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CONDUCT OF MONETARY POLICY
(Pursuant to the Full Employment and Balanced Growth
Act of 1978, P.L. 95-523)
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-SEVENTH CONGEESS
FIRST SESSION
JULY 14, 21, 22, AND 23, 1981
Serial No. 97-17
Printed for the use of the
Committee on Banking, Finance and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON: 1981
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST GERMAIN, Rhode Island, Chairman
HENRY S. REUSS, Wisconsin
J. WILLIAM STANTON, Ohio
HENRY B. GONZALEZ, Texas
CHALMERS P. WYLIE, Ohio
STEWART B. McKINNEY, Connecticut
JOSEPH G. MINISH, New Jersey
GEORGE HANSEN, Idaho
FRANK ANNUNZIO, Illinois
JIM LEACH, Iowa
PARREN J. MITCHELL, Maryland
WALTER E. FAUNTROY, District of
THOMAS B. EVANS, JR., Delaware
Columbia
RON PAUL, Texas
STEPHEN L. NEAL, North Carolina
ED BETHUNE, Arkansas
JERRY M. PATTERSON, California
NORMAN D. SHUMWAY, California
JAMES J. BLANCHARD, Michigan
STAN PARRIS, Virginia
ED WEBER, Ohio
CARROLL HUBBARD, JR., Kentucky
JOHN J. LAFALCE, New York
BILL McCOLLUM, Florida
DAVID W. EVANS, Indiana
GREGORY W. CARMAN, New York
NORMAN E. D'AMOURS, New Hampshire
GEORGE C. WORTLEY, New York
STANLEY N. LUNDINE, New York
MARGE ROUKEMA, New Jersey
MARY ROSE OAKAR, Ohio
BILL LOWERY, California
JIM MATTOX, Texas
JAMES K. COYNE, Pennsylvania
BRUCE F. VENTO, Minnesota
DOUGLAS K. BEREUTER, Nebraska
DOUG BARNARD, JR., Georgia
ROBERT GARCIA, New York
MIKE LOWRY, Washington
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland
PAUL NELSON, Clerk and Staff Director
MICHAEL P. FLAHERTY, General Counsel
JAMES C. SIVON, Minority Staff Director
(II)
CONTENTS
Page
Hearings held on:
July 14, 1981
July 21, 1981
July 22, 1981
July 23, 1981
1
157
327
419
STATEMENTS
Coan, Carl, legislative counsel, National Housing Conference
Connell, Hon. Lawrence, Chairman, National Credit Union Administration
Board
Fry, Paul, executive assistant director of finance and administration, American Public Power Association
Mehle, Roger W., Assistant Secretary of the Treasury for Domestic Finance ....
Mullins, Robert, director of legislation, National Farmers Union
Pratt, Hon. Richard T., Chairman, Federal Home Loan Bank Board
Samuel, Howard, president, Industrial Union Department, AFL-CIO
Sprague, Hon. Irvine H., Chairman, Federal Deposit Insurance Corporation
Sprinkel, Hon. Beryl, Under Secretary of the Treasury for Monetary Affairs ...
