuyers (including
home improvement and energy conservation loans) ,
and auto dealers and buyers in a normal manner —
that is, consistent with the banks' credit standards
and liquidity and capital needs. Customers particularly
dependent on bank financing and enlarging production
capability in response to urgent needs, such asi energy,
may warrant accommodation, Jf . in meet.ing these needs,
total loans appear to be rising to or above the 9%
guideline, banks are expected t;p restrain loans to
other borrowers, including those with access to other
sources of funds and those outside the normal lending
area. Banks respecting these priorities finding their
total loans rising faster than consistent with the 9
percent guideline will be expected to demonstrate that
their policies are consistent with these priorities in
their reports and reviews with the regional Federal
Reserve Banks. Banks will be justified in exceeding
the quantitative guidelines when such a demonstration
can be made.
(3)
All banks are requested, as before, to avoid use of
available credit resources to support essentially
speculative uses of funds, or to finance transactions
such as takeovers or mergers that can reasonably be
postponed and that do not contribute to etfnomic
efficiency or productivity.
(4)
The Board will continue to monitor the program through
special reports and evaluation of the continuous flow
of data on bank loans that it obtains through its
regular reporting channels. TO Deduce the administrative
burden of the program, however, the. number of special
reports will be reduced. Reports from large' banks Will
henceforth be obtained on a bi-monthly rather than a
monthly basis. Reports from large corporate borrowers
will be discontinued. The first quarterly report from
intermediate-size banks will be simplified, and the need
for any. further report will be cons^dere^d afte^r that
check point is passed. As before, no reports will be
required from small banks.
,.^,.t ,. ._-, ,
>:(-.,
Sincerely,"
Paul A. Volcker
215
FEDERAL RESERVE press release
July 3, 1980
For immediate release
The Federal Reserve Board today announced plans to complete the
phase-out of the special measures of credit restraint that had been put
in place, or reinforced, on March 14 of this year.
The special measures were designed to supplement, temporarily, more
general measures of credit and monetary control, and recent evidence indicates
that the need for those extraordinary measures has ended. For the year to
date, credit expansion, particularly at banks, is clearly running at a
moderate pace. In recent months, there has been apparent contraction in
consumer borrowing, indications are that anticipatory and speculative demands
for credit have subsided, and funds have been in more ample supply.
While the special conditions necessitating the extraordinary credit
restraints are no longer present, the Board emphasized that its general goals
of achieving restrained growth in money and credit aggregates are unchanged.
Those continuing goals are closely related to its concern with further reduction
of inflationary pressures in the economy.
The Board previously, on May 22, had halved the special deposit
requirements in connection with the credit restraint program and had modified
the guidelines for the special program for restraining bank credit growth.
Today, the Board scheduled completion of the phase-out by taking the
following measure^:
216
—Elimination of the remaining 5 percent marginal reserve requirement
on managed liabilities of large banks and agencies and branches of foreign
banks.
This action applies to managed liabilities beginning July 10, for
reserves required beginning July 24.
In addition, the Board eliminated,
effective the same date, the 2 percent supplementary reserve requirement
applicable to member banks on large time deposits.
This requirement had
been initiated in November 1978.
--Elimination of the remaining 7-1/2 percent special deposit requirement that applies to increases in covered consumer credit, effective for
covered credit extended in June and thereafter.
Thus, no further special
deposits will be required after the present deposit maintenance period ends on
July 23.
To permit orderly implementation of changes now in process and to
assure adequate notice of such changes to credit users, the Board's rule
permitting creditors to modify the terms of credit accounts will remain in
effect for notices mailed only on or before September 5.—'
—Elimination of the remaining 7-1/2 percent special deposit requirement that applies to increases in covered assets of money market mutual funds
and other similar institutions.
This action applies to covered assets beginning
July 28, and hence no special deposits will be required beginning August 11.
—Phase-out of the Special Credit Restraint Program under which banking
institutions and finance companies were asked to limit domestic loan growth
to a range of 6 to 9 percent in 1980.
Available data for the first five months
of this year indicate that bank loans to domestic borrowers have increased at
around a 3 percent annual rate.
Banking institutions with $300 million or
\J Under the consumer credit restraint program, to make certain changes in terms
of accounts, a creditor must send a 30-day advance notice explaining the changes
and giving the consumer the option of paying down the existing balance according
to the original terms. Subsequent use of the account by the consumer is deemed
to be acceptance of the new terms.
217
more deposits will be expected to complete reports (either the quarterly report
or the monthly report for the larger institutions) due under this program
July 10 for data as of June 30.
After those reports are received, discussions
will be held with individual banks to review experience with the special
program.
In phasing out the aggregate 6-9 percent guideline for individual
institutions, the Board feels that normal competitive and market incentives
can again be relied upon to assure the flow of credit consistent with normal
banking standards, and that qualitative guidelines are therefore no longer
appropriate.
However, the Board remains concerned over the volume of credit
that appears to have flowed to essentially speculative purposes in the past,
and is considering the need for additional means of monitoring such developments in the future.
The Board:1 s orders in these matters are attached.
218
Special Credit Restraint Prograi
Answers to Questions
^^m^m^^^^::^^^:^^
For immediate release
March 26, 1980
The staff of the Federal Reserve Board has supplied the attached
answers to frequently asked questions it has received concerning the Board's
anti-inflation program announced March 14.
Other sets of questions and answers will be issued as they
become available.
219
1.
Does the Special Credit Restraint Program apply to sales of federal funds?
Answer;
No.
2. Are loans to non-U.S. residents covered by the guidelines under the Special
Credit Restraint Program?
Answer:
covered.
Loans by domestic or foreign offices to non-U.S. residents are not specifically
However, excessive growth in such loans may have an undesirable effect
on the liquidity and/or capital positions of the bank and the Federal Reserve intends
to monitor such positions carefully*
3.
Will the reporting forms be revised to add, to the statistical information
requested of banking organizations, a memo item for loans to foreigners?
Answer:
It has been decided not to revise the forms for the additional item.
In
their contacts with banks, Reserve Banks will suggest that, when a respondent has
a special situation regarding loans to foreigners (e.g., a large increase in
total loans that mostly reflects loans to foreigners), this fact should be called
to the attention of the Reserve Bank by noting it in the space provided for
explanations (section D).
4.
To what period does the limitation on loan growth "in 1980" refer?
Answer:
5.
It refers to the period from December 1979 to December
1980.
The reporting forms do not ask for the December 1979 "base period."
obtain these base-period levels?
How will we
220
Answer: For almost all respondents subject to the lending constraint, data for the
December 1979 base period are generally available from reports they file regularly
with the Federal Reserve or with one of the other bank supervisory agencies.
6. Does "December 1979" mean December 31?
Answer:
In order to avoid the distortions in base period levels that could arise
from calculating them as of a single day, an average for the month of December should
be used to the extent permitted by available data.
For weekly reporting banks, an
average of the four Wednesdays in December 1979 seems appropriate.
For businesses
(e.g. finance companies) from which we have been receiving end-of-month reports,
November and December figures should be averaged. For respondents such as nonmember
banks, however, December 31 data will have to be used for the base period.
7.
Is it essential that reporting of data by bank holding companies be as of
the last Wednesday of the month, or are data as of the last business day of the
month acceptable?
Answer:
Data as of the last business day are entirely acceptable, especially
if this reduces the reporting burden on respondents.
«£
8.
Should the statistical information on loan commitments outstanding include
lines or just commitments? —
Answers;
Total amounts or just the unused portions?
The figures reported for loan commitments should be unused confirmed
lines plus unused commitments, to both nonfinancial and nonbank financial
business customers.
221
9. Are any classes of bank loans (such as loans to small business) to
U.S. residents "exempt" or excluded from the 6 to 9 percent quantitative
guideline for growth in bank loans in the Special Credit Restraint Program?
Answer: No. The qualitative objectives of the program call upon banks and
other lenders to ensure that flows of credit to small business, farmers,
homebuyers, smaller correspondent banks and others as stipulated in the
Program are maintained. However, growth in these loan categories are
included in the overall quantitative guidelines relating to lending. Consequently, where necessary, individual banks are expected to exercise special
restraint on loans to large business customers or others that have access to
other sources of funds so that credit to groups requiring special attention
can be maintained. The guidelines thus apply to overall loan growth; the
special categories are "hot "exempt" in judging overall growth, but the
restraint should fall on other sectors.
10. How can a bank that is already high in or above the 6 to 9 range cope
with takedowns of legally binding commitments that would push the bank's
overall loans over or further beyond the 9 percent limit?
Answer: As a first step, banks should review existing commitments carefully
to determine which are, in fact, legally binding. Also, banks in such a
position should attempt aggressively to encourage prospective borrowers to
postpone such takedowns where possible and/or to consider alternate sources
of funding. If these options are not realistic and the loans are made, the
Federal Reserve would fully expect that such a bank would be extraordinarily
careful about making new commitments, and'that it would not accommodate such
loans by reducing credit to small business, homebuyers, farmers and other
similar customers. Moreover, in these circumstances, the Federal Reserve's
.attitude toward the bank's performance will be importantly influenced by the
bank's, liquidity and capital position relative to that of its peers.
11. How firm is the 6 to 9 percent limit-on loan growth?
circumstances will faster growth be acceptable?
Under what
Answer: In the current economic and market circumstances, the 6 to 9 percent
range is a firm guideline for the December 1979-Becember 1980 period. Banks
should j.udge current trends in the light of that yearly target. It is
recognized, that loans or commitments made during the first two months of the
year, seasonal peaks in lending (as, for example, around tax dates),
exceptionally strong local growth, or other particular factors might cause some
banks temporarily to exceed a path consistent with the guideline. In such
cases, special consultations will be held with the regional Federal Reserve Bank
in which the bank(s) should be prepared to explain and justify the
*Questions and answers were last previously supplied under this heading in
the set of questions and answers dated March 26.
222
circumstances surrounding the departure and to discuss plans for slowing
the pace ot lending, particularly in areas not subject to special treatment,
so as to move back within the range; One important element in such special
consultations will be the lending pattern of the bank in relation to its
capital and liquidity position.
12. Does the 6 to 9 percent growth limit apply equally to the credit extended
by nonbank subsidiaries of bank holding companies?
Answer:; Yes, the general limitation on loan growth does apply to the bank
and nonbank subsidiaries of bank holding companies. The Federal Reserve is
mindful of the possibility that each unit in a bank holding company may not
experience the same rate of credit expansion. In these circumstances the
Federal Reserve will look at the aggregate rate of credit expansion. by the
overall holding company as well as the performance of individual reporting
units within the holding company structure.
13. Does the 6 to 9 percent growth limit apply to the credit extended by
finance companies that are not 'ffiliated with bank holding companies?
Answer: Finance companies are expected to respect the overall intent of the
program. Consistent with the framework of the program, no special restraint
is suggested for consumers and small business lending, which would include
auto dealers with credit lines of $1.5 million or less. Lending to larger
businesses should be reduced to accommodate any increases in consumer and
automobile paper so that the overall growth can stay within the guideline.
The Federal Reserve recognizes that in some instances the firm's customer base
and/or seasonal or cyclical patterns of lending by such finance companies may
require evaluation on a case by case basis. In such instances, finance
companies should, in their subsequent reporting to their respective Federal
Reserve Banks, provide appropriate information bearing on such circumstances.
14. Page 1 of the Fed press release states that special efforts will be made
to maintain credit for farmers and small businessmen, including accommodation
of the needs of correspondent banks serving such customers. What is the nature
of these special efforts?
Answer; .The Federal Reserve expects that individual banks without special
lending and credit availability programs will design appropriate programs
to maintain the flow of such credit and promptly put them into effect.. These
programs should reflect the nature of that bank's business, its existing
customer base, and other appropriate circumstances. While the nature and
substance of such programs must and should be determined by the individual
banks, the banks are asked to inform their Federal -Reserve Bank of their
programs. Moreover, bank examiners will monitor the implementation of these
special programs as part of the usual examination process.
15. The program states that account will be taken of a bank's capacity to
finance its loan portfolio without straining capital or liquidity. How will
this be done?
223
Answer; The Federal Reserve Is mindful of the fact that both the capital and
liquidity positions of some banks are lower than may be desirable over time and
that some banks are therefore not as well equipped as others to absorb increases
in lending. In view of this, and in the light of the continuing interest of
the Federal Reserve and the other federal, bank regulatory agencies in promoting
stronger capital and liquidity positions in the banking industry, the Federal
Reserve will be especially sensitive to those banks with loan growth in the
upper area of, or temporarily above, the guideline range at the expense of
further declines in already relatively low capital and liquidity positions.
In some instances, capital and liquidity considerations may require special
consultations even when a bank's loan growth is well within the specified range.
16. Are export loans included in the total of loans subject to the 6 to 9
percent growth limitation?
Answer; They are. But the Board would not want .banks to reduce the
availability of export loans in order to make less desirable types of loans.
Any bank that exceeds the growth limit because of export loans should note
that fact in Section D of its report.
17. Are extensions of credit by Edge Act subsidiaries included in the 6-9
percent guideline?
Answer; Loans by Edge Act subsidiaries to U.S. addressees are to be included
in total loans and leases to U.S. addressees by banks, branches and agencies,
and bank holding companies. The 6-9 percent growth limitation applies to
this measure of bank lending. Thus, Edge Corporations are not exempt from
the growth limit on bank loans.
224
18. If a corporation reporting on form FR 2062e does not have timely, or any,
records for some components of the corporation's indebtedness to non-U.S.
entities — in particular, debt initially placed in the United States through
third parties, and open-book credit—and is unable even to make a "good faith"
estimate of such components, how should these items be reported?
Answer; It is not necessary for reporting corporations to determine the amount
of debt issued directly to U.S. lenders or raised through U.S. dealers or other
U.S. third parties that is now held by non-U.S. entities. No part of the outstanding amounts of such debt should be reported in item A2 of form FR 2062e.
However, a shift toward placing debt abroad through U.S. third parties for other
than normal business reasons would, of course, not be consistent with the spirit
of the Special Credit Restraint Program.
Reporting corporations are expected to include open-book credit (trade
notes and accounts payable) in reporting their indebtedness to non-U.S. entities,
if this is feasible. If data on net payables to non-U.S. subsidiaries and
affiliates and/or gross payables to other non-U.S. entities are available, but not
on a timely basis, the corporation should consult with its Reserve Bank as to
whether to include this component with a lag or to make some other adjustment. If
there is no practical way for the corporation to develop data' on open-book credit
owed to non-U.S. entities, this component may be omitted from item A2 but the
Reserve Bank should be informed of the omission. In any event, open-book credit—
and all other components as well—should be reported on a consistent basis from
month to month.
19. May data be reported as of some day other than the one called for on the
reporting forms—that is, other than the last Wednesday of the month for commercial banks, branches and agencies of foreign banks and bank holding companies,
and the last business day of the month for all other reporting entities?
Answer: It is not necessary to develop data as of the stipulated day if records
for all or part of the reporting entity are generally available only as of some
other day during the month. However, data should be reported on a consistent basis
from month to month, and the date (or dates, in the case of mixed reporting) to
which they refer should be noted on the reporting form.
20. At least part of the data for a bank's foreign offices that are required to
complete the bank's (or holding company's) Special Credit Restraint Program report
normally do not become available to the U.S. parent in time to permit filing the
report with the Reserve Bank by the stipulated deadline. Is an extended deadline
available? May some or all data be reported with a one-month lag? For example
for the April report, may the "current month" in fact be March either for some items
in their entirety, or for the foreign-office component of all items?
Answer; Reporting problems of this kind should be discussed with the Reserve Bank,
since they will be considered on a case-by-case basis. In general, extension
of the reporting deadline by a few days is preferable to lagged reporting,
especially for data relating to loans. In cases where lack of timely data for
225
foreign offices relates only to the liquidity and capital measures, reporting
with a one-month lag of items affected by the foreign data will be considered.
Any such adjustments in reporting must be approved by the Reserve Bank in
advance.
21. Are industrial revenue bonds to be included in total loans and leases
subject to the 6 to 9 percent growth limitation?
Answer; No. Industrial revenue bonds are defined as investments, not loans.
However, Reserve Banks should be alert to the possibility of a bank's arranging
an industrial revenue bond financing as a substitute for the commercial and
industrial loan the bank would have made in the absence of the Special Credit
Restraint Program. Any bank that appears to be acquiring an unusually large
amount of industrial revenue bonds should be asked for an explanation.
22. Are factoring receivables included in total loans subject to the 6 to 9
percent limitation?
Answer: Since the instructions to the Call Report appear to define such accounts
as loans, they should be defined as loans for purposes of the Special Credit
Restraint Program.