Stafford, William, executive assistant to the mayor of Seattle, representing
the U.S. Conference of Mayors
Turner, J. C, International Union of Operating Engineers, AFL-CIO
Volcker, Hon. Paul A., Chairman, Federal Reserve Board
343
64
361
436
345
35
364
3
428
362
328
163
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD
Articles from various publications regarding bank mergers:
"Analysts Expect More Mergers Among Oil Companies," Wall Street
Journal
"Canada Asks Banks To Reduce Their Loans Used for Takeovers," Wall
Street Journal, July 30, 1981
"Mergers Are Not Growth," editorial, Business Week magazine, August
10, 1981
"Overlapping Shareholdings Pervade Competition for Control of Conoco,"
Wall Street Journal
"Poor Little Rich Banks," Economist magazine, July 25, 1981
"The New Urge To Merge," Newsweek magazine, July 27, 1981
Connell, Hon. Lawrence, prepared statement on behalf of the National Credit
Union Administration
Hansen, Hon. George, opening statement, hearing of July 23, 1981
Mullins, Robert, prepared statement on behalf of the National Farmers
Union
National Association of Realtors, statement on behalf of by Dr. Jack Carlson,
executive vice president and chief economist, dated July 24, 1981
Pratt, Hon. Richard T.:
Prepared statement on behalf of the Federal Home Loan Bank Board
Response to the request for additional information from:
Congressman Jim Mattox
Congressman Bill Patman
Congressman J. William Stanton
Response to written questions submitted by:
Congressman Chalmers P. Wylie
Congressman Bill Lowery
nil)
311
298
308
309
306
299
67
425
347
395
38
129
146
109
493
497
St Germain, Chairman Fernand J:
Letters:
Dated June 12, 1981, to Mr. Anthony M. Solomon, president, Federal
Reserve Bank of New York, regarding Federal Reserve repurchase
agreement transactions
Response of Mr. Solomon, dated July 7, 1981
Dated July 15, 1981, to Chairman Volcker, regarding financings involving the takeovers of large corporations
Newspaper articles:
"Chase and Citibank Help Raise Billions in Takeover Stakes," New
York Times, July 14, 1981
"Clarifying Some Mixed Signals on Antitrust Law," New York
Times, July 19, 1981
"Credit Needs Cited for Oil Industry," New York Times, June 3,
1981
"High Borrowing Costs Fail To Stem Interest in Takeover Activity,"
Wall Street Journal, July 7, 1981
"Merger Boom Finds Bank Loans Plentiful, Sparking Fear on Credit
Markets' Health," Wall Street Journal, July 14, 1981
"S.E.C.'s Chief Gives Blessing to Mergers," New York Times, July 14,
1981
" 'Sweeping Legislative Changes' Urged by FHLBB Chief To Aid S. &
L.'s," from Washington Financial Reports, article submitted in regard
to colloquy with Mr. Pratt
Sprague, Hon. Irvine H.:
Prepared statement entitled "State of the Banking Industry and the
FDIC Ability To Handle Problems"
Response to request for additional information from Congressman Ron
Paul
Sprinkel, Hon. Beryl, response to written questions submitted by:
Congressman Hansen
Congressman Lowery
.'.
Turner, J. C, joint prepared statement on behalf of the International Union
of Operating Engineers; Carl Coan on behalf of the National Housing
Conference; Robert Mullins on behalf of the National Farmers Union; Paul
Fry on behalf of the American Public Power Association; William Stafford
on behalf of the U.S. Conference of Mayors; and Howard Samuel on behalf
of the Industrial Union Department of the AFL-CIO
United Automobile Workers, Detroit, Mich., letter dated July 22, 1981, from
President Douglas A. Fraser, re the restrictive monetary policy of the
Federal Reserve Board
Volcker, Hon. Paul A.:
Prepared statement
Response to request for additional information from Chairman Fernand
J. St Germain
Response to written questions of:
Congresswoman Marge Roukema
Congressman Bill Lowery
r.
Congressman Douglas K. Bereuter
pa e
s
253
255
190
199
192
194
195
197
201
141
6
115
488
490
330
411
170
203
312
313
325
CONDUCT OF MONETARY POLICY
TUESDAY, JULY 14, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:35 a.m. in room 2128 of the Rayburn
House Office Building; Hon. Fernand J. St Germain (chairman of
the committee) presiding.
Present: Representatives St Germain, Gonzalez, Minish, Annunzio, Blanchard, LaFalce, Oakar, Mattox, Vento, Barnard, Schumer,
W. Coyne, Stanton, Wylie, Leach, Paul, Shumway, Weber, McCollum, Carman, Wortley, Roukema, Lowery, and J. Coyne.
The CHAIRMAN. The committee will come to order.
Most of 1980, and all of 1981, interest rates have been at intolerably high double-digit levels. As a result, mutual savings banks and
savings and loan associations, and some banks and credit unions,
are suffering serious reductions in their ability to extend needed
credit to important sectors of our Nation's economy. Their financial soundness may also be falling into jeopardy. It is this aspect of
the conduct of monetary policy that will be explored in today's
hearing, the first of several by the House Committee on Banking,
Finance and Urban Affairs in its semiannual monetary policy
hearings held pursuant to the Full Employment and Balanced
Growth Act of 1978.
Almost every day now I see press reports on the plight of the
thrift industry. Rumors and conflicting statements abound, and in
some instances, aggravate public concern and confusion. This
spring, this committee stood ready to act quickly in a full bipartisan manner to consider solutions to the thrift industry problem.
At that time, this committee was asked, in the most urgent
terms, by the Federal Reserve, Federal Deposit Insurance Corporation, Federal Home Loan Bank Board, and the National Credit
Union Administration, to consider statutory changes to broaden
their merger and acquisition authorities, and to expand the resources of the Federal deposit insurance funds. Mr. Stanton and I
met on several occasions with the regulators individually, the
Chairman of the Federal Reserve, and informally with newly appointed administration officials, beginning with Secretary Regan,
and with our counterparts in the Senate, concerning draft legislation.
Mr. Stanton and I arranged for full briefings of committee members and staff by agency representators on the so-called regulators'
bill. Given the circumstances facing depository institutions, as they
were explained to me, the regulators' bill seemed to contain needed
statutory changes. Unfortunately, inflammatory statements by
(l)
high-ranking administration officials culminated in a Treasury Department veto. This, combined with trade association turf battles
and the inability of the agencies concerned to stay together, halted
further consideration of the legislation.
Now, all attention is on the "All Savers Act." However, this
legislation possibly might not be enacted or it may not be a full
solution, leaving us back where we began—in a situation of punishingly high interest rates, thrift institutions with serious problems,
and no mechanism or solution in hand.
To assure the availability of at least one support capability, I
have since last November tried to get the Federal Reserve to
comply with the terms of the Monetary Control Act and offer
discount window credit to thrift institutions on the same terms as
those offered to banks. Recently, I again wrote to Chairman
Volcker, stressing my concerns in this regard, and I expect to
question him next week on this issue.
Further confusing the matter is the Federal Home Loan Bank
Board's latest draft legislation. Rather than addressing the shortrun problem, the bill would bring about a long-term restructuring
of thrifts overnight, destroying the last vestige of a specialized
mortgage finance supplier. I look forward to a full exploration of
the rationale for this changed emphasis, in the weeks and months
ahead.
As the heads of the Federal deposit insuring agencies, gentlemen,
you have been asked to report to this committee on the present
condition of the institutions under your respective jurisdictions,
and provide us your best judgment as to the impact of current and
projected monetary policy on the conditions of those institutions.
Because interest rate levels will be a critical determinant of depository institution well-being, and since you have little control over
future rates, we have asked you to evaluate future safety and
soundness in the context of the three interest rate scenarios developed by the Banking Committee staff. These include: A high rate
scenario, in which the 6-month Treasury bill rate is assumed to
rise from its present level to 16 percent by year end, decline to 14
percent in 1982, and continue to average 14 percent through 1983;
a second scenario, which assumes the 6-month Treasury bill rate
declines to 12 percent by yearend 1981, and averages 12 percent
through 1982; and a euphoric scenario, in which the 6-month Treasury bill rate declines to 7.5 percent by yearend 1981, and averages
7.5 percent through 1983.
Lastly, we would appreciate hearing an explanation of your contingency plans and your recommendations as to how the problems
facing depository institutions in a tight money, high interest rate
environment should be dealt with by the present administration.
I will now call on Mr. Stanton, our ranking minority member.
Mr. STANTON. Thank you, Mr. Chairman.
I join you in the opening of these hearings, which will have as
their primary goal the intention to place emphasis on the effect of
current monetary policy on depository institutions, and their ability to deliver credit to the various sectors of the economy. I think in
this regard, Mr. Chairman, it is well to keep in mind that President Reagan's programs, as announced originally on February 18,
addressed as part of the four-point program this very subject. As a
'6
matter of fact, each of the four elements of the President's program
should have a substantial, substantive, and positive impact on the
ability of insured depository institutions to survive, and to adapt
successfully to rapid changing market conditions in the years
ahead.