226
APPENDIX C
Special Credit Restraint Program
Statistical Tables
Table IA1
Credit Demands and Loan Policies
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
March
April
(number of respondents)
170
170
Current strength of total private credit demands from tf.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
26
126
18
5
104
61
Applications for commercial and industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
in recent years.
Significantly larger
Essentially unchanged
Significantly less
63
33
24
19
95
56
17
124
29
3
133
34
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for commercial and industrial loans to meet basic and emerging
needs for smaller businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
4
131
35
2
116
52
2
155
13
0
151
19
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
227
Table IA1 (cont'd)
March
April
Commercial and industrial loans for purely financial activities.
Requests: Yes
No
Approvals: Yes
No
Commitment takedowns: Yes
N
O
80
90
33
132
32
138
71
99
34
136
23
147
Loans to business customers for speculative purposes.
Requests: Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
47
123
9
161
7
163
41
129
5
165
4
166
Applications for commercial and industrial loans or loan commitments for non11. S. affiliates of U.S. firms, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
3
161
6
i
158
11
0
0
j^
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
^53
7
9
228
Table IB1
Selected Financial Data
(Amounts outstanding, in billions of dollars)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
March
1979 1980
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
Total
Total
Total
Total
Total
liquid assets
discretionary liabilities
assets
equity capital
loans and leases
453.5
346.6
135.8
126.9
29.0
50.6
4.6
155.6
6.0
514.0
401.8
159.4
150.5
32.2
60.7
5.1
175.3
8.5
8.7 13.1
228.1 293.3
4.0
5.1
171.7
423.1
867.2
39.4
338.4
193.2
505.7
994.6
46.7
398.8
456.1
348.3
138.2
129.4
29.7
51.5
4.7
153.8
6.2
514.9
403.6
161.9
152.9
32.3
61.5
5.2
174.8
8.7
9.1
13.6
247.8 334.0
4.3
December 1979
Memo:
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
5.0
175.6 187.5
430.9 502.4
880.11001.6
42.7 46.9
343.0 401.9
398.1
294.1
April
1979 1980
461.4
353.7
142.0
133.5
30.6
51.8
4.8
155.0
6.3
515.2
403.4
159.0
152.5
32.7
61.6
5.2
174.2
8.8
8.5 13.2
249.4 341.1
4.3
5.2
175.2 197.3
429.7 506.7
893.21011.7
43.0 47.9
349.1 403.5
March 14, 1980
xxxxxx
328.8
229
Table IB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
U.S. Commercial Banks
Assets $1 Billion or more
All Federal Reserve Districts
Change from year-ago month
February
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
Total loans and leases
60.5
55.2
23.6
23.6
3.2
10.1
0.5
19.7
2.4
58.8
55.3
23.7
23.4
2.6
10.1
0.4
21.0
2.5
53.9
49.7
16.9
19.0
2.2
9.8
0.4
19.2
2.4
4.4
65.2
1.1
60.3
4.4
87.1
0.7
59.0
4.7
91.7
0.9
54.3
Change from preceding month
March
April
1979
1980
1979
1<.980
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
'
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices to
U.S. addressees
Total loans and leases
2.6
1.7
2.5
2.6
0.6
0.9
0.1
-1.7
0.1
0.9
1.8
2.5
2.4
0.1
0.8
0.1
-0.5
0.2
5.3
5.4
3.8
4.1
0.1
1.2
0.2
1.1
0.2
0.3
-0.2
-2.9
-0.3
0.3
0.1
-0.0
-0.6
0.1
0.4
19.7
0.4
40.6
-0.7
1.6
-0.4
7.2
0.3
45
-O.I
3.2
0.0
6.1
0.2
-1.5
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
0.6
-0.8
3.8
39.9
5.3
47.1
230
Table IB3
Selected Financial Data
(Percent changes in amounts outstanding)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
March
ibruary
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
Total loans and leases
13.3
15.9
17.4
18.6
10.9
20.0
10.5
12.7
40.6
9.5
7.6
13.6
40.1
12.4
38.6
50.8
28.6
48.7
34.8
55.6
36.8
27.8
17.8
16.3
17.2
20.8
15.6
12.9
15.9
17.1
18.1
11.7
14.1
11.9
14.2
8.9
7.1
19.6
18.9
Change from preceding month
March
April
1979
1980
1979
1980
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices to
U.S. addressees
Total loans and leases
0.6
0.5
1.8
2.0
2.2
1.7
2.0
-1.1
2.4
0.2
0.4
1.6
1,6
0.4
1.4
1.1
-0.3
2.1
1.2
1.5
2.7
3.1
2.9
0.7
1.3
0.8
2.6
0.1
-0.0
-1.8
-0.2
1.2
0.2
-0.4
-0.3
1.5
5.1
8.6
3.6
13.9
-7.3
0.6
-3.0
2.2
6.8
1.3
-2.9
0.8
0.8
1.8
4.7
0.4
Change from December 1979
February
March
April
Total loans and leases to f.S*
•ddreftsees
Loan commitments to U.S. addressees
0.2
-0.3
1.0
13.6
1.3
16.0
231
Table IB4
Loans, by Type
(Percentage distribution)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
February
1979 1980
Type of loan
March
1979 1980
April
1979 1980
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
100.0 100.0
39.2 39.7
36.6
37.4
8.4
8.0
14.6
15.1
1.3
1.3
44.9 43.6
100.0 100.0
39.7 40.1
37.2
37.9
8.5
8.0
14.8
15.2
1.4
1.3
44.2 43.3
100.0 100.0
40.2 39.4
37.7 37.8
8.6
8.1
14.7
15.3
1.4
1.3
43.8 43.2
Total C & I loans
To U.S. addressees
To smaller businesses
100.0
93.5
21.4
100.0
93.7
21.5
100.0
94.0
21.5
100.0
94,4
20.2
100.0
94.4
20,0
100.0
96.0
.20.6
Table IBS
Relationship of Unused Loan Commitments to Total Loans and Leases
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
1979
December
February
1980
March
April
(percent)
Unused commitments/
Total loans and leases
73.9
73.6
83.1
84.6
232
Table IB6
Liquidity and Capital Ratios
(Percent)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Ratio
Liquid assets/Total assets
Discretionary liabilities/
Total assets
Liquid assets minus disc, liab./
Total assets
•
Liquid assets/Discretionary
liabilities
Total equity capital/Total assets
February
1979 1980
March
1979 1980
April
1979 1980
19.8 19.4
20.0
18.7
19.6
19.5
48.8 50.8
49.0
50.2
48.1
50.1
-29.0 -31.4
-29.0
-31.4
-28.5
-30.6
40.6 38.2
4.5 4.7
40.7
4.9
37.3
4.7
40.8
4.8
38.9
4.7
233
Selected financial Pata
(Distributions of Individual respondent percent changes in amounts outstanding)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month (quartlies)
February
2
i
4.8 10.1
6.8 11.6
2.2 11.7
3.3 12.0
Total loans & investments
Total loans
Total C $ I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability
on acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
Total
Total
Total
Total
Total
0.4
5.1
•22.8
15 .6
17 .5
21.0
22 .4
21 .3
8.4
13.3 26 .0
2.2
4.0
9.0
-5.3
15.3
3.8
5.8
2.1
2.2
-0.6
March
^
9.4
15.1
13.2
15.4
18.4
16.9
16.6
24.9
24.0
14.1
39.7
136 .6
30 .7
-2 .5 71.3 199.2
8 .4 18.6 34.3
2 .9 7.6
16 .9
3.9 9.1
22 .3
1.2 8.8
1.6 9.4
22 .6
19 .2 -2 .1 4.9
27 .3
3 .8 12.9
21 .1 -25 .9 -2.5
15 .8
0 .3 7.6
44 .4 -5 .4 14.9
11.5
11.1
11.5
6.5
4.8
24 .3 -27.5
16 .4
3.1
40 .6 -5.1
12.3
0.6
9.0
16.6
-18.8 43.2 143 .7 -4.5 53.3
8.9 18.4 30 .7
9.2 18.4
-29.3 14.9 65 .6 -33.3
liquid assets
discretionary liabilities
assets
equity capital
loans and leases
•12.0
4.6
4.1
5.2
5.3
16,4
10.3
7.0
April
£
3_
19.6
81 .5 -20 .4 19.9 103.9
3.8
25 .1 -12 .3 10.9 40.9
1.8 14.4 28.8
26 .9
4 .6 10.7 16.7
16 .7
5 .2 9.1 12.0
11.5
15.0
2.8
6.7
5.4
15.0
11.0
9.5
27 .1
29 .4
16 .0
12 .2
11.9
18,5
5.6
11.4
9.1
18.8
3.9
9.5
15.4
Change from preceding month (quartlies)
March 1979^
March 1980
April 1979"
April 1980
Total loans & investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability
on acceptances
Loan commitments4
C & I loans by foreign
offices to U.S. addressees
Total
Total
Total
Total
Total
liquid assets
discretionary liab.
assets
equity capital
loans and leases
-0.6 0.6 1.7 -1.0
-0.4 0.9 1.9 -0.7
-0.1 1.9 4.0 -1.0
0.1 2.3 4.3 -0.9
-0.4 1.3 4.1 -1.2
-0.2 0.9 2.0 -0.5
-4.3 0.6 6.5 -3,0
-2.4 -0.1 1.7 -1,9
-0.7 0.0 2.0 -0,8
•12.7
-0.8
-5.6
•11.3
-3.0
-2,2
-0.3
-0,1
1.4 19.7 -12.3
1.4 3.8
0.0
0,0
6.1 -10.3
-0.8 10.4 -10.6
0.6 6.2 -4.6
-0.3 2.0 -1.2
0.8 1.5 -0.5
0.9 2.0 -0.6
0.0
0,3
0.7
1.0
0.4
0,3
0.0
-0.3
0.0
2.5
2.3
o.o
1.4
1.4
3,4
3.8
2.6
1.3
3.8
1.2
2,1
0.0
0.4
0.3
0.4
-0.4
-0,2
-6.6
-1.3
-1.2
1.3
1.3
2.2
2.6
1.9
0,9
0.4
1.1
0,2
2.8 -1.6 -0.1 1.5
2.8 -1.5 -0.1 1,0
4.2 -2.2 -0,1 2.5
4.6 -2.2 -0.3 2.6
5.7 -3.5 -0.5 3.4
2.9 -1.2 0,4 2,3
6.0 -8.9 -0.9 4,1
3.0 -2.8 -0.8 1.4
3.0 -1.3 -0.0 2.3
21.5 -16.3 -0,9 13,8 -15.8
5,6 -3.0 0,8 3.5 -2.2
5.3
-4.4
o,,o
18.7 -10.2
•0.7 11,1 -9.2 0.2 13,5 -9.7
-0.4 3,7 -3 .8 1.4 6.8 -4.3
0.4 2.3 4,4 -0.4
0.4
2.8
0.0
0.4
1.1 -0,0 0.8 1,3
1,6
0,3
®*A 1.6 3.3 -1.5
1.6 31.0
0.3 3.3
0.0
7.3
2.6 20,7
0,0 5.9
1.6 3,9
1.0 1*9
0.0 1.1
234
Table IC1 (cont'd)
Change from December 1979 (quartlies)
February
March
April
1
2
3
1
~
~
2
3
1
2
3
Loan commitments to
U.S. addressees
0.0
Total loans and leases to
U.S. addressees
2.6
7.1
1.6
5.3
-2.0 -0.1 1.5 -1.7 0.1
Change from December 1979
0.0
13.5
2.1 -2.1 0.2
2.1
March
April
(Number of respondents)
Actual:
less than 0.0
O.O-rS.99
6.00-9.00
over 9.00
Axmualized:
less than 0.0
0.0-5.99
6.00-9.00
over 9.00
6.5
February
(percent)
Total loans and leases
to U.S. addressees
10.7
87
1
0
76
87
4
3
78 ,
86
3
3
87
24
16
43
76
39
15
40
78
44
18
30
82
Table IC2
Loans, by Type
(Individual respondent data)
U.S. Commercial Banks
Assets $1 Billion or more
All Federal Reserve Districts
March 1979
Type of loan
1
2
3
1
March 1980
April 1979
(quartlies)
2
3
1
2
3
April 1980
1
2
3
Percent of total loans
C & I loans
To U.S. add.
To smaller bus.
Real estate, resid.
Agricultural
All other
28.0
26.6
4.2
7.0
0.0
40.6
35.3
33.7
10.3
14.7
0.4
45.7
44.6 27.7 36.8 44.4 29.1
43.5 26.4 35.0 42.9 27.7
17.3 4.8 9.9 17.3 4.2
23.1 7.7 14.6 23.2 7.2
1.3 0.0 0.4 1.4 0.0
52.3 39.8 45.4 51.2 40.3
36.1
34.4
9.9
14.7
0.4
45.9
43.9 27.9 37.1 44.6
43.6 26.7 34.8 44.1
17.5 4.7 9.9 17.2
22.4 7.8 15.0 23.2
1.3 0.0 0.3 1.4
53.3 39.6 45.4 51.4
Percent of C & I loans
& I to U.S. add. 94.4
To smaller bus.
98.3 100.0
29.3 54.8
94.7 98.1 100.0 94.3 98.1 100.0 94.4 98.3 100.0
12.5 30.0 55.0 10.8 28.9 54.2 11.4 30.8 56.6
235
Table IC3
Relationship of Unused Loan Commitments to
Total Loans and Leases
(Distribution of individual respondent ratios)
U.S. Commercial Banks
Assets $1 Billion or More
AH Federal Reserve Districts
1980
March
February
April
(quartiles)
2
Unused commitments
(percent of total
loans and leases) 31,7 52.0 86.0
33,3 53.0
3
1
91.0
33.5
54.2
94.3
34.1
56.4
Table IC4
Liquidity and Capital Ratios
(Distribution of Individual respondent ratios)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
February
1979"
1980
Ratio
March
197?
1980
April
1980
1979
]
(percent)
Liquid assets/Total
assets
Discretionary liabilities/
Total assets
1
Total equity capital/
Total assets
7.4
8.5
7.6
8.2
8.0
12.9
20.3
13.0
18.6
13.1
20.7
12.7
18.0
13.1
19.0
12.7
19.1
11
25.4
34.9
45.8
27.1
37.0
48.4
26.6
34.8
46.1
25.9
37.0
49.0
25.5
34.3
46.3
25.9
36.8
49.7
-28.4
-20.3
-12.7
-32.8
-22.9
-14.1
-29.6
-21.5
-12.3
-32.6
-23.7
-14.7
28.7
39.0
54.4
25.2
36.3
50.0
27.7
38.5
54.5
24.1
35.7
50.8
28.4
38.6
54.8
25.4
35.9
53.4
5.0
5.9
6.8
5.1
5.8
6.8
5.1
5.9
6.8
5.0
5.8
6.7
5.0
5.8
6.7
4.9
5.7
6.6
2
3
Liquid assets minus disc,
liab./Total assets
Liquid assets/Discretionary
liabilities
8.6
2
3
1
2
3
-30.0
-32.8
-20.6 - -22.7
-13.5
-14.0
97.3
236
Table IIA1
Credit Demands and Loan Policies
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
March
April
(number of respondents)
139
139
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
23
110
6
8
118
13
Applications for commercial and industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
in recent years.
Significantly larger
Essentially unchanged
Significantly less
34
98
7
18
110
11
8
H6
15
3
118
18
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for commercial and industrial loans to meet basic and emerging
needs for smaller businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
5
127
7
3
129
7
3
131
5
1
132
6
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
.
Significantly smaller than usual
237
Table IIA1 (cdnt'd)
March
Requests: Yes
No
Approvals: Yes
No
Commitment takedowns: Yes
No
19
120
1
138
7
132
April
13
126
2
137
2
137
Loans to business customers for speculative purposes.
Yes
No
Approvals: Yes
No
Commitment takedowns: Yes
No
Requests:
5
134
0
139
2
137
3
136
0
139
0
139
Shifts out of United States, during the current month, of commercial and
industrial lending to U.S. addressees.
Rebooking of maturing loans offshore
Yes
No
A
135
Sale of loans to non-0. S. offices of foreign parent
Yes
%
^
«^
3
136
2
m
Booking of new loans abroad rather than in United States
^*»
**
mi
*&s
Applications for foreiTgn-bbblked commercial arSli industrial loans 0% Yoalh
ments for U.S. addressees, aft cotaparmd with the same month in recent years
Essentially unchanged
S%nificairtl5r t^sk
Proportion of such applications approve^.