Employment of a stable, noninflationary monetary policy offers
the single best hope of restoring sufficient stability to the long-term
money markets, and to permit depository institutions to offer mortgages and other long-term financing at predictable interest rates,
once again. The President's effort to check the rate of growth of
Federal spending will benefit the depository institutions by controlling the Federal deficit, while the consequent pressures upon the
Treasury and the Federal Reserve to finance the deficits, in competition with depository institutions and private lenders, will be
alleviated.
Mr. Chairman, you did allude to the conversations and the cooperation, and coordination that we had with the regulatory agencies
led by the Federal Reserve Board, here several months ago, in
regard to their requests for additional powers. I join you in expressing my regret that we did not succeed at that time in furthering
the desires and hopes of the regulators. We were united in this
effort, members of both sides of the political aisle, not only here in
the House, but I think we had almost unanimous cooperation from
the other body. It is regrettable that we did not separate the
questions of the emergency legislation that the regulators asked for
from the additional powers that the Federal Home Loan Bank
Board has now requested.
But we are, and I am sure you join me, Mr. Chairman—realists,
and take things as they come. So we will proceed today to take a
look at what the regulators have to say in these hearings. Hopefully, out of the next few weeks of hearings, we can pursue a policy
that would be best for our constituency, the country, and the world
as a whole.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Mr. Stanton.
At this time, I would call upon our witnesses. We have Chairman
Pratt, Chairman Connell, and Chairman Sprague.
We will hear from Chairman Sprague, first.
STATEMENT OF HON. IRVINE H. SPRAGUE, CHAIRMAN,
FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. SPRAGUE. Thank you, Mr. Chairman.
I am grateful to be invited here today. As you know, I always
welcome an opportunity to return to the House, which was my
home for some 25 years, in various capacities.
Mr. Stanton, I am pleased to see you participating. I applaud
your opening comment. I think I should recognize the fact that my
hometown Congressman, Norm Shumway, is present. So we have
two Stocktonians in the room today.
You specifically asked me to discuss current contingency planning efforts, and to make a statement of the adequacy of our
resources.
Mr. Chairman, it has been 31 long years since the Congress has
addressed our powers to handle failed or failing institutions. In
these decades, the fund has increased from $1.2 billion to $11.5
billion. Banking assets have increased from $192 billion to over $2
trillion. Insured deposits have increased from $91 billion to $948
billion. Our insurance coverage has increased from $10,000 to
$100,000. Thirty years ago, we had 262 banks, with assets over $100
million; today, there are 1,919. Thirty years ago, there were 18
banks with assets of $1 billion or more; today, there are 228.
In this period, banking has taken on an enormous new dimension of complexity and sophistication. Technology, transportation,
telecommunications, and computers have revolutionized the banking industry. Worldwide competitive pressures and the continuing
volatile economic environment insure that this change of pace will
continue.
The FDIC now has seven basic options in handling failed or
failing banks. We have utilized these 577 times in the Corporation's
history. They are described in detail in my statement. While these
procedures have served us well over the years, they are insufficient
today, and we ask you to provide us with two additional tools to
help us do our job in today's environment:
First, we seek authority to make capital infusion in instances
where severe financial conditions exist which threaten the stability
of a significant number of insured banks. Today, in order to make
this capital infusion, we must find that an institution is essential
to its community before providing such aid. The language is, very
frankly, designed to provide us the option of providing capital
assistance to the New York thrifts.
Second, we seek authority to make an out-of-State merger of a
failed institution having over $2 billion in assets. Only 107 institutions in the Nation would be eligible.
These authorities parallel ability of the Federal Savings and
Loan Insurance Corporation that it already has for Federal institutions. Granting these powers would enable the FDIC to better do
its job of protecting the insured depositors of America. It would
preserve our fund, and would result in a materially lesser impact
on the Federal budget than in proceeding solely with our present
authorities. It is not designed as a bailout of savings banks. Even
with the new authority, some banks certainly will ultimately fail
under adverse interest rate scenarios. We ask you to act now on
these two modest provisions.