Significantly Ijtae^nr thkn visual
tsffentially unc>iln|^t
Significantly smaller ^^litt usual
238
Table IIA1 (cont'd)
March
April
Applications for foreign-booked commercial and industrial loans or loan
commitments for non-U.S. affiliates of U.S. firms, as compared with the same
month in recent years.
Significantly larger
Essentiality unchanged
Significantly less
1
134
4
0
135
4
0
134
5
1
133
5
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Table IIHI
Selected Financial'Data
(Amounts outstanding, in billions of dollars)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Total loafis and investments
Total loans
total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
•Total loans and leases
February
1979 1980
Match
1979~T980
April
197* 1980
65.0
50.2
28.1
18.2
0.5
0.1
*
22.0
*
56.5
53.1
29.7
18.8
0.5
0.1
*
23.3
*
56.6 74.1
53,4 70.8
29.6 38.9
18.7 24.9
0.5 0.7
0.1 0.1
*
*
23.8 31.8
*
*
3.4 4.4
32.5 59.4
28.0 42.0
Memo: Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
* Less than $50 million.
72.7
68.7
38.9
25.2
0.7
0.1
*
29.7
*
75.8
71.5
40.3
26.1
0.7
0.1
*
31.0
*
3.8 4.6
33.3 64.5
27.9 43.5
3.9
35.1
28.5
4.7
65.0
40.9
December 1979
March 14, 1980
39.8
51.1
xxxxxx
62.8
239
Table IIB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Change from year-ago month
February
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
7.7
18.5
10.8
7.0
0.2
0.0
19.3
18.4
10.6
7.3
0.2
0.0
17.4
17.4
9.3
6.2
0,2
0.0
7.7
7.7
8.0
1.0
26.8
14.0
0.8
31.2
15.6
0.8
29.9
12.4
Change from preceding month
March
April
1980
1979
1980
1979
1<
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
-8.5
2.9
1.6
0.7
0.0
0.0
3.0
2.8
1.4
0.9
0.0
0.0
1.3
1.4
0.5
0.8
0.4
0.7
-0.1
0.2
5.1
1.5
0.1
1.9
0.7
0.1
0.6
-2.6
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
2.1
8.2
3.7
13.3
1.1
13.9
240
Table IIB3
Selected Financial Data
(Percent changes in amounts outstanding)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
from year-ago month
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
30.8
32.5
31.3
32.9
27.6
34.8
33.2
33.9
28.8
82.5
50.0
21.8
93.8
56.0
19.2
85.1
43.4
Change from preceding month
Matth
Aptil
1979
1980
1979 19§9
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loansLease financing receivables
D.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
-13U
5.7
4.2
4.1
5.6
3.6
*. 7
3,7
5.8
11.3
2.3
-0.3
0.2
-2.3
0. "f
-0.3
-0.9
-3.6
-0,4
-4.7
4.6
2.0
2.5
5.3
8.6
3.7
3.8
5.6
2.3
1.5
0.9
-5.9
Change from December 1979
.April
-March
Total loans and leases to U.S.
addressees
"Loan commitments to U.S. addressees
5.3
16.1
9.2
26.1
27.2
241
Table IIB4
Loans, by Type
(Percentage distribution)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
February
1979 1980
Type of loan
March
1979 1980
April
1979 1980
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
100.0 100.0
56.0
56.6
36.2 36.7
1.0
1.0
0.1
0.1
0.0
0.0
43.8
43.2
100.0 100.0
55.9 56.4
35.5 36.5
1.0
1..0
0.1
0.1
0.0
0.0
43.9
43.4
100.0 100.0
55.4 54.9
35.0 35.2
1.0
1.0
0.1
0.2
0.0
0.0
44.5
44.9
Total C & I loans
To U.S. addressees
To smaller businesses
100.0
64.6
1.9
100.0
63.4
1.7
100.0
63.3
1.8
100.0
64.8
1.8
100.0
64.8
1.8
Table IIB5
Relationship of Unused Loan Commitments to Total Loans and Leases
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
1979
December
Unused commitments/
Total loans and leases
128.3
141.4
148.1
158.8
100.0
64 0
Irr
242
Table IIC1
Selected Financial Data
(Distributions of individual respondent percent changes in amounts outstanding)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Change from year-ago month (quartiles)
February
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
40.0 76.4
41.5 81.6
36.6 98.3
42.1 132.8
-9.4 31.0 80.8
90.8
6.6 38.6
4.5
9.4
4.1
3.9
*
2.8
*
*
*
51.2 151.9
*
*
6.4
7.9
3.7
-0.2
-7.4
-7.1
*
0.0
*
-52.2 15.9 138.7 -62.9
22.3 65.7 136.7 20.3
1.6 41.4 93.7
4.7
38.5 70.7
8.6
41.0 71.6
8.0
2.4
29.0 86.6
30.7 116.7 -3.1
14.7 103.1 -17.6
21.0 61.2 -7.9
*
*
49.8 171.1
*
*
*
34.2
35.8
33.0
28.0
4.6
28.1
*
70.0
71.8
83.6
93.8
56.4
60.6
*
-4.5 37.4 125.4
*
*
*
-1.2
85.8 -62.6 7.8 186.8
72.6 195.3 13.5 62.8 154.9
45.3 116.6
3.5 35.8 123.3
Change from preceding month (quar
(quartiles)
March 1980
April 1979
April 1980
-2.3 5.1 17.8 -1.8 3.9 13.2 -6.0 0.8 10.0
-8.8
Total loans and investments
-2.1 5.3 17.9 -1.8 4.7 12.4 -5.2 1.1 9.6 -9.2
Total loans
-2.1 3.9 16.3 -4.5 1.9 11.9
-6.6 1.8 9.0 -10.5
Total C & I loans
-2.8 3.5 14.1 -9.7 0.0 12.1
-9.5 2.1 8.9 -10.6
To U.S. addressees
-10.7 0.0 7.3 -6.1 -0.3 8.9 -7.8 3.3 22.2 -17.9
To smaller businesses
0.0 3.8 -2.1 0.0 1.8 -2.0
Real estate loans, resid. prop. -0.5 0.9 5.6 -0.6
Agricultural loans
-7.7 3.4 25.3 -2.9 8.2 28.6 -12.6
2.8 29.3 -18.8
All other loans
Lease financing receivables
U.S. customers' liability on
-8.5 5.1 20.8 -28.7 -4.8 11.7 -41.6 -0.9 20.7 -28.7
acceptances
-1.3 0.0 7.8 -0.5 2.6 13.7 -3.2 0.4 12.7 -9.1
Loan commitments
-6.4 1.3 14.0 -2.6 3.6 17.6 -6.6 2.7 14.4 -17.4
Total loans and leases
number of institutions reporting amounts in these categories is too small to
compute quartiles.
0.0 6.6
-0.4
7.2
-0.1 7.6
-1.1 10.0
-0.9 5.5
0.0 2.9
-1.4
15.7
-2.0
-0.3
-1.2
44.7
3.8
7.9
243
Table IIC1 (cont'd)
Change from December 1979 (quartiles)
February
March
April
1
2 " 3
1
2
3
1
2
Loan commitments to
U.S. addressees
Total loans and leases to
U.S. addressees
0.0
8.8
38.9
-9.0
2.2
16.2 -6.4
Change from December 1979
13.5 51.2 -2.5 13.2 48.1
0.0
February
26.5 -20.9 -1.9 24.1
March
(number of respondents)
(percent)
Total loans and leases
to U.S. addressees
8.1
Actual:
less than 0,0
0.0-5.99
6.0-9.00
over 9.00
48
19
8
56
34
18
8
71
62
6
5
58
Annualized:
less than 0.0
0.0-5.99
6.0-9.00
over 9.00
48
6
2
75
34
7
0
90
62
3
1
65
* Excludes eight respondents with no loans and leases to U.S. addressees in
December, 1979.
Table I1C2
Relationship of Unused Loan Commitments to
Total Loans and Leases
(Distribution of individual respondent ratios)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
1979
December
April
Unused commitments
(percent of total
loans and leases)
1.4 49.4
124.00.3
53.1154.2
3.0
58.4 152,0-
1.1
56.7
171.5
244
Table IIIA1
Credit Demands and Loan Policies
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
March
April
(number of respondents)
161
161
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
7
138
16
1
123
37
Applications for commercial and industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
in recent years.
Significantly larger
Essentially unchanged
Significantly less
9
127
25
3
109
49
1
133
27
1
135
25
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for commercial and industrial loans to meet basic and emerging
needs for smaller businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
'3
131
27
3
112
m
0
145
1*6
0
139
22
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
245
Table IIIA1 (cont'd)
March
April
Commercial and industrial loans for purely financial activities.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
38
123
10
151
8
153
29
132
10 151
5
156
36
125
8
153
5
155
26
135
4
157
3
158
Loans to business customers for speculative purposes.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
246
Table IIIBl
Selected Financial Data
(Amounts outstanding, in billions of dollars)
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
February
1979 1980
March
1979 1980
April
1979 19*"BQ
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. oust. liab. on accept.
Loan commitments
All* nonreporting subsidiaries
Total loans and leases4
9.6
20.6
19.1
20.6
0. 2
0.2
0.2
*
12.0
0.1
14.2
0.1
13.2
0.1
15.3
*
13.0
0.1
15.4
85.0
97.3
86.0 98.2
83.9
93.8
18.7
0. 2
Memo: Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting bank subsidiaries
9.6
7.$
December 1979
Less than $50 million.
7.7
9.3
7.4
94.8
19.6
0. 2
20.6
0. 2
March 14, 1980
247
Table IIIB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
bruary
March
April
Nonreporting subsidiaries
U.S. nonbank
. C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
1.9
2.0
1.9
1.9
1.5
1.0
*
2.2
*
2.1
*
2.4
12.3
12.2
12.2
9.9
Change from preceding month
March
April
1979
1980
1979 V.980
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
.,1'iC & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
<U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
0.2
0.3
0.1
0.4
0.0
0.5
*
*
*
1.2
1.1
-0;2
0.1
1.0
0.9
-2.1
-4.4
it
Change from December 1979
February
March
April
Total.loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting subsidiaries
* l»css than $50 million.
2.5
3.4
-1.0
-0.2
0.9
1.0
248
Table IIIB3
Selected Financial Data
(Percent changes in amounts outstanding)
•
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
March
April
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C &•I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
25.7
26.3
24.7
10.2
7.9
5.1
18.3
15.9
18.5
14.4
14.2
11.8
Change from preceding month
March
April
1979
1980
1979
1980
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
2.7
3.2
1.3
2.1
2.6
10."6
7 ."7
1.2
0.9
0.7
-2.4
-4.5
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting subsidiaries
2.6
3.6
-1.1
-1.4
6.2
6.9
Table IIIB4
Relationship of Unused Loan Commitments to Total Loans and Leases
Bank Holding Companies
U.S. Assets $1 Billion or More
All Federal Reserve Districts
1979
December
Unused commitments/
Total loans and leases
15.2
February
1980
March
April
16.4
249
Table IIIC1
Total Loans and Leases to U.S. Addressees
(Distributions of individual respondent percent changes)
Bank Holding Companies
U.S. Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month (quartiles)
February
March
April
1
1
3
1
2
3
1
2
2.7
9.0
1.0
8.6
14.6
0.8
5.9
Change from preceding month (quartiles)
March 1980
April 1979
1
2
3
J
.
2
3
1
March 1979
1
1
1
0.0
15.7 2.4
1.8
-0.5
0.0
1.1
-1.2 1.1
2.7
3
12.6
April 1980
.
2
3
-2.0 -0.3
Change from December 1979 (quartiles)
February
1
2
-2.3
-0.3
1
1
March
1
1.2 -1.9 -0.1
Change from December 1979*
(percent)
April
1 1 1
1.8 -5.4 -0.5
3
2.3
February
April
_
:s)
(number of respondents
Actual:
less than 0.0
0.0-5.99
6.0-9.00
over 9.00
83
54
5
10
79
54
7
12
85
43
10
14
Annualized:
less than 0.0
0.0-5.99
6.0-9.00
over 9.00
83
27
4
38
79
29
9
35
85
28
4
35
* Excludes nine respondents with no loans and leases to
U.S. addressees in December, 1979.
0.9
250
Table IVA1
Credit Demands and Loan Policies
Finance Companies
Business Receivables $1 Billion or
More
All Federal Reserve Districts
March
April
(number of respondents)
15
15
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
4
9
2
1
8
6
Applications for business loans to meet basic credit demands for normal
operations, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
6
6
3
3
7
5
2
9
4
1
12
2
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for business loans to meet basic and emerging needs for smaller
businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
3
9
3
0
10
5
1
10
4
0
13
2
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Business loans for purely financial activities.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
3
12
0
15
0
15
i
14
1
14
0
15
Loans to business customers for speculative purposes.
Requests:
Yes
No
Yes
N
O
Commitment takedowns:
Approvals:
Yes
No
0
15
0
15
0
15
0
15
0
15
0
15
251
Table IVB1
Selected Financial Data
(Amounts outstanding, in billions of dollars)
Finance Companies
Business Receivables $1 Billion or MoreAll Federal Reserve Districts
February
1979 1980
March
1979 1980
April
1979 198Q-
Total accounts receivable
68.3
76.5
73.0
81.0
74.5
81.6
Total business receivables
40.6
43.1
40.1
45.5
44.4
45.7
From U.S. addressees
38.6
40.4
39.5
40.5
43.8
44.9
From smaller businesses
26.9
28.0
27.7
28.0
30.0
29.6
Lease financing receivables
Business loans by foreign
offices to U.S. addressees
9.1
9.5
10.3
9.5
10.3
10.8
0.0
0.0
0.0
0.0
0.0
0.0
252
Table IVB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Finance Companies
Business Receivables $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
tbruary
March
April
Total accounts receivables
8.2
8.0
7.1
Total business receivables
2.5
5.4
1.3
From U.S. addressees
1.8
1.0
1.1
From smaller businesses
1.1
0.3
-0.4
Lease financing receivables
0.4
-0.8
0.5
Business loans by foreign offices
to U.S. addressees
Change from preceding month
April
March
1980
1979
1980
1979
Total accounts receivables
4.7
4.5
1.5
0.6
Total business receivables
-0.5
2.4
4.3
0.2
From U.S. addressees
0.9
0.1
4.3
4.4
0.8
*
2.3
1.6
1.2
it
*
1.3
From smaller businesses
Lease financing receivables
Business loans by foreign offices
to U.S. addressees
* Less than $50 million.
253
Table IVB3
Selected Financial Data
(Percent changes in amounts outstanding)
Finance Companies
Business Receivables $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
March
April
Total accounts receivables
12.0
11.0
9.5
Total business receivables
6.2
13.5
2.9
From U.S. addressees
4.7
2.5
2.5
From smaller businesses
4.1
1.1
-1.3
Lease financing receivables
4.4
-7.8
4.9
Business loans by foreign offices
to U.S. addressees
Change from preceding month
March •
April
1979
1980
1979
1980
Total accounts receivables
6.9
0.1
2.1
0.7
Total business receivables
*
56
10.7
0.4
From U.S. addressees
2.3
0.2
10.9
10.9
From smaller businesses
3.0
*
8.3
5.7
13.2
*
*
13.7
Lease financing receivables
Business loans by foreign offices
to U.S. addressees
* Less than .05 percent.
254
Table VA1
Selected Financial Data
(Amounts outstanding, in billions of dollars)
Selected ^ Corporat ions
All Federal Reserve Districts
February
1979 198[0
March
1979 1980
April
1979 1980
365 Respondents
Commercial paper issued in U.S.
XX
XX
Amount outstanding
58,.7
75. 1
Total backup U.S. bank lines
XX
XX
XX
XX
58.,8 75,,2
62. 3 79. 1
73.,4 100. 0
74. 9
125. 3
76. 1 107. 0
13.,4
19. 3
14. 4 20. 4
12. 5 19. 6
Foreign offices of U.S. banks
2. 0
2. 0
2. 1
2. 0
1. 8
2. 0
Foreign offices non-0.8. banks
2. 6
3.9
2. 7
4. 7
2. 7
5. 0
Non-U.S. affiliates (net)
3. 1
6. 0
3.4
6. 4
1. 9
5. 5
Other non-U.S. sources
5. 7
7. 1
6. 2
7. 4
6. 1
7. 2
Indebtedness to non-U.S. entities
255
Table VA2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Selected Corporations
All Federal Reserve Districts
Change from year-ago month
February
March
April
xx
xx
xx
Amount outstanding
16.4
16.4
16.8
Total backup U.S. bank lines
26.6
50.4
30.9
Indebtedness to non-U.S. entities
5.9
Commercial paper issued in U.S.
6.0
7.1
Foreign offices of U.S. banks
*
-0.1
0.2
Foreign offices hon-U.S. banks
1.3
2.0
2.3
Non-U.S. affiliates (net)
2.9
3.0
3.6
Other non-U.S. sources
1.4
1.2
1.1
Change from preceding month
March
April
1979
1980
1979
1980
Commercial paper issued in U.S.
Amount outstanding
0.1
Total backup U.S. bank lines
1.5'
Indebtedness to non-U.S. entities
0.1
3.5
3.9
25.3
1.2
-18.3
1.0
1.1
-1.9
-0.8
Foreign offices of U.S. banks
0.1
*
-0.3
*
Foreign offices non-U.S. banks
0.1
0.8
*
0.3
Non-U.S. affiliates (net)
0.3
0.4
-1.5
-0.9
Other non-U.S. sources
0.5
0.3
-0.1
-0.2
* Less than $50 million.
256
THE CONSUMER CREDIT RESTRAINT PROGRAM
One element of the credit restraint package was designed to limit the
growth of certain types of consumer credit—all open-end credit, such as creditcard debt, and closed-end credit either unsecured or secured by collateral not
being purchased with the proceeds of the credit. As with other elements of the
program, consumer credit controls were regarded as supplementary to the pursuit
of restraint through traditional tools of monetary policy, and were intended to
discourage the flow of available funds into unproductive or speculative uses.
Selected types of closed-end consumer credit, such as auto loans, were exempted
from this part of the program in view of the evident weakness in demands for
various types of consumer durable goods. Borrowing for the purchase or
improvement of a home also was excluded*
To discourage overly expansive growth in covered consumer credit, the
Board's program required that creditors maintain a non-interest-bearing deposit
with the Federal Reserve equal to 15 percent of any increase above a base amount
in covered consumer credit outstanding.
Originally, the base amount was to
have been the amount of covered credit outstanding on March 14, 1980, but the
Board subsequently provided for an optional base calculation that would permit,
without penalty, seasonal fluctuation and some initial underlying growth.
Creditors with less than $2 million of covered credit were exempted.
The special deposit requirement tied to credit growth created a cost
disincentive against expansion of covered types of credit, but allowed lending
institutions considerable flexibility regarding the specific means used to slow
credit growth. It contrasted with credit controls programs during the Korean
and Second World War periods, in which the Board had established maximum loan
maturity and minimum downpayment requirements for a wide variety of loans.
257
In both 1977 and 1978, prior to the credit controls program, consumer
credit outstanding had expanded by almost 20 percent, with particular strength
in auto credit and in revolving credit.
As sales of domestically produced
automobiles weakened in the spring of 1979, however, growth in automobile (and
total) consumer credit began to slow, while revolving credit remained generally
strong.
By the second half of last year, expansion in total consumer installment
credit had fallen to an 11 percent annual rate, and it eased further, to a 7
percent pace, in the first quarter of 1980.
By the end of last year, revolving
credit also was growing at a reduced rate, but accelerating inflation in early
1980 raised the possibility that card-holders might decide to draw more heavily
upon their open lines of credit.
The application of controls to revolving
credit and other selected types of personal loans was intended to reinforce
the emerging trend toward less intensive use of credit.
In the first few weeks after controls were announced, many commercial
banks, other lending institutions, and some retailers took initial or further
steps to restrict the supply of consumer credit, most often by adopting more
stringent credit approval standards.
Many banks instituted user fees on credit
cards, lowered maximum borrowing limits, or stopped issuing credit cards
altogether.
Several banks had taken such measures before March 14 in response
to sharply higher costs of funds and statutory ceilings on lending rates, but the
announcement of controls triggered a marked stepup in such actions.
Retailers
most commonly tightened credit terms through stricter lending standards and by
raising minimum monthly payment requirements.
Meanwhile, consumers voluntarily cut back substantially on borrowing
after the credit restraints were invoked.
Retail stores in particular reported
258
a steep decline in credit card usage and a sudden drop in applications for new
accounts.
Banks also noted sharply reduced credit card use and loan demand. Some
consumers may have been confused about how controls would affect them, or may have
expected repayment terms to be tightened severely, which motivated them to avoid
new credit purchases.
Some may have reacted cautiously to uncertainty over the
economic impact that controls would exert, particularly in light of the historically high levels of consumer Indebtedness and the low rate of saving that had
been reached in recent months.
Consumer installment credit contracted at a seasonally adjusted annual
rate of 8 percent in April, the first full month under credit controls, and 13
percent in May, compared with increases of 5 percent in March and 7 percent
during the first quarter as a whole. By May, the volume of new credit extended
was 25 percent below the peak level in September 1979. The April-May decline
in outstanding debt was the largest—in percentage as well as in dollar terms—
since the World War II period.
Still unclear is the extent to which the restraints
on consumer credit, as well as the Board*s guidelines for overall loan expansion
at commercial banks and finance companies, contributed to the decline in credit
outstanding In April-May. However, the suddenness of the shift from positive
to negative growth, and qualitative Information from Federal Reserve System
surveys and other sources, indicates that the program did exert downward pressure
on both credit supply and demand.
Although consumer credit outstanding declined on balance in April and
May, about one-sixth of the Institutions subject to the program experienced
increases in covered credit and thus were liable for maintaining a special
deposit with the Federal Reserve.
In April a total of 1,027 institutions placed
an aggregate of $81.4 million in special depostis. The total special deposit
259
remained at $81 million in May.
The largest aggregate deposits in April were
reported by groups designated as savings and loan associations, followed by
commercial banks and bank holding companies (see table). (Multiunlt firms
were classified into whichever category represented 60 percent or more of their
business; thus reporting categories do not correspond precisely to customary
Industry groupings.)
On May 22, in view of the broadly curtailed use of credit since midMarch, the Board modified its credit restraint program.
Under the consumer
credit controls, the deposit requirement on increases in covered credit was
lowered to 7-1/2 percent from 15 percent for credit outstanding in June. On
July 3, the Board announced plans to complete the phase-out of the special
measures of credit restraint, as evidence accumulated that the need for such
extraordinary measures had ended. Thus no further special deposits were to be
required after the end of the then-prevailing deposit maintenance period on
July 23, 1980.
260
COVERED CONSUMER CREDIT AND SPECIAL DEPOSITS BY TYPE OF CREDITOR,
1
APRIL 1980
(Amounts in millions of dollars)
Type of institution
Institutions with covered credit
above base
Amount
1
1
1 Credit 1
I Special I Number
Credltl above
base I
base
I deposit I
I All institutions
(with covered credit
(Amount I
1 of
I
1 credit I Number
I base |
Commercial banks and
bank holding companies
9,130
107.8
16.1
287
205,515
Mutual savings banks
1,078
53.5
8.0
109
2,589
243
Credit unions
1,603
22.0
3.3
163
16,629
1,824
Savings and loan
associations
13,005
247.8
37.2
409
33,626
1,050
finance companies
2,221
28.5
4.3
10
13,871
152
Retail stores
321
3.0
0.5
22
9,496
244
Oil companies
1,928
61.3
9.2
17
2,532
28
709
18.9
2.9
10
15,165
46
29,995
542.8
81.4
1,027
299,424
6,402
Conglomerates and others
All Groups
2,815
Note: Multi-unit firms operating within two or more separate categories are classified
in whichever category accounts for at least 60 percent of the firm's business. If no
unit accounts for 60 percent of a firm's business, the firm is classified as a conglomerate.
1.
Disaggregated data for May not yet available.
261
THE MANAGED LIABILITY MARGINAL RESERVE AND
SPECIAL DEPOSIT PROGRAMS
The Board's reserve action of October 6 established an 8 percent
marginal reserve requirement for large member banks, Edge Corporations, and
the U.S. branches and agencies of foreign banks against net Increases In
covered managed liabilities above a base period level.1 This program was
designed to damp the rate of expansion of bank credit available to domestic
residents by increasing the cost of managed liabllties used to finance
such expansion. It was announced as part of a policy package intended to
better control bank credit and the monetary aggregates.2
As shown in Table 1, the amount of managed liabilities in excess
of base levels at all institutions, and thus subject to marginal reserve
requirements, declined during the fourth quarter. This was largely
attributable to a reduction in reservable managed liabilities at agencies
and branches.
Table 2 shows detail for a sample consisting of 25 large domestic
chartered banks that held over $120 billion of managed liabilities during
the base period, which accounted for roughly 60 percent of total covered
1. The original base period was the two statement weeks ending September 26,
1979. For Institutions whose managed liabilities were less than $100 million
. during the base period, the base level was calculated as follows: if managed
liabilities were positive, the base was set equal to $100 million; if managed
-liabilities were negative—that is, the institution was a net creditor of its
foreign offices—the base was set equal to the algebraic sum of $100 million
and the base period level of managed liabilities. Covered managed liabilities
Included large time deposits with original maturity of less than one year,
certain Eurodollar borrowings, repurchase agreements net of trading accounts,
and federal funds borrowings from institutions not subject to the marginal
requirement.
2. Other actions taken were an increase in the discount rate from 11 to
12 percent and a change in the method used to conduct monetary policy. The
latter Involved a shift In emphasis in day-to-day operations away from confining federal funds rate fluctuations toward controlling the supply of bank
reserves.
262
member bank managed liabilities at that time.1 Managed liabilities at
these 25 banks declined between the base period and the week ending
December 26 by about $5-1/4 billion.
As of this week, 22 of these banks
were not required to hold marginal reserves, since their managed liabilities were below their base levels.
For these 22 banks, this "cushion"
below base levels totaled about $5-1/2 billion.
Table 3 shows detail for branches and agencies of foreign
banks. Of the 132 foreign bank "families" represented, only 11 were
over their bases as of the week ending December 26 by a total amount of
about $1/2 billion.^ As a group, branches and agencies were below their
aggregate base by about $9-1/4 billion at this time. This net cushion was
about one-fourth of these institutions' total managed liabilities.
The decline of covered managed liabilities during the fourth
quarter appears largely to have been the by-product of slow bank credit
growth.
The resulting large net cushion below base levels by the end of
the fourth quarter indicated an absence of pressure resulting from the
marginal reserve program on bank costs of funds, since the cushion at
banks below their bases could easily be transmitted to those banks above.
Banks below their bases could acquire funds through issuing managed liabilities without being subject to marginal reserve requirements.
1. There were 251 member banks with managed liabilities of more than
$100 million and thus required to file base reports. These banks had
total managed liabilities of about $220 billion. No individual bank
data on managed liabilities are available throughout the full period
for the banks other than those in the 25 bank sample.
2. All U.S. branches and agencies of a foreign bank reported on a
consolidated basis. The 132 foreign bank families were those that
reported each week throughout the period.
263
-38Further, since federal funds borrowed from member banks and branches and
agencies of foreign banks were exempt from the program, funds raised by
banks below their bases could be passed to banks at or above their base
levels.
Thus, banks were in a position to fund additional credit growth
without incurring significant marginal reserve requirements.
During January and February, as bank credit growth began to
accelerate, bank reliance on managed liabilities increased. As shown in
Table 1, both the number of institutions above their base levels and the
amounts in excess increased somewhat during this period. Table 2 shows
that, at the 25 large member banks, the number of banks in excess increased
from 3 to 5 from the week ending December 26 to the week ending February 27.
The net cushion below the 25 banks' aggregate base fell substantially, from
$5-1/4 billion to $2 billion. As shown in Table 3, the number of agencies
and branches in excess of their base levels also increased during this
period—from 11 to 19—while the foreign bank families' net cushion below
their aggregate base fell from $9-1/4 billion to about $7 billion.
The discrepancy between strong credit growth and somewhat slower
growth in reservable managed liabilities reflected a reduction in the net
cushion and efforts to economize on covered managed liabilities as a source
of funding.
One method for economizing involved purchases of federal funds
from small member banks well below their bases of $100 million. Small banks
financed such sales in part with funds obtained from money market certificates which grew strongly during the first quarter. In addition, banks
apparently stepped up sales of large CDs with original maturity of one year
or more.
264
On March 14, as part of the overall credit restraint program, the
Board announced a tightening of the marginal reserve program. This involved
an increase from 8 to 10 percent in the marginal reserve requirement and a
reduction in the base used to calculate the reserve requirement.
The base,
effective the week ending March 26, was reduced by either 7 percent or by
the net reduction in foreign loans that had occurred between the September
base period and the week ending March 12, whichever was greater.1 Additional reductions in foreign loans after March 12 would further reduce the
base. The reduction in the base resulted in a substantial increase in
managed liabilities above the new base during the week ending March 26.
In addition to the tightening of the marginal reserve program,
the March action extended similar requirements to nonmember banks with
managed liabilities of over $100 million. These banks were required to
maintain non-interest-bearing special deposits equal to 10 percent of
any increases in their managed liabilities over their base levels as of
the two-week period ending March 12. Sixty-one nonmember banks had
managed liabilities of at least $100 million during the base period.2
These banks had total managed liabilities during the base period of
about $17 billion.
1. The latter provision affected primarily 30 foreign bank families
whose bases were reduced by an average of about one-fourth. Prior
to the March action, banks were able to finance domestic credit growth
without incurring marginal reserve requirements by reducing foreign
loans.
2. Subsequently, a few additional nonmember banks' managed liabilities
went above $100 million and thus became subject to the program.
265
As shown on Table 1, the number of member banks and foreign
bank families in excess of their base levels, as well as the amounts
in excess, were substantially increased as a result of the March actions.
In addition, 43 nonmember banks were in excess of their bases during
the week ending March 26. However, the aggregate amount in excess of
base levels at these banks was only about $1/2 billion.
Table 2 displays
the reversal of the position of the 25 member banks relative to their
bases, from a net cushion of $2 billion for the week ending February 27
to a net excess of about $10 billion for the week ending March 26.
Foreign bank family data, shown in Table 3, reveal the virtual elimination of the net cushion below base levels at these institutions.
The
sharp reduction of the net cushion at foreign bank families and the
development of a substantial net excess at the 25 member banks had the
result of increasing the cost of managed liability funding to covered
institutions.1
During April and May, the weakening of bank credit was accompanied by a sharp reduction of the amounts in excess of base levels at
member banks and foreign bank families (Table 1). At nonmember banks,
both the number of institutions over their base levels and the aggregate
amount in excess fell by about one-half.
1. This increased cost of managed liabilities was reflected in the
substantial spread that developed during this period between rates on
nonreservable federal funds purchased from member banks and reservable
federal funds purchased from nonmembers.
266
As part of the overall easing of the credit restraint package
announced on May 22, base levels at all covered institutions were
increased by 7-1/2 percent1 while the marginal reserve and special deposit requirements were reduced from 10 to 5 percent, effective the week
ending June 4.
As shown in Table 1, by June 25 the number of member
banks and foreign bank families over their bases and the amounts in
excess had fallen to about the same levels that existed just prior to
the March action.
At nonmember banks, the number of banks and the
amounts in excess of base levels declined further.
Tables 2 and 3 show
that substantial cushions had developed by June 25 at both the 25 member banks and the foreign bank families.
On July 3, the Board announced the removal of the marginal
reserve requirement on managed liabilities at member banks and foreign
bank families, as well as the special deposit requirement on managed
liabilities at nonmember banks, effective the week beginning July 10.
1. Banks whose original bases were $100 million or less were not
affected by this action.
267
Table 1
Covered Managed Liabilities
Number of
Institutions above
Base Levels
Week
Ending
Amount in Excess
of Base ($ billions)
Branches
and
NonMembers^ Agencies^ members
102
28
1979— Oct. 31
Nov. 28
126
10
Branches
Non/
and
Members^-' Agencies members
2.9
1.5
Total
4.4
4.7
.3
5.0
Dec. 26
92
11
2.3
.4
2.7
1980— Jan. 30
111
11
2 .9
.4
3.2
Feb. 27
115
19
3.0
1.1
4.0
Mar. 26
199
44
43
16 .8
3.8
6
21.2
Apr. 30
138
24
20
7.9
1.6
.4
9.9
May
28
155
24
17
10 .2
2.0
.3
12.6
June 25
95
22
10
3.3
1.5
.3
5.1
I/ Includes Edge Act corporations.
Figures may not add due to rounding.
Week
Ending-'
Marginal Reserves^'
($ millions)!/
Member
Branches and
Banks
Agencies
Special Deposits-'
($ million) I/
Nontnetnber
Banks
1979—Oct. 31
230
120
Nov. 28
380
20
Dec. 26
30
180
1980— Jan. 30
230
30
Feb. 27
90
240
Mar. 26
380
60
1,680
Apr. 30
790
160
40
30
1,030
200
May 28
June 25
170
70
20
I/ These are the statement weeks during which the managed liabilities in excess of
base levels were reported. The marginal reserves and special deposits were required to be held 2 weeks after the statement week.