I notice that Mr. Pratt and Mr. Connell, who are with me here
today, are also seeking some emergency provisions, along with the
major restructuring of their industries. I suggest that a reasonable
approach would be to take our bill as the framework, and add to it
the credit union sections relating to mergers of institutions with
dissimilar bonds, and the Bank Board provisions, expanding its
present authority for out-of-State mergers.
This would basically be the regulator bill that we discussed with
you earlier. You could then deliberate and consider all of the turf
battles involved in adding much larger powers to the institutions.
I submit that if we hold up the emergency bill for this broader
legislation, it would take all summer just to read it, let alone pass
it. I think we do not have the option of waiting that long. You have
the ultimate responsibility, and you have three basic options:
First, you can pass our legislation. If we didn't need it, it would
not be used; it would self-destruct in a few years. Nobody would be
harmed. You would have acted responsibly.
The second option would be for you to pass the legislation. We
need it, we use it, and again, you have acted responsibly.
The third option would be for you not to pass the legislation—
and we need it.
I would be pleased to respond to any questions.
The CHAIRMAN. Thank you, Mr. Sprague.
Now we will hear from Mr. Pratt of the Federal Home Loan
Bank Board.
Excuse me. I noted that Mr. Sprague summarized his statement.
Therefore, without objection, we will put his entire statement into
the record.
[On behalf of the Federal Deposit Insurance Corporation, Mr.
Sprague submitted a prepared statement entitled ''State of the
Banking Industry and FDIC Ability To Handle Problems" for inclusion in the record. The statement follows:]
STATEMENT
BY
IRVINE H. SPRAGUE, CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
It is good to be here today to give you our view of the
state of the banking industry and our ability to handle problems that might arise.
I can report that our nation's banking system is fundamentally sound.
Americans can continue to bank with confidence.
But we need to remain vigilant.
There are problems, particu-
larly in the savings banks, as you know.
We must improve our
capacity to respond to any eventuality.
You specifically asked me to discuss "current contingency
planning efforts and a statement as to adequacy of resources
available to you to respond to all predictable contingencies."
Your request is mast timely.
We would be derelict in not
saying that this matter is uppermost in our minds too.
I refer
to the need to expand our powers to deal with failed bank and
failing bank situations.
We have been working under virtually the same provisions
of law for 31 years.
In these three decades, our insurance fund has grown from
$1.2 billion to $11.5 billion.
The amount of assets in the
banking system has increased from $192 billion to more than
$2 trillion.
The total of insured deposits has risen from
$91.4 billion to $948.7 billion.
The statutory amount of
deposit insurance has been increased from $10,000 to $100,000.
In 1950, there were 262 banks of more than $100 million
in assets.
In 1981 there are 1,919.
Thirty-one years ago
there were just 18 banks of more than $1 billion in assets.
Today there are 228.
Banking has taken on enormous new dimensions of complexity
and sophistication.
Technology, including vast improvements
in transportation systems, telecommunications, and computers,
has revolutionized the banking industry.
And there is no
indication that the pace of change will slow down.
To the
contrary, intense, worldwide competitive pressures and the
continuing volatile economic environment make it more likely
than ever that precipitous change will continue.
Yet, we are being asked to monitor the banking world in
the jet age with nothing more than the tools that served us in
banking's horse and buggy days.
We are at present in the process of managing the phase out
of interest rate ceilings as mandated in the Depository Institutions Deregulation and Monetary Control Act of 1980.
The
Depository Institutions Deregulation Committee three weeks ago
voted to take actions effective August 1 that will make long
steps in that direction.
An important part of our task is to
oversee the transition of thrifts to a deregulated environment,
the likes of which they have never experienced.
Yet, we have had no major changes in a fundamental area of
FDIC jurisdiction since the enactment of the Federal Deposit
Insurance Act of 1950, which included for the first time Section
13(c) power to make capital infusions to failing banks under
very restricted circumstances.