_2/ The required marginal reserves and special deposits are calculated by multiplying
the amounts in excess of base levels by the appropriate marginal reserve or special deposit requirement ratios.
3/ Rounded to nearest $10 million.
268
Table 2
25 Member Banks*
Week
Ending
Number of
Institutions
(1)
($ billions)
Current
Managed
Base
Liabilities
Level
(2)
(3)
Excess C+)
or Cushion (-)
(2> - (3)
1979—Nov. 28
over base
under base
total
9
16
25
62.7
60.2
122.9
60.1
62.7
122.8
+2.6
-2.5
+0.1
Dec. 26
over base
under base
total
3
22
25
25.1
92.5
117.6
24.7
98.1
122.8
+0.4
-5.6
-5.2
1980— Jan. 30
over base
under base
total
6
19
25
37.3
81.9
119.2
36.9
85.9
122.8
+0.4
-4.0
-3.6
Feb. 27
over base
under base
total
5
20
25
31.8
89.0
120.8
31.2
91.6
122.8
+0.6
-2.6
-2.0
Mar. 26
over base
under base
total
23
2
25
117.1
6.4
123.5
106.6
6.8
113,4
+10,5
-0,4
+10.1
Apr, 30
over base
under base
total
13
12
25
70.3
45,1
115.4
66.5
46.3
112.9
+3.8
-1.2
+2.6
May
28
over base
under base
total
14
11
25
67.4
50.0
117.4
61.1
51.8
112.9
+6.3
-1.8
+4.5
June
25
over base
under base
total
6
19
31.3
84.3
115.6
29.9
91.6121.5
+1.5
-7.4
-5.9
25
Figures may not add due to rounding.
*25 large member banks that reported throughout the period,
269
Table 3
Foreign Bank Families*
Week
Ending
Number of
Institutions
(1)
(2)
6.3
(3)
6.0
Excess C+)
or Cushion (-)
C2) - (3)
+0.3
-9.9
-9.6
over base
under base
total
122
132
32.6
38.9
over base
under base
total
11
121
132
5.0
4.6
34.2
39.2
43.9
48.5
over base
under base
total
11
121
132
7.4
7.0
32.1
39,4
41.5
48.5
+0.4
-9.4
-9.1
Feb. 27
over base
under base
total
19
113
132
14.8
26.8
41.6
13.7
34.8
48.5
+1.1
-8.0
-6.9
Mar. 26
over base
under base
total
43
89
132
24.8
15.7
40.5
21,0
20.6
41.5
' +3.8
-4.9
-1.0
Apr. 30
over base
under base
total
24
108
132
13.2
23.4
36.6
11,6
29.6
41.2
+1.7
-6.3
-4.6
May
28
over base
under base
total
24
108
132
13.8
21.9
35.7
11.7
29.3
40.9
+2.1
-7.3
-5.2
June 25
over base
under base
total
22
110
132
12.0
23.5
35.5
10.5
33.2
43.7
+1.5
-9.7
-8.2
1979—Nov. 28
Dec. 26
1980— Jan. 30
10
($ billions)
Current
Managed
Base
Liabilities
Level
42.5
48.5
Figures may not add due to rounding.
* 132 foreign bank families that reported throughout the period.
+0.4
-9.7
-9.3
270
CREDIT RESTRAINT PROGRAM FOR MONEY MARKET
FUNDS AND SIMILAR CREDITORS
As short-term interest rates rose to extraordinary levels in late
1979 and early 1980, the assets of money market mutual funds (MMMFs) and
similar creditors climbed sharply.
For example, MMMF assets increased almost
$15 billion in the first two months of 1980.
This unprecedented growth was
diverting funds from thrift institutions and smaller commercial banks, and
it threatened to interfere with reasonable flows of credit to several important segments of the economy, including housing, small businesses, and agriculture.
The tendency for money market funds to channel funds from around
the country to the central money market helped large borrowers meet their
credit demands with relatively little restraint.
One aspect of the set of
monetary and credit actions adopted by the Board on March 14 was a provision
requiring money market funds and similar creditors to maintain a special
non-interest bearing deposit with the Federal Reserve equal to 15 percent
of the amount by which the investment assets of these creditors exceeded
their assets on March 14, 1980.
The aim of the special deposit requirement
was to restrain the growth of money market funds by reducing the returns on
marginal increases in their shareholdings, and thereby to provide some greater
assurance of the continued availability of funds to worthy borrowers who
have access to only a limited range of credit sources while restraining
flows of credit to other borrowers.
Total assets of MMMFs declined more than $1.0 billion over the
four-week period following the mid-March announcement of the Credit Restraint
Program (table 1).
This decline probably was in response both to some uncer-
tainty among investors about the impact of the special deposit requirement
and, as anticipated, to decisions by many MMMF trustees to restrict or suspend
271
sales of shares to new depositors.—
to accommodate new depositors, a num-
ber of MMMF management companies organized and promoted new "clone" money
market funds that are similar to their original counterparts except that
all of their non-exempt assets are subject to the special non-interest bearing deposit requirement.
On March 28, the Board announced several modifications in the
regulation applying to money market funds and similar entities to assure a
more equitable treatment of similar types of shareholders. Among other
actions, the Board extended the exemption for bank-operated collective investment funds to bona fide personal trusts, pension, retirement, and tax-exempt
assets of money market funds that allocate at least 80 percent of their assets
to short-term tax-exempt obligations, as well as providing a minimum base
($100 million) for money market funds engaged in continuous public offering
on March 14. These Board actions, together with a wider availability of
"clone" MMMFs, contributed to the beginning of a resurgence in growth in the
assets of these creditors in the second half of April. Sales of MMMFs were
I/ On March 14, 1980, the SEC issued a general statement of policy (Investment Company Act of 1940; Release No. 11088) concerning some of the implications of the money market fund regulation in order to provide guidance to
fund management companies and trustees. The statement expressed the view
that money market fund boards of directors and investment advisers, consistent with their fiduciary obligations, should consider the appropriateness
of continued sales of fund shares and the implementation of measures designed
to protect the interests of existing shareholders against dilution. On
April 22, 1980, the SEC promulgated additional rules (Investment Company
Act of 1940; Release No. 11137) designed to facilitate the creation and issuance of more than one class of shares for MMMFs. Under these rules, a MMMF
can create three classes of stock: one held primarily by existing shareholders, a second held by exempt accounts, and a third offered to new shareholders.
272
buoyed further in May when several funds whose covered credit totals were
below their base levels began accepting deposits of new shareholders.
Non-interest bearing special deposits totaled $215 million over
the week of April 14--the first week that such deposits were required at
Federal Reserve Banks; approximately one-third of 101 reporting managed
creditors maintained deposits (table 2),—
By late May, special deposits
totaled $433 million, and one-half of the 127 reporting creditors were maintaining deposits. On May 22, the Board announced modifications of its
March 14 credit restraint program, including a reduction--effective for
assets held in the week beginning June 16—from 15 to 7-1/2 percent in the
special deposit requirement. Special non-interest bearing deposits peaked
at $869 million in the week before the reduction; more recently, deposits
totaled $547 million with approximately three-fourths of reporting creditors
maintaining deposits. Since outstanding credit of reporting money market
funds and similar creditors climbed $21.6 billion from early April to early
July and covered credit increased only $9.4 billion, more than one-half
of the increase in assets of these creditors have been in accounts that are
exempt from the Board's special deposit requirement. In fact, almost onehalf of the gain in MMMF assets since mid-March has been at funds that limit
their depositors to institutional investors (these MMMFs accounted for less
than one-fifth of total MMMF assets in early March), and a large portion of
these accounts presumably are fiduciary in nature and exempt from the deposit
requirement.
I/ During the 7-day deposit maintenance period beginning April 14, 1980,
each managed creditor was required to maintain a special deposit equal to
the sum of the special deposits required for the reporting periods beginning
March 14, March 24, and March 31.
273
The imposition of the special deposit requirement reduced the average net yield to MMMF shareholders. For example, the average 7-day net yield
to shareholders of "clone" MMMFs was about 160 basis points lass than "first
generation*1 MMMFs over the seven day period ending July 3> 1980, and about
two-third* of this difference can be attributed to the 7-1/2 percent special
non-interest bearing deposit requirement that was in effect over this period.(The remaining portion is attributable to the portfolio mix and average
maturity of the "clone" assets.)
Indeed, total assets of "clone" MMMFs have
increased by less than $3.7 billion since the program was announced on
March 14. However, total assets of non-clone MMMFs have climbed by more than
$14.8 billion over this period. One reason for this large increase is that
MMMF portfolio managers lengthened the average maturity of their portfolios
in early April, thereby retarding the decline in their net yields to shareholders as the yield curve became upward sloping (table 3).
Perhaps even
more important, a sizable number of MMMFs calculate their net yields to
shareholders by "marking to market" all or a portion of their assets on a
daily basis.
As a result, the sharp decline in money market interest rates
resulted in annualized net yields to shareholders that were, because of the
capital gains associated with the rise in prices of the money market obligations, well in excess of returns available on alternative investments.
For
example, the 7-day net yield to shareholders of first generation MMMFs
exceeded the effective yields available on MMCs by 3-1/2 percentage points,
on average, in the first four weeks of May, although this spread vanished
in^ealrf^ \July?<*?In aHdf€idnV?MMMF peffctfoldo..managers.*jLsofappear to have
'*reSil'ocaee'd^tihei* <£nvescable fetn*ds away if-ropi,/lower yielding y.S.-.Treasury
securities afid toward 'other higher yielding money market obligations in
"o*der t:©1maintain 'relatively attractive net .yields .to their
I/
Net yields exclude capital gains or losses.
274
Table 1
ASSETS AND NET YIELDS TO SHAREHOLDERS
OF MONEY MARKET MUTUAL FUNDS
End of
Total
Change from
previous period
6
13
20
27
55,232
56,889
58,148
59,858
2,179
1,657
1,259
1,710
5
12
19
26
60,620
60,769
61,288
61,130
762
149
519
2
9
16
23
30
60,456
60,446
60,045
60,388
60,689
-699
May
7
14
21
28
June
July
Feb.
Mar.
Apr.
Average 7 -day net yield
to shareholders!/
---__
12.78
12.77
12.78
13.04
..
--__
Memo: MMC
effective yield
12.37
12.52
12.81
12.63
----
13.22
13.79
14.13
14.59
204
98
25
65
71
139
203
15.04
15.56
16.03
16.32
16.03
15.80
17.00
15.46
13.90
16.55
15.57
14.95
14.21
12.42
63,028
65,212
67,642
69,306
2,075
1,955
2,152
1,273
254
229
278
391
15.52
13.61
12.72
11.99
11.89
9.93
10.06
8.76
11.24
9.86
9.33
9.33
4
11
18
25
71,243
72,851
74,324
75,595
1,604
1,608
1,179
1,054
333
216
294
217
10.73
10.63
9.79
9.19
8.16
8.16
7.76
7.53
8.28
8.98
8.01
8.01
2
9
16
76,848
78,175
79,170
940
1,016
313
311
310
8.66
8.82
8.57
7.50
7.83
7.71
8.01
8.91
8.93
-158
-75
-472
685
--._
14.30
15.56
15.74
15.73
T 7 N e t yield to shareholders after deduction of management fees and other expenses.
Includes, in some cases, realized and unrealized capital gains or losses on existing portfolios.
275
Table 2
OUTSTANDING CREDIT, COVERED CREDIT AND NON-INTEREST
BEARING SPECIAL DEPOSITS OF SHORT-TERM
FINANCIAL INTERMEDIARIES
(Millions of dollars)
Outstanding
credit
(1)
Covered
credit
(2)
Apr. 6
14
20
27
n.a.
59,472
60,712
61,688
n.a.
48,325
49,520
49,732
0.8126
0.8157
0.8062
„..
215
123
125
4
11
18
25
62,542
63,123
68,696
70,511
50,014
50,080
50,444
52,185
0.7997
0.7934
0.7343
0.7401
157
186
231
433
June 1
8
15
22
29
71,928
71,487
73,277
74,840
76,75*
54,354
54,640
54,813
56,052
56,247
0.7557
0.7643
0.7480
0.7490
0.Jf77
555
681
Period
May
July 6
(2) /(I)
__
79,666
0,7160
57',039
81,064
0,7*25
57V755
n.a. --not available . p- -pr el iminary .
if
Non-interest
bearing special
deposits
77a
869
486
511
547
276
Table 3
PORTFOLIO COMPOSITION AND AVERAGE MATURITY
OF MONEY MARKET MUTUAL FUNDS
(Billions of dollars)
CP
BA
Other
Average
maturity
(days)
4.0
11 .0
0.4
0.4
0.3
1.0
0.3
0.4
1.7
4.8
0.2
0.5
1.0
2.9
0.1
0.8
0.1
0.1
75
48
17 .7
26 .0
34 .8
45,.4
0.3
1.5
1.3
1.1
2.0
2.1
2.8
3.0
0.7
0.6
1.0
2.6
6.3
7.8
11.4
14.0
1.4
2.6
5.4
4.4
5.1
7.8
8.0
14.0
1.6
3.1
3.3
5.4
0.3
0.4
0.5
0.5
48
55
44
34
53,.1
60 .3
60 .5
60 .7
70 .0
76 .7
3.0
4.1
7.0
5.3
6.6
4.4
3.8
3.6
3.6
4.0
4.2
6.8
2.2
2.8
2.6
2.4
3.4
3.6
14.0
16.0
14.0
13.9
15.3
16.2
5.9
6.3
6.3
5.4
6.4
6.8
17.9
18.7
19.5
20.6
24.3
28.2
6.4
7.9
6.6
8.6
8.3
9.1
1.0
0.9
0.9
0.6
1.5
1.6
41
38
29
38
38
49
Memo: Change
12/31 to 3/31 -1-15 .1
3/31 to 6/30p +16 .2
+5.9
-2.6
+0.6
+3.2
_•
..
+1.0
+2.2
+1.9
+0.5
+4.5
+8.7
+1.2
+2.5
+0.4
+0.7
._
--
End of
period
1977
1978
1979-Ql
Q2
Q3
04
1980- Jan.
Feb.
Mar.
Apr.
May
Junep
Total
assets
p--preliminary.
U.S. Gov't.
Other
Treas.
Type of obligation
Euro
RPs CDs
CDs
277
D O A R O OF G O V E R N O R S
OF T H E
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 2 0 5 5 1
. A. V O L C K E R
July 31, 1980
The Honorable P.arren J. Mitchell
Chairman
Subcommittee on Domestic Monetary Policy
Committee on Banking, Finance and
Urban Affairs
House of Representatives
Washington, D. C. 20515
Dear Mr. Mitchell:
I fully appreciate the evident frustration you feel over
a situation that has, contrary to the conventional "wisdom", of
a few years ago, left us with both inflation and unemployment
at excessive levels. I share that frustration, but I also feel
some optimism that we are beginning to come to grips with problems
and policies that have been "shoved" aside for years. It seems
to me evident that the kind of problems we face have accumulated
over a long period of time and there is growing realization that
the solutions cannot lie in a painless "quick fix." That understanding seems to me, in turn-, to lay the kind of base we. need
to in fact deal with the problems effectively. Monetary policy
is an important part—but only a part— of that picture.
It is against that background that I'm glad to answer your
specific questions.
Question 1 indicates your doubts about our intent in not
providing specific numerical targets for money growth for 1981
in our Humphrey-Hawkins Report. I regret the confusion that
arose on this score, and I believe your specific questions are
answered fully in the attached letter to Chairman Reuss. If you
have any remaining questions about our intentions with respect
to the monetary aggregates or doubts about our wish for effective
'communications with the Congress, I hope you will bring those
concerns to my attention.
Your second question inquires as to the meaning of the
short fall in actual M-l growth from targets in April and May
(prior to that time, money growth was relatively strong). I
would note, in responding, that in recent weeks M-l growth has
.been relatively strong, with M-lB returning within the target
range; M-2 is currently in the upper part of its range. Very
few economists, to my knowledge, attach real significance to
fluctuations in monetary growth lasting for less than, say,
one quarter.
278
As I explained in my statement before the Committee, the
sharp April-May drop was both unexpected and unusually large
in relation to economic activity and interest rates. The
Federal Reserve actively supplied reserves through open market
operations in accordance with our targeting procedures, but it
was apparent, always in retrospect, that demands for money (and
credit) were dropping rapidly; banks repaid borrowings for a
time so rapidly that those repayments offset the provision of
reserves through open market operations. The precipitous
decline in interest rates at the virtual onset of recession—
historically unusual at least in degree—certainly has been
anti-recessionary in effect.
The argument can be made, hypothetically, that with'
greater foresight and even more aggressive open market
operations, all of the April-May shortfall could have been
forestalled, and interest rates would have declined more.
But then a further judgment would have to be made as to
whether, after all, that would have been desirable in the
light of such questions as: (1) whether strong momentum
in the money supply figures would not soon have required
cutbacks in the provision of reserves through open market
operations, with an abrupt change in the direction of
interest rates; (2) whether perceptions of a weakening of
the resolve of the Federal Reserve to deal with inflation,
might not have actually delayed or frustrated the downward
adjustment of critical long-term interest rates and led to
intensified inflationary expectations generally; (3) whether
the potential "whip sawing" of markets and market perceptions,
by fermenting widespread public confusion, would not have been
ultimately damaging to our efforts to maintain policy consistency.
These matters of judgment cannot be escaped when, in the
technical jargon, the "money demand function" gyrates over a
period of a few months in a manner that cannot be explained on
the basis of past relationships. I am convinced, in the context
of the frustration about the inflation/unemployment dilemma you
expressed, that we do not have the simple choice of abandoning
concern about inflation and inflationary perceptions as we deal
with recession. Indeed, in my judgment, failure to deal with
inflation will ultimately be reflected in an unsatisfactory
recovery. Viewed in that light, I am not at all convinced,
even in retrospect, that leaning much harder against the
temporary falling away of money demand in recent months would
have been constructive.
I believe the reply to your third question about why the
money supply declined so precipitously in April and May is discussed above, as well as in my statement to the Committee. Given
279
the nature of our open market operations during the period, it
is evident the impetus .for the decline came from the demand
side. There are precedents as recently as late 1978 and early
1979 for a decline in M-l demand following a sharp rise in
interest rates; this year, there is some evidence the extraordinary declines are also related to decisions by consumers
to rapidly cut their indebtedness, drawing on cash balances
.in the process. Of course, a substantial part of the decline
was related to the decline in business activity itself.
Questions of cause and effect in that relationship have been
a matter of controversy among economists for many years, but
I know of no analysis that suggests that a decline in the money
supply has an instantaneous effect on business activity.
Your fourth question about the "intent" of the Federal
Reserve in permitting money growth to accelerate from 1976 to
1979 can, I believe, be generally answered by saying that the
responsible officials indeed felt that their decisions would
contribute over time to growth and employment. Obviously,
those officials were reaching those decisions in a particular
context, constrained and influenced by existing circumstances.
In fact, an enormous growth in employment was achieved during
those years, but I share your sense of dissatisfaction over
the level of both unemployment and inflation. This is not the
place for an extended analysis of the extent to which other
policies and developments (e.g., rising energy prices) affected
our economic performance during that period, or indeed constrained
the actions of the Federal Reserve, but I am sure you recognize
that monetary policy decisions (and ultimately growth of the
money supply) cannot be analyzed without taking those other
policies and circumstances into full account.
In retrospect, I too would wish the Federal Reserve had
pressed somewhat harder to curtail monetary growth in those
years, as implied by your question 5. But that simple hindsight
judgment can hardly do justice to the difficulty and complexity
of the decision-making at the time.
What is important is that, we recognize the need for monetary
"discipline as we move ahead, and that we also recognize the need
for complementary policies in other areas. Your own leadership
in achieving that understanding has, in my opinion, been a signal
public service. Indeed, it is only that kind of understanding
and public support that, over time, will provide a solid base
for the Federal Reserve to "follow through" on our intent to
reduce over time monetary growth to non-inflationary levels—
the essence of your last question. That is why I consider
frank and open relations with you and other members of the
Committee and the Congress of such crucial importance, and I
look forward to working with you in your leadership role in
the future.
Sincerely,
280
U.S. HOUSE OF REPRESENTATIVES
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
OF THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
WASHINGTON, D.C.
20515
July 24, 1900
The Honorable Paul Volcker
Chairman
Board of Governors
Federal Reserve System
Washington, D.C. 20551
Dear Mr. Chairman:
I listened to your testimony on the "Conduct of Monetary Policy", which was
delivered before the Banking Committee last Wednesday, with great interest.
Unfortunately, a schedule conflict forced me to leave the hearing before my
turn to question you came up. I had prepared a seven question sequence which I
intended to put to you at the time. Let me ask that you give me written answers
to these questions at your earliest convenience. It is my intention to circulate
both my questions and your answers.
I want to focus on the relationship between the Federal Reserve's conduct of
monetary policy and our apparent inability as a nation either (1) to prevent
unemployment from growing, or (2) to get inflation under control. A few years ago,
nearly all economic commentators would have said that we couldn't possibly fail on
both counts. However, somehow we did. While I recognize that we had a run of bad
luck and that other policies played a part, I want to explore with you the Federal
Reserve's role in this incredible double failure as well as your present and future
course.
Question 1
In your July 22 Report to the Congress, pursuant to the Hawkins-Humphrey Act,
you and your fellow governors on the Federal Reserve Board present projections for
our economy's performance --for real GNP growth, inflation and unemployment-- in 1931.
However, you refuse to target money growth for 1981. This suggests that you and
your colleagues think that money growth doesn't matter, or matter very much anyway.
How do you explain this? Do you really believe that how well or badly our economy
performs in 1981 is independent of how slow or fast our money supply (use the M1B
measure) grows that year?
Before going on to the next question, let me put myself on record as being sorely
disappointed with your failure to present 1981 monetary growth targets. The spirit of
the Hawkins-Humphrey Act for sure, and I believe the letter of the law as well, requires
it; although in some artful, self-serving techinical sense, your lawyers may construe
the act otherwise. Long ago, Sam Rayburn said, "I have been forced to the conclusion
that the Federal Reserve authorities. . .consider themselves immune to any direction
or suggestion by the Congress. . . . " I had hoped that today's Federal Reserve officers,
especially you, were more open and less elitist than past Federal Reserve authorities.
281
However, in view of your unilateral waiving of the provisions of Section 2A of the
Federal Reserve Act, as amended by the Hawkins-Humphrey Act, there now appears little
if any reason to think that.
Question 2
For three years from September 1976 to September 1979, M1B, our basic money
supply, had grown faster, on average, than Ql$ percent per year. Then it plunged.
Between the fourth quarter of 1979 and the second quarter of 1980, M1B grew only
1.7 percent, and from December 1979 to May 1980 it didn't grow at all.
The historical record indicates that when money growth is caused or allowed to
decelerate as sharply as it did during the first half of this year, recessions
develop or, if already underway, are exacerbated. Is there any reason to think
differently; to believe that sharp declines in money growth are ant_i-recessionary
in their effects? Specifically, consider the latest sharp decline, the one that's
been developing since early this year. Has this helped to keep the economy moving
forward and to prevent unemployment from rising this year?
Why was money growth caused or allowed to decelerate so precipitously and
dangerously this year?
In the quarter of a century since the Korean War, when money growth has accelerated,
by and large and on average inflation has followed along two years later; and when
money growth has declined, two years later, inflation also has dropped. In the late
1970's, money growth jumped beginning in the second half of 1976 from 5 percent per
year to over 8 percent per year. In the twelve months ending September 1976, M1B grew
only 5%. For the next three years, from September 1976 to September 1979, as was
earlier noted, it averaged over 8-2% per year. What was the Federal Reserve trying to
do when it caused or allowed this explosion of money growth to develop? If the effort
was made to increase real growth and reduce unemployment, did it succeed?
Could the Federal Reserve have prevented the soaring of money growth in the late
1970's? (I note in passing, that it occurred together with declining budget deficits.
Thus it occurs to me that you were not prevented from doing your job by growing fiscal
excesses.)
Where are you taking money growth from here?
Question 7
How can we be sure you'll follow through?
Sincerely,
Parren J. Mitchell, Chairman
Subcommittee on Domestic Monetary
Policy
282
B O A R D OK G O V E R N O R S
F E D E R A L R E S E R V E SYSTEM
W A S H I N G T O N , D. C. 2 0 5 5 1
UL
A . V O L C K E R
August 22, 1980
The Honorable Jim Leach
House of Representatives
Washington, D. C. 20515
Dear Jim:
I have hesitated for too long in answering your inquiry
about money market funds for one reason: I frankly am not comfortable that I have an adequate answer to the concerns you express.
As a starting point, I certainly agree with your observation that the money funds have attracted deposits from both banks
and thrifts. In a period of high interest rates, investors obviously
have found the yield and liquidity characteristics of the funds to
be superior to deposits for many purposes — a disparity that reflects
to a substantial extent the more restrictive regulations faced by
banks and thrifts.
As you also suggest, the diversion of deposits to money
funds probably has had its greatest impact on the availability of
credit at smaller institutions, such as those often prominent in
rural areas. This distortion of credit flows was especially serious
when financial conditions generally were under extraordinary strain,
and it led to the March 14 actions imposing a special deposit requirement on growth in money fund assets. The requirement was
removed only after the pressures in financial markets had eased
substantially and credit increasingly was available to'a wide
variety of borrowers at lower interest rates.
The relaxation of these immediate difficulties, of
course, does not signal any change in the fundamental- competitive
positions of money funds and depository institutions. A number
of factors constrain the ability of banks and thrifts to compete
with money funds. Recognizing the particular problem of ceiling
rates, the Depository Institutions Deregulation Committee moved
to raise permissible rates a bit on certain time deposits relative
to market interest rates, as a first step in the Congressionally
mandated process of phasing out these ceilings. But there are
obvious limitations on the extent to which that can be an answer
in the near term, given the existing assets and earnings of the
283
institutions. Even when the "deregulatory" process is completed,
depository institutions still will operate under much more pervasive regulations than money funds, including reserve requirements on transactions and nonpersonal time accounts.
There is, of course, another side of the story. Partially offsetting the regulatory disadvantages are insurance on
deposits and the ability of depository institutions to offer
customers a wide variety of services in one location. I have
been surprised recently with the rapid growth in passbook savings
accounts at both banks and thrift institutions even though money
fund rates are well over yields on these accounts. More broadly,
from the savings and consumer standpoint, money market funds
are attractive and efficient; they contribute to both consumer
satisfaction and the national interest in savings.
Nevertheless, savers have become extremely sensitive to
even small changes in the relative advantages of holding different
assets. In the still uncertain financial environment we face,
a substantial diversion of flows from depository institutions to
money funds could recur, and, indeed, except for the past few weeks,
the money funds have remained in a relatively strong competitive
position.
Given the urgent need to encourage savings that can be
channeled into investment, it would obviously be preferable to
redress competitive imbalances by removing restrictions on banks
and thrifts when possible rather than to impose limits on money
funds. But given the restraints on progress in that direction, I
am left with the nagging concern that the situation is unbalanced.
Imposing an interest rate ceiling, a la Reg. Q, seems neither desirable nor feasible. One approach toward balance might be to,
in effect, force a choice between reserve requirements or conducting
only a "non-transaction account" business. But that would be a
substantial departure from the traditions of mutual fund regulation. Moreover, we need to balance the needs of consumers and
savers.
In sum, I have no legislative proposal now--but I do
believe the situation bears watching. And I would be delighted
to explore your own thinki^~ further.
Sincerely,
284
JIM LEACH
BANKING. FINANCE AND I RBAN AFFAIRS
POST OFFICE AND CIV IL SERVICE
IIT DISTRICT. IOWA
CONGRESS OF THE UNITED STATES
July 24, 1980
The Honorable Paul A. Volcker
Chairman, Board of Governors
Federal Reserve
21st Street and Constitution Ave. NW
Washington, DC 20551
Dear Mr. Chairman:
During the Banking Committee hearing yesterday I briefly raised
the problem of insuring equitable competition between financial
institutions and money market mutual funds. The current advantages
enjoyed by money funds have caused massive deposits to be shifted
from banks and savings and loans into near-bank operations. The
money fund development would appear to be particularly damaging to
small, rural financial institutions, compared to money-center ones,
and consequently to the overall rural economy.
1 would be appreciative of any thoughts you might have on this
problem and if you could indicate whether the Federal Reserve intends
fo utilize its authority and/or recommend legislation to establish
competitive equality between financial institutions and money funds.
Thank you for your
consideration.
Sincerely,
Jim
Member of Congress
285
Congressional Research Service
The Library of Congress
Washington, D.C. 20540
BRIEFING MATERIALS FOR MID-YEAR 1980 MONETARY POLICY OVERSIGHT
Prepared for the Committee on Banking,
Finance and Urban Affairs
United States House of Representatives
by
F. Jean Wells
Roger S. White
Specialists in Money and Banking
Economics Division
July 21, 1980
286
BRIEFING MATERIALS FOR MID-YEAR 1980 MONETARY POLICY OVERSIGHT
Congressional review of economic policies, including monetary policy, is
conducted on a coordinated basis pursuant to the Full Employment and Balanced
Growth Act of 1978 (P.L. 95-523).
The Act requires the Federal Reserve to submit
a monetary policy report to the Congress twice annually.
These reports are to
present a review of -recent economic trends, a statement of objectives for growth
of money and credit, and an assessment of the relationship of the growth objectives
to economic goals set forth in the Economic Report of the President.
In the mid-
year report, objectives for growth of money and credit are to be stated for the
next calendar year as well as the year in progress.
This briefing document is
designed to assist the House Committee on Banking, Finance and Urban Affairs in
reviewing the Federal Reserve's monetary policy report to the Congress for midyear
1980.
The first section contains presentations relating to monetary and financial
measures.
It includes charts portraying money and credit growth for the year
in progress in relation to targets set in February 1980 for this year.
A devel-
opment influencing monetary and financial measures during the first half of
1980 was a series of special monetary and credit restraint programs initiated
on March 14 and to be phased out by the end of July.
Data pertaining directly
to these programs are not'included.
The remaining sections present budget data, forecasts for the economy,
and data tracing past behavior of selected economic variables.
This information
is provided to assist the Committee in reviewing the Federal Reserve's plans
287
and objectives for monetary policy as they relate to prevailing economic conditions and to economic goals set forth by the Administration.
The Adminis-
tration's mid-session budget review expected to be released Monday, July 21,
will contain revised budget estimates and related economic assumptions and
forecasts.
Assistance in preparing this report was obtained from Laura A. Layman,
Economic Analyst; Barbara L. Miles, Specialist in Housing; Barry E. Molefsky,
Analyst in Econometrics; Arlene E. Wilson, Analyst in International Trade and
'Finance; Philip D. Winters, Analyst in Regional Economics; and Nancy Drexler,
Editorial Assistant.
Listing of tables and graphs
Monetary and financial measures:
Monetary and credit aggregates—actual levels and growth
rates, 1977-1980, and Federal Reserve projected growth
ranges announced February 1980:
Money supply: M-1A and M-1B (graphs).
Money supply: M-2 and M-3 (graphs) ..
Bank credit (graph)
Growth rates for selected monetary and credit aggregates,
1975-1980 and Federal Reserve one-year targets announced
February 1980 (table)
Growth rates for selected reserve aggregates and the
monetary base, 1975-1980 (table)
Income velocity of money, M-1A and M-1B, rates of change,
1975 through second quarter 1980 (graphs)
Selected interest rates, 1975 through June 1980:
Graph.
Table.
Funds raised in U.S. credit markets, 1975 through first
quarter 1980 (table)
288
Federal budget data:
Federal budget receipts and outlays, fiscal years
1975-1980 (table)
Budget receipts and outlays as a percent of GNP,
1958-1983 (table)
III.
Economic forecasts and economic goals:
1980 and 1981 economic forecasts of Chase Econometrics
Associates, Inc. and Data Resources, Inc., released
June 1980
1980 economic projections of the the Board of Governors
of the Federal Reserve System, released February 1980...
1980 and 1981 economic forecasts of the Administration,
released January 1980 and revised March 1980
Summary of Administration's economic goals consistent
with the objectives of the Humphrey-Hawkins Act, released
January 1980
V.