The only other change in
-3this area since then occurred with passage of the International Banking Act of 1978, which extended our failed and
failing bank authority to insured branches of foreign banks.
FAILED OR NEAR-FAILING BANK OPTIONS
The FDIC now has seven options for handling failed or near
failing banks.
First, FDIC can pay off insured depositors of
a failed bank.
This was done, for example, earlier this year
in the failure of The Des Plaines Bank, Des Plaines, Illinois,
and it was done in three bank failures in 1980 and three in
1979.
In the Des Plaines case, the bank had total deposits
of $42.9 million in 15,000 accounts. In a payoff, depositors
are paid to the statutory limit of $100,000.
Account holders
with deposits exceeding the limit and other creditors receive
a pro rata share of the proceeds from the liquidation of the
bank's assets over a period of years.
FDIC's second option is what we call a purchase and
assumption (P&A) transaction between banking organizations in
the same State.
Healthy existing banking organizations or new
organizations bid to assume the deposit liabilities of the
failed bank and to purchase certain assets and the failed bank's
goodwill.
Such transactions have been arranged in three cases
this year and seven times each in 1980 and 1979.
One notable
example of this procedure occurred in 1973 when the $1.3 billion
United States National Bank of San Diego, California, failed.
There, FDIC as Receiver of the bank, arranged a purchase and
-4assumption transaction in which Crocker National Bank was the
successful bidder,
A purchase and assumption transaction by
law must be projected to be less expensive than a payoff.
In
practice, such transactions have also proved to be less
disruptive.
Depositors and other general creditors recover
all their funds, and banking service continues with little or
no interruption, normally at the same location.
A third option takes the form of a purchase and assumption transaction involving foreign interests.
This has
occurred six times, the most highly publicized in 1974 after
the failure of the Franklin National Bank in New York.
Franklin, at the time of its failure, had over $3.6 billion
in assets and $1,4 billion in deposits.
It was sold to
European American Bank & Trust Company, which is owned by a
consortium of European banks.
A fourth option, also a variation of the purchase and
assumption procedure, is to partition the failed bank's
assets and liabilities and arrange for the transfer of assetliability packages to more than one participating bank.
This
occurred after the 1978 failure of the $607.6 million Banco
Credito y Ahorro Ponceno of Ponce, Puerto Rico.
FDIC divided
the bank between two assuming banks which lessened the anticompetitive effects of the transaction.
FDIC's fifth option, under very limited circumstances,
is to provide assistance in order to prevent the failure of a
troubled bank.
This has occurred only five times since FDIC
received the power in 1950, most recently last year when FDIC,
10
-5along with 27 banks, loaned the First Pennsylvania Bank $500
million to avert its failure.
As a condition to receiving
FDIC assistance, all directors and principal officers serve
subject to FDIC approval, and FDIC must approve their compensation.
FDIC also must sanction any dividends and the bank's
"plans and objectives".
FDIC also received warrants for the
purchase of First Pennsylvania Corporation's common stock.
These are some of the key conditions which we tailored for
the First Pennsylvania assistance.
In another such case, we
would expect to develop a similar but separate set of terms
and conditions as necessary to meet the situation.
A sixth option, under Section 13(e) of the FDI Act,
involves assistance to facilitate the merger of a failing
bank into a healthy bank prior to actual failure, but this
procedure is rarely used for a variety of reasons.
The
most recent instance was in November, 1975, when the Corporation authorized a loan of up to $10 million to facilitate the
merger of Palmer First National Bank and Trust Company of
Sarasota, Florida, into a newly formed national bank subsidiary
of Southeast Banking Corporation of Miami, after written confirmations were received from the Comptroller of the Currency
and the Board of Governors of the Federal Reserve System that
such assistance was essential to effect the proposed acquisition and to prevent the imminent failure of the Palmer Bank.
A seventh option is a Deposit Insurance National Bank
(DINB).
The DINB would serve solely as a vehicle for the orderly
payoff of insured deposits.
In 1975 the Corporation established
-6two DINB's in connection with the closings of the Swope ParkwayNational Bank, Kansas City, Missouri, and The Peoples Bank of
the Virgin Islands, St. Thomas, Charlotte Amalie, Virgin Islands.