Past behavior of economic goal variables:
Employment—total civilian employment, persons aged
16 and over, 1975-1980 (graph)
Unemployment—percent of total civilian labor force,
persons aged 16 and over, 1975-1980 (graph)
Production—real gross national product, rates of change,
1975-1980 (graph)
Real income—real disposable income, rates of change,
1975-1980 (graph)
Productivity—nonfarm business sector, rates of change,
1975-1980 (graph)
Prices—consumer price index, rates of change, 19751980 (graph)
Prices—GNP implicit price deflator, 1975-1980 (graph)
Selected international statistics:
Exports, imports, trade balance and trade-weighted
exchange value of the U.S. Dollar, 1975-1980 (table)
289
MONEY SUPPLY (M-1A)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
Ill
1977 \
-1978-
-1979-
IV
IQ
-1980-
MONEY SUPPLY (M-1B)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth-Range from Fourth Quarter 1979 to Fourth Quarter 1980
460
440
420
400
380
360
340
320
IU
IV
1Q
-1981-
290
MONEY SUPPLY (M-2)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
MONEY SUPPLY (M-3)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1S79 to Fourth Quarter 1980
2100
1900
-
1700
-
291
BANK CREDIT
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
1400
1300
Growth rate range for
the period IIQ 1980
to IVQ 1980 continent
with the 6.0% to 9.0%
one-year growth range
announced Feb. 1980.
1200
1100
1000
900
800 -
I
I
1977v
-1978-
-1979-
-1980-
-1981
•Growth ratw are Mason»tfy «diutt«d compound wmual r«tw.
Data Source: Quarterly observations and growth ratM are calculated from seasonally adjusted data series of the Board of Governors of the Federal
Reserve System.
f
GROWTH RATES FOR SELECTED MONETARY AND CREDIT AGGREGATES, 197*5-1980
AND FEDERAL RESERVE ONE-YEAR TARGETS, 1980-1981
(Seasonally adjusted compound annual growth rates, percent)
time period
M-1A
1975
4.7
1976
1977
1978
Monetary aggregates
,M-1B
M-2
M-3
Bank
credit
4.1
4.9
12.3
9.4
5.5
6.0
13.7
11.4
7.5
7.7
.8.1
11.5
12.6
11.1
7.4
)8.2
8.4
11.3
13.5
1979
5.0
7.6
8.9
9.8
12.3
1980-first quarter
4.9
6.1
7.4
8.0
9.8
1980-first half
0.4
1.8
6.4
6.8
4.5
1980-targets 2/
3.5 to 6.0
4.0 to 6.5
6.0 to 9.0
6.5 to 9.5
6.0 to 9.0
1981-targets 3/
I/
Annual data are for periods from the fourth quarter of the previous year to the fourth quarter
of the year indicated. First quarter data are for the period from the fourth quarter of 1979
to the first quarter of 1980.
First half data are for the period from the fourth quarter of
1979 to the second quarter of 1980.
27
Announced by the Federal Reserve in its Monetary Report to the Congress, February 19,
3/
To be announced by the Federal Reserve in its 1980 mid-year report to the Congress on monetary
policy.
Sources:
1980.
Calculated from data series of the Board of Governors of the Federal Reserve System,
!
accessed July 1980 from data files of Data Resources, Inc.
to
GROWTH RATES FOR SELECTED RESERVE AGGREGATES AND THE MONETARY BASE, 1975-1980
(seasonally adjusted compound annual growth rates, adjusted for
changes in reserve requirements, percent)
y
time period
total
reserves
required
reserves
nonborrowed
reserves
monetary
base
1975
0.0
3.2
5.8
1976
0.8
0.8
0.9
6.7
1977
5.1
5.2
2.9
8.2
-0.2
1978
6.8
6.9
6.9
9.2
1979
2.9
2.7
0.9
7.6
1980-first quarter
4.5
5.5
3.6
7.7
1980-first half
3.3
3.8
6,0
6.6
\J
Annual data are for periods from the fourth quarter of the previous year to the fourth quarter
of the year Indicated. First quarter data are for the period from the fourth quarter of 1979
to the first quarter of 1980.
First half data are for the period from the fourth quarter of
1979 to the second quarter of 1980.
Sources:
Calculated from data series of the Board of Governors of the Federal Reserve System,
accessed July 1980 from data files of Data Resources, Inc.
8
CO
294
INCOME VELOCITY OF MONEY (M-1A)
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annuol rote of chonge
1975
7
1976
1977
1978
1979
1980
Colculoied from seasonally adjusted Ooto
Data sources: Federal Reserve Board; Department of Commerce
INCOME VELOCITY OF MONEY (M-1A)
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rote of chonge
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data
Data sources: Federal Reserve Board; Deportment of Commerce
295
SELECTED INTEREST RATES
October 1975 through June 1980
Rate for
Conventional First Mortgages
on New Homes
federal Reserve
Discount Rate
4
-°J-
Federal Funds Rate
>. . i . . i . . i . . i . . I . . i . . i .
O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J
1975y\
1976
A
1977
A
1978
A
J A S O N D J F M A M J
1979
'V-isso-
•From March 14,1980 through May 6,1980. banks with daposits of $500 million or mora ware subject to a 3 percentage point surcharge
on borrowings for more than one week in a row or more than 4 week* in a calendar quarter.
Data Source*: Board of Governors of the Federal Reserve System and Federal Housing Administration Department of Housing
•SELECTED INTEREST RATES, 1975-1980
(average, percent per annum)
Year or
Month
Treasury
bills,
3 month,
new
issues
Treasury
bonds,
over
10 years,
composite
Corporate Aaa
bonds ,
Moody 's
Prime
commercial
paper,
3
months
Prime rate
charged by
banks
New home
mortgage
yields,
FHA/HUD
series
Federal
Reserve
Discount
rate
Federal
funds
rate
1975
5.84
7 .00
8.,83
6.25
7 .86
9.10
6.25
5.82
1976
4.99
6..79
8.,43
5 .24
6.84
9 .00
5.50
5.05
1977
5.26
7,.06
8.,02
5 .55
6.82
9.00
5.46
5.54
1978
7.22
7,.89
8..73
7 .94
9 .06
9.70
7.46
7.94
1979
10.04
8.74
9..63-
10 .97
12 .67
11 .14
10.28
11.20
Jan.
12.04
10,.03
11.,09
13 .04
15 .25
12 .80
12.00
13.82
Feb.
12.81
11 .55
12.,38
13 .78
15 .63
14 .10
12.50
14.13
Mar.
15.53
11 .87
12.,96
16 .81
18 .31
16 .05
13.00
17.19
17.61
1980:
14.00
10 .83
12..04
15 .78
19 .77
15 .55
13.00
May
9.15
9 .82
10,.99
9 .49
16 .57
13 .20
12.90
10.98
June
7.00
9 .40
10,.58
8.27
12 .63
11.43
9.47
Apr.
Sources:
NA
Board of Governors of the Federal Reserve System, Department of Housing and Urban Development, and
Moody's Investors Service.
FUNDS RAISED. IN U.S. CREDIT MARKETS
[In billions of dollars; quarterly data are seasonally adjusted at annual rates]
1975
Total funds raised,
by instrument:
1977
1978
223.5
296 .0
392 .5
481 .7
-.1
481.4
1980
(II)
1979
(III)
(IV)
486.8
557.0
429.1
1979
(I)
516.6
-1 .0
-.9
-1 .0
-2.1
-.6
-2.7
-5.1
-1.0
10.8
12 .9
4.9
4.7
7.3
5.8
8.3
9.5
13.5
212.8
284 .1
388 .5
478 .0
476.2
551.4
424.7
504.1
U.S. Government securities
98.2
88 .1
84 .3
95 .2
89.9
74.3
95.3
117.4
116.6
State and local obligations
16.1
15 .7
23 .7
28 .3
21.4
12.5
25.3
25.3
21.1
Corporate and foreign bonds
36.4
37 .2
36 .1
31 .6
32.2 '
35.8
35.4
22.8
25.4
Mortgages
57.2
87 .1
134 • 0|
149 .0
158.1
164.5
161.0
148.6
140.7
9.7
25 .6
40 .6
50 .6
42.3
44.2
45.1
29.3
26.0
-12.2
7 .0
29 .8
58 .4
52.5
64.0
96.2
16.5
78.3
-1.2
8.1
15..0
26 .4
40.5
44.9
55.3
24.1
50.6
8.7
15 .3
25 .2
38 .6
39.5
41.4
37.7
40.7
45.4
Investment company shares
Other corporate equities
Debt instruments:
Consumer credit
'Bank loans, n.e.c.
Open market paper
Other loans
Source:
1976
Board of Governors of the Federal Reserve System.
481.6
1980(1) based on incomplete data.
298
FEDERAL BUDGET RECEIPTS AND OUTLAYS
(in billions of dollars) _!/
Budget
receipts
Budget
outlays
Fiscal year or period
Budget
surplus or
deficit
1975
281.0
326.2
-45.2
1976
300.0
366.4
-66.4
81.8
94.7
-13.0
1977
35 7. .8
402.7
-45.0
1978
402.0
450.8
-48.8
1979
465.9
493.7
-27.7
Budget Revisions, March 1980~
532.4
568.9
-36.5
Third Concurrent Resolution, June 12, 1980
525.7
572.7
-47.0
Budget Revisions, March 1980~
628.0
611.5
16.5
First Concurrent Resolution, June 12, 1980
613.8
613.6
.2
Fiscal year 1979
292.1
328.2
-36.0
Fiscal year 1980
325.8
381.9
-56.0
Transition quarter
1980 (estimates):
1981 (estimates):
Cumulative total, first 8 months:
y
Unified budget basis.
2J
Estimates from Office of Management and Budget, Fiscal Year 1981 Budget
Revisions, March 1980.
Source:
Economic Indicators, June 1980.
299
BUDGET RECEIPTS AND OUTLAYS AS A PERCENT OF GNP, 1958-1983
Fiscal year
1958
1959
1960
1961
196,2
1963
1964
1965
1965
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
(I/)
1977
1978
1979
Budget, 1980:
1980 estimate
1981 estimate
1982 estimate
1983 estimate
Budget revisions,
March 1980:
1980 estimate
1981 estimate
1982 estimate
1983 estimate
_!/
Gross
national
product
($ billions)
Budget receipts
as percent of GNP
Budget outlays
442.1
473.3
497.3
508.3
546.9
576.3
616.2
657.1
721.1
774.4
829.9
903.7
95910
1,019.3
1,110.5
1,237.5
1,359.2
1,457.3
1,621.0
18.0
16.7
18.6
18.6
18.2
18.5
18.3
17.8
1.8,1
19.3
18.5
20.8
20.2
18.5
18.8
18.8
19.5
19.3
18.5
18.7
19.5
18.5
19.2
19.5
19.3
19.2
18.0
18-.7
20.4
21.5
20.4
20.5
20.7
20.9
20.0
19.8
22.4
22.6
1,843.3
2,060.4
2,313.4
19.4
19.5
20.1
21.8
21.9
21.3
2,518.0
2,764.4
3,107.6
3,513.0
20.8
21.7
22.2
22.7
22.4
22.3
22.1
22.0
2,554.6
2,796.7
3,151.0
3,570.7
20.8
22.5
23.0
23.5
22.3
21.9
21.7
21.3
Transition quarter omitted.
Source:
Office of Management and Budget, Federal Government Finances, January
and April 1980 editions.
300
1980 AND 1981 ECONOMIC FORECASTS OF CHASE ECONOMETRICS ASSOCIATES, INC.
AND DATA RESOURCES INC., RELEASED JUNE 1980
1981
1980
2/
I/
I/
DRI
Item
21
DRI
I!
Level, fourth quarter
Employment (millions)
Unemployment (percent)
96.2
96.0
97.8
98.3
8.7
8.8
8.5
8.4
Percent change, fourth quarter to fourth quarter
5.0
4.6
12 .3
13 .8
Real gross national product
-a .5
-4 .0
3.1
4.4
Real disposable income
-2 .2
-1 .6
1.7
2.7
Productivity
4/
total economy
private business
private nonfarm
-1 .0
-2 .9
— .5
-2
.-1.3
1.0
1.4
Consumer price index
12 .9
11 .5
9.7
9.1
8.9
8.9
9.0
9.0
Nominal gross national product
GNP implicit price deflator
$16 billion beginning on October 1, 1980 and that corporate taxes will be
reduced by $9 billion effective January 1, 1981. It is also assumed that
there will be an easing in Federal Reserve policy. Chase expects some further
increases in OPEC prices, but these advances are assumed to be much more
modest than the hikes imposed over the past year.
2J
The DRI forecast assumes a $30 billion Federal tax cut will become effective
January 1, 1981. This tax reduction provides $18 billion in personal tax
relief and a $12 billion cut in corporate tax liabilities. Monetary policy
is expected to become more accommodative, although it is assumed that the
Federal Reserve will adhere to the monetary growth targets established in
February 1980.
The forecast also assumes a modest increase in the price of
oil. OPEC is expected to raise its prices by 15 percent between the fourth
quarter 1980 and the fourth quarter 1982.
3/
Seasonally
47
Based on total real GNP per hour worked.
Sources:
adjusted.
Chase Econometrics Associates, Inc. Standard Forecast of June 20, 1980.
Data Resources, Inc. Central Forecast of June 22, 1980.
301
1980 ECONOMIC PROJECTIONS OF THE BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM,
RELEASED FEBRUARY 1980
Actual
Item
1979
Projected
,
1980
Level, fourth quarter
Employment (millions)
Unemployment rate (percent)
97.7
5.9
97
to 98 3/4
6 3/4 to 8
Percent change, fourth quarter to fourth quarter
Nominal gross national product
9.9
7 1/2 to 11
Real gross national product
0.8-
-2 1/2 to 1/2
Implicit price deflator
9.0
9 to 11
Annual rate of change in fourth quarter, percent
Consumer price index
Source:
13.2
83/4tol2
Board of Governofs of the Federal Reserve System, Monetary Policy
Report to Congress, February 19, 1980, p. 7.
302
1980 AND 1981 ECONOMIC FORECASTS OF THE ADMINISTRATION,
RELEASED JANUARY 1980 AND REVISED MARCH 1980
1980_
1981
Level, fourth quarter
Employment (millions)
January 1980
March 1980 revisions
Unemployment rate (percent)
January 1980
March 1980 revisions
97.8
—
99.7
7.5
7.2
7.3
7.3
Percent change, fourth quarter to fourth quarter
Nominal gross national product
January 1980
March 1980 revisions
7.9
10.0
11.7
11.4
Real gross national product
January 1980
March 1980 revisions
-1.0
-0.4
2.8
2.2
Real disposable income
January 1980
March 1980 revisions
c
I/
Productivity—total economy
January 1989
March 1980 revisions
1.1
1.3
Consumer price index
January 1980
March 1980 revisions
10.7
12.8
8.7
9.0
GNP implicit price deflator
Janaury 1980
March 1980 revisions
9.0
10.4
8.6
9.1
\J
Seasonally adjusted.
2J
Based on total real GNP per hour worked.
Sources:
U.S. Council of Economic Advisers. Economic Report of the President.
Washington. U.S. Govt. Print. Off., 1980.
Office of Management and Budget. Fiscal Year 1981 Budget Revisions,
March 1980.
303
SUMMARY OF ADMINISTRATION'S ECONOMIC GOALS CONSISTENT WITH THE OBJECTIVES
OF THE HUMPHREY-HAWKINS ACT, RELEASED JANUARY 1980 I/
YEAR
Goal Requirements
Goal Forecasts
Item
1980
1981
~
1982
1983
1984
1985
108.0
4.8
110.7
4.0
Level, fourth quarter 2/
Employment (millions)
Unemployment (percent)
97.8
7.5
99.7
7.3
102.5
6.5
105.3
5.6
Percent change, fourth quarter to fourth quarter
Real gross national product
Real disposable income
Productivity 3/
Consumer prices
-1.0
.5
-.3
10.7
2.8
1.1
1.3
8.7
5.0
4". 7
2.3
7.9
5.0
4.7
2.5
7.2
4.8
4.6
2.5
6.5
4.6
4.4
2.5
5.8
J7 Among the provisions of the Humphrey-Hawkins Act are those setting an
unemployment goal of 4% among individuals aged 16 and over in the civilian labor
force by 1983 and an inflation rate of 3% as measured by the consumer price index,
also by-1981. The Act requires that beginning in the 1980 Economic Report the
'
»J2jifi&idetit-,^raview . th»~ JiumericaL*goals and . t imetables for reducing uneaploymeae^dnd-^
inflation and report to the Congress on the degree of progress being made in these
areas. From" this time, if the President finds it necessary, he may recommend modification of the timetable(s) for achieving the unemployment and inflation goals.
According to the 1980 Economic Report:
.-...the- President has used the authority provided to him in the
V*. --^HuiapjhEa^TjH^
for^ achiesi-ngva.<..4-pec**=
cent unemployment rate and 3 percent inflation. The target year
for achieving 4 percent unemployment is now 1985, a 2-year deferment.
The target year for achieving 3 percent inflation has been postponed
until 3 years beyond that. Economic goals through 1985 consistent
with this timetable are shown [in the table above].
The short-term goals represent a forecast for 1980 and 1981.
The medium-term goals for 1982 through 1985 are not forecasts but
projections of the economic performance needed to achieve the unemployment rate and inflation goals within the Administration's
timetable...
(p. 94)
In March 1980 some-revised forecasts and projections were included in the
Office of Management and Budget Fiscal Year 1981 Budget Revisions; these revisions
have not been incorporated i*i the table above.
2J
Seasonally adjusted.
3/
Based on total real GNP per hour worked.
Source:
U.S. Council of Economic Advisers. Economic Report of the President.
Washington, U.S. Govt. Print. Off., 1980.
304
EMPLOYMENT
TOTAL CIVILIAN EMPLOYMENT
Millions
•"* 1976 r
—
Data source:
Ifif77
----- "tgyg
—- 1979 """-1980
Seosonolly odjusted data
Bureau of Labor Statistics, Department of Labor
UNEMPLOYMENT
PERCENT OF CIVILIAN LABOR FORCE
Percent
7.5
5.5
1975
1976
Doto source:
1977
1978
1979
1980
Seasonally odjusted data
Bureau of Labor Statistics. Deportment of Labor
PRODUCTION:
REAL GNP
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
1975
1976
1977
1978
1979
1980
Calculated from seasonally adjusted (data expressed in 1972 dollars
Data source: Bureau of Economic Analysis, Department of Commerce
1981
REAL INCOME:
DISPOSABLE PERSONAL INCOME
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
6 5 4 -
1975
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data expressed in 1972 dollars
Data source: Bureau of Economic Analysis, Department of Commerce
1981
PRODUCTIVITY:
% CHANGE
NONFARM BUSINESS SECTOR
FROM SAME QUARTER, PREVIOUS YEAR
Annual rote of change
Data for 2d
quarter 1980
not available.
1975
1976
1977
1978
1979
1980
Based on output per hour, seasonally adjusted
Data source: Bureau of Labor Statistics, Department of Labor
1981
308
PRICES:
CONSUMER PRICE INDEX
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
Data for 2d
quarter I960
based on April
and May only.
1975
1976
1977
1978
1980
1979
Colculoted from seasonolty adjusted data
Data source: Bureau of Labor Statistics, Department of Labor
PRICES:
GNP IMPLICIT PRICE DEFLATOR
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rote of change
1976
Data source:
1977
1978
1979
1980
Calculated from seasonally adjusted data
Bureau of Economic Analysis, Deportment of Commerce
EXPORTS, IMPORTS, TRADE BALANCE _!/ AND TRADE-WEIGHTED EXCHANGE
VALUE OF THE U.S. DOLLAR 2/
1979
1975
1976
1977
1978
1979
I
II
1980
III
IV
Ip
II
(in billions of dollars; qu?irterly data seatjonally <id justed)
Exports
107.1
114.7
120. 8
142.1
182.1
41 .8
42.8
4 7 ,.2
50.2
54.7
Imports
98.0
124.0
151. 7
175.8
211.5
46 .9
50.9
54..3
59.5
65.6
9.0
-9.4
-30.9
-33.8
-29.5
-5.1
-8.1
-7.1
-9.2
-10.9
27.0
34.6
45.0
42.3
60.0
11.6
13.5
16.1
18.9
105.57
103.30
92.39
88.09
88.14
89.79
86.97
87.37
Trade balance
Memorandum item:
Petroleum imports
Index of the
weighted-average
exchange value
of the U.S. dollar
98.34
87.38
87.78
I/
Merchandise, excluding military, on balance of payments basis (adjusted from Census data for differences
in timing and coverage).
2]
Index of weighted average exchange value of U.S. dollar against currencies of other G-10 countries
(Germany, Japan, France, United Kingdom, Canada, Italy, Netherlands, Belgium, Sweden) and Switzerland.
March 1973=100. Weights are 1972-1976 global trade of each of the 10 countries.
Sources:
Exports, imports, and trade balance - Department of Commerce, Bureau of Economic Analysis. Tradeweighted exchange value of the U.S. Dollar - Board of Governors of the Federal Reserve System.
310
BRIEFING MATERIALS
PREPARED FOR HEARINGS ON
THE CONDUCT OF MONETARY POLICY
PURSUANT TO P,L, 95 - 523
HELD BEFORE THE COMMITTEE ON
BANKING, FINANCE & URBAN AFFAIRS
JULY 23, 1980
PREPARED BY STAFF, SUBCOMMITTEE
ON DOMESTIC MONETARY POLICY
311
The Economy in 1980, Midyear Forecast
Our economy's overall or in-the-large performance usually is judged
by what happens to prices and production. Unemployment is linked to the
latter. In February, we forecast that, in 1980, "prices will increase 7
to 10 percent and output will rise 1% percent, give or take 1% percent."
That forecast was conditioned on the assumption that the supply of
coin, currency and checking deposits in depository institutions, collectively
known as M1B, would grow 6% percent between the fourth quarters of 1979 and
1980. However, in the first half of the year, that is, through the second
quarter of 1980, M1B growth averaged less than 2 percent per annun. It is
extremely unlikely therefore, that it will grow 6h percent over the year as
a whole. Instead, we now estimate that M1B will grow only 4 percent in 1980.
Based on this sharply lower estimate for money growth, we now forecast
that the production of GNP goods and services will decline in 1980.
Specifically, our new forecast is that output will fall 1^ percent this year,
give or take 1^ percent. Here's why.
We continue to forecast that the GNP price deflator will rise 7 to 10
percent in 1980. In this regard, the die was cast by the money growth we
had in 1977, 1978 and 1979. Our best bet is for an inflation rate, measured
by GNP prices, of 8*5 percent this year. Total spending on GNP goods and
services, assuming M1B growth of 4 percent, will rise by only 7 percent.
Subtracting the 8% percent inflation from the increase of 7 percent in
spending on GNP goods and services, we are led to forecast a point estimate
of minus 1^ percent in the production of GNP goods and services. However,
with good luck inflation will be only 7 percent this year, in which case
production will neither rise nor fall; but with bad luck prices will rise
10 percent and in this case production will fall 3 percent.
What should we do now? Our answer is that M1B growth should be maintained
at 4 percent per year through 1981, and then reduced to 2 percent per year in
two yearly steps. This policy will assure that recovery from the current
recession (which, incidentally, is in no small measure due to the failure of
the Federal Reserve to prevent the collapse of M1B growth from over 8 percent
per year to under 2 percent during the first half of this year) will occur
together with the slowing of inflation.
312
CHART 1.
Exhibit 1 breaks the 1954-1977 period into nine
consecutive 3-year periods: 1954-1956, 1957-1959, etc.*
For
each 3-year period, Chart 1A relates average M1B growth to the
average rate of rise in the Gross National Product deflator
(inflation); Chart IB relates average M1B growth to the average
rate of interest on 3-month Treasury bills; Chart 1C relates
average M1B growth to the average rate of unemployment.
The exhibit shows that there is a close positive relationship
between money growth and inflation (Chart 1A) and between money
growth and the rate of interest (Chart IB).
It shows that as
money growth increases, so do both inflation and the rate of
interest.
The exhibit also shows that there is no relationship between the
rate of money growth and the rate of unemployment (Chart 1C).
This belies the Phillips Curve theory that inflation is inversely
correlated with unemployment.
*The last period consists only of two years —1978 and 1979.
313
AVERAGES IN 3-YEAR
OF Ml-B GROWTH &
THE G N
1954
NON-OVERLAPPING PERIODS
THE RATE OF GROWTH IN'
P DEFLATOR
75 77
- 1979
- *
g
1
4.0
5.5
7.0
Ml-B PERCENT GROWTH
AVERAGES IN 3-YEAR NON-OVERLAPPING PERIODS
OF Hl-B GROWTH & THE 3 MONTH TREASURY BILL
MTE
2.5
1954 - 1979
4.0
6.5
Nl-B PERCENT GROWTH
AVERAGES IN 3-YEAR NON-OVERLAPPING PERIODS^.
OF Ml-B GROWTH 4 THE UNEMPLOYfCNT RATE
1954 - 1979^.
S...
4.0
5.5
IH-B PERCENT GROWTH
7.0
314
CHART 2.
In March 1979, pursuant to the Full Employment and
Balanced Growth Act, the Committee recommended reducing money
growth 1 percentage point a year over the next four to five
years.
Using the new M1B measure of money supply, which equals
publicly held coin, currency and checkable deposits in all
depository institutions, money growth averaged 8.2 percent
between the fourth quarters of 1977 and 1978.
projection for 1979 was 7.2 percent.
not achieved.
Thus, the
Unfortunately, this was
Actual money growth averaged 8 percent in 1979.
Moreover, during the year, M1B growth first fell short of the
projection and then moved up sharply beginning in April.
The
shortfall changed the economy's momentum from up to down during
the first half of last year.
The sharp resurgence halted the
slide and generated new inflationary pressures during the third
or summer quarter.
In turn, the resurgence in money growth that
occurred last year beginning in April prompted the Open Market
Committee, beginning in October 1979, to focus on controlling
money growth and to deemphasize control of interest rates.
Nonetheless, this year another shortfall in money growth has
developed.
It is greater than last year's shortfall and so is
the accompanying recession of economic activity.
Some
commentators blame the shortfall in money growth which developed
this year (after February) on the failure of the Federal Reserve
to allow the Federal funds rate and other interest rates to
fluctuate freely enough to prevent sharp fluctuations in money
growth.
CHART 2
ACTUAL MONEY SUPPLY
VERSUS
HOUSE BANKING COMMITTEE'S RECOMMENDATION op MARCH, 1979
•448
420 -
PROJECTION LINE IS BASED ON 7.2% GROWTH FROM NOVEMBER 1978 THRU NOVEMBER 1979
AND 5,25% GROWTH (THE MID-POINT OF THIS YEAR'S TARGET RANGE)
FROM NOVEMBER 1979 THRU NOVEMBER 1980,
BASE PERIOD IS AVERAGE OF Ml-B FOR OCTOBER, NOVEMBER, &
DECEMBER, 1978.
THE INITIAL PROJECTION OF 7.2% IS 1% BELOW THE ACTUAL 8,2%
GROWTH IN 1978.
-420
-408
400 -
to
2
£\
CQ
r440
Ml-B
H
-380
380-
PROJECTION LINE
sea -
340
78
-360
I '
79
I '
88
MONTHLY DATA
340
H
m
CO
»—i
Ol
316
CHART 3.
M1B growth, measured between the same months of adjacent
years (for example, January 1947 to January 1948), cycled down and
up seven times between the end of World War II and 1978.
in early 1979 it appeared to start down once again.
slide was quickly reversed in April 1979.
Beginning
However, that
But this year, as the
chart shows, it has happened again for sure.
Our economy's performance in the post World War II period is
mirrored in this chart of money growth.
Inflation was broken
after World War II and again after the Korean War by sustained
low money growth.
It was rekindled after 1964 by upsurges in
money growth in the late 1960s, 1971-1973, and 1976-1979.
Recessions, including the one we are now in, have occurred in
the wake of sharp decelerations in M1B growth.
Recession periods
are delineated by the vertical lines on the time axis.
In February, we wrote that, "Barring (a) another sharp prolonged
deceleration in money growth, or (b) disruption in the flow of
foreign oil, we do not foresee a major recession developing in
1980."
Unfortunately, condition (a) was violated.
As the chart
shows, the Federal Reserve permitted money growth to decline very
sharply beginning in February.
12
CHART 3
NARROWLY DEFINED MONEY SUPPLY, Ml-B
PERCENT CHANGE. YEAR TO YEAR
10
2
O
CO
47 '48 '49 '60 '61 M52 'S3 'E4 'EG '56 !S7 "S8 '58 '68 '61 '62 '63 'eves '66167168T6a 7CIT71 '72'73'74 '7G '76 '77 '78 '78'88'
MONTHLY DATA
THRU JUNEj 198
°
318
EXHIBIT 4.
Charts 4A and 4B map year-over-year percentage changes
in the CPI and Gross National Product deflator, respectively, against
year-over-year percentage changes in M1B (money supply) lagged two
years.
These charts show that the rate of inflation follows M1B
growth of two years earlier fairly closely.
319
CHART 4A
YEAR TO YEAR PERCENT CHANGE
BAR CHART IS C P I _
LINE IS Ml-B MONEY SUPPLY, LAGGED 2 YEARS
«7-
'66 'S7 T SS '
13 * 64 166 ' 00 ' 07 ' 68 ' 6d ' 70 ' 71 ' 7Z ' 73 • 74 ' 78 '
77 ' 78 ' 78 ' «» ' «1
YEARtY AVERAGE OF MONTHLY DATA
YEAR TO YEAR PERCENT CHANGE
BAR CHART IS THE G N P DEFLATOR
LINE IS Mi-B MONEY SUPPLY, LAGGED 2 YEARS
YEARLY AVERAGE OF DATA
320
CHART 4.
(continued)
Charts 4C and 4D map percentage changes
measured between the same quarters from one year to the next in
the Consumer Price Index (CPI) and the Gross National Product
deflator, respectively, on percentage changes in the quarterly
average in M1B, also measured between the same quarters from one
year to the next but lagged eight quarters.
These charts also
show that the rate of inflation follows M1B growth of two years
earlier fairly closely.
Together, the several exhibits of Chart 4 provide hope that
inflation will begin to subside in 1981, or at the latest 1982.
321
CHARTS
YEAR TO YEAR PERCENT CHANGE
SOLID LINE IS C P I
DASHED LINE IS Ml-B HONEY SUPPLY. LAGGED i
62
64
66
68
78
72
74
76
78
88
82
QUARTERLY DATA
YEAR TO YEAR PERCENT CHANGES
13-
MEASURED BETWEEN THE SAME QUARTERS FROM ONE YEAR TO THE NEXT
12-
SOLID LINE IS THE G N P DEFLATOR
DASHED LINE IS Ml-B MONEY SUPPLY, LAGGED 8 QUARTERS
II-
taa8-
7
i "
g 6Q.
SB "CT "6*T6a T7» T 7t T7ZT73 '74 ' 7S '76 '77 ' 7« ' 78 ' 88 '81 '«
QUARTERLY DATA
322
CHART 5.
This chart plots the monthly average of the Federal
funds rate—the overnight inter-bank interest rate, and percentage
changes in the Consumer Price Index (CPI) from twelve (12) months
ago.
It shows that monthly movements in the Federal funds rate
occur very closely together with changes in the inflation rate
measured from the same month a year ago.
This indicates that
even short-term interest rates are very powerfully affected by
immediate past inflation.
CHART 5
-18
CPI, PERCENT CHANGE YEAR TO YEAR
vs
FEDERAL FUNDS RATE CAT N . Y . BANKS}
-17
-16
-16
-14
-13
-12
II-
-II |-10 O
-9
-8
-7
-6
-5
-4
7B
' 7 1 ' 7 2 ' 73
' 74
MONTHLY DATA
[
76
76
77
78
' 78
LU
CL
CO
324
CHART 6.
This chart graphs year over year inflation (vertical
axis) against yearly unemployment averages (horizontal axis).
The top panel graphs the two concurrently,, the middle panel
lags unemployment 1 year, and the bottom panel lags inflation
one year.
The concurrent panel (6A) reveals that the so-called Phillips
curve is unstable.
On average, the trade-off was highly
favorable from 1954 to 1965 but has worsened significantly
since then.
The middle panel (6B) reveals much the same story.
Specifically,
for an arbitrarily selected unemployment rate, the rate of
inflation the following year is much higher today than it was
in the 1950s and early 1960s.
Finally, the evidence plotted in the lower panel (6C1 reinforces
this story.
As indicated here, there is even some tendency for
accelerating inflation to be followed by higher unemployment.
Viewed together with Chart 1, these three panels show that unemployment cannot be reduced by accelerating money growth and
inflation.
The only enduring result of faster money growth is
higher inflation.
325
INFLATION vs UNB1PLOYMENT (NEITHER LAGGED)
CHART 6A
12.8
-i
YEARLY AVERAGE OF MONTHLY DATA
1954 - 1979
S.S
6.5
UNEMPLOYMENT RATE
CHART 6B
12.C -|
INFLATION vs UNEnPLOYHEHT (LAGGED 1 YEAR)
YEARLY AVERAGE OF MONTHLY DATA
1954 -
CHART 6C
12.0 -i
INFLATION (LAGGED 1 YEAR) vs UNEMPLOYT1ENT
YEARLY AVERAGE OF MONTHLY DATA
1954 - 1979
S.S
0.S
UNEMPLOYMENT RATE
@FedFRASER