PROPOSED LEGISLATION
We have proposed to the Congress and solicit your active
and aggressive support for legislation to provide an eighth and
ninth option:
to modify the statutory Section 13(c) test to
enable us to make capital infusions more easily, particularly
in the New York thrifts, and to permit FDIC as the Receiver of
a large failed FDIC-insured bank to arrange a Section 13(e)
purchase and assumption transaction with an out-of-State
institution, but only if the failed bank had $2 billion or
more in assets.
—
Only 107 banks in the Nation would be eligible
89 commercial and 18 savings banks in 26 States, concentrated
in New York, California, Ohio, Texas, Pennsylvania and Illinois.
The qualifying size is indexed so inflation will not artificially
increase the universe of eligible institutions.
The other 15,000
smaller banks in the nation would not be affected and have no
reason whatsoever to oppose our seeking a large bank solution.
Our legislation is designed to give FDIC powers which are
similar to those that the Federal Savings and Loan Insurance
Corporation (FSLIC) already has.
Currently, FSLIC may provide
assistance to an insured S&L even if the association is not
essential to its community and FSLIC may assist the merger of
a failing insured S&L with an out-of-State Federal S&L.
proposed legislation gives FDIC similar capabilities.
The
Because
12
-7of the unique nature of the various financial institutions,
total comparability between FSLIC and FDIC powers probably
is not desirable.
Our legislation, however, will provide
greater comparability between the two insuring agencies.
In the case of the failure of a bank of qualifying size,
FDIC could consider this new alternative for arranging a purchase and assumption transaction, together with all the other
possible courses of action.
The interstate option would permit
the FDIC to consider a course that would produce a meaningful
purchase premium for assets, avoid anticompetitive effects and
continue banking service.
Under the interstate option the FDIC would be required
to inform the State banking superintendent in advance whenever
the FDIC determines that the interstate option might be used.
This is true whether a national or State-chartered bank is
involved.
If the State superintendent objects to an out-of-State
transaction and FDIC agrees with the superintendent's reasons,
then FDIC would abandon the interstate option and attempt to
arrange an in-State purchase and assumption transaction or
proceed with an insurance pay off.
The FDIC can go forward
with the interstate option, the superintendent's objections
notwithstanding.
However, before any out-of-State transaction
may be made, the Board of Directors of the FDIC must unanimously
agree on the decision.
The Board also must provide the super-
intendent with a written certification of its determination.
Under the interstate option, FDIC as the Receiver of a
failed bank of qualifying size would solicit offers from any
13
-8bank and bank holding companies in the country that the FDIC
determines are qualified and capable of acquiring assets and
liabilities of the failed bank.
If the highest acceptable bid
is from an out-of-State bank or bank holding company, the FDIC
must provide the highest in-State offeror an opportunity to make
a higher offer.
must accept.
If the in-State offeror offers more, then FDIC
If the in-State offeror does not, FDIC must give
the same opportunity to the highest offeror from a State adjoining the State in which the closed bank was located.
If the
adjacent State offeror also declines, then the FDIC may accept
the high bid, regardless of the location of the bidder.
This section of the bill would provide that a winning outof-State bidder may reopen a closed bank only as a subsidiary
so that no interstate branching will result.
State banking law
will prevail in the operation of the subsidiary.
The section
would authorize operation of the subsidiary, the Douglas Amendment notwithstanding.
The section also would require that
before any sale may be accomplished, appropriate State and
Federal approvals must be obtained.
For instance, a bank hold-
ing company must have approval of the Federal Reserve to acquire
assets of a closed bank as a subsidiary.
The section would pro-
hibit FDIC from making any sale that would have serious anticompetitive results.
Finally, the section has a five-year
sunset provision.
The other basic change in our law would enable the FDIC
to provide assistance to institutions whose problems stem
principally from such causes as the interest rate squeeze.
14
-y-
Currently, the FDIC can provide assistance to a bank only
when it is in danger of failing and its continued operation is
essential to provide adequate banking services in the community.
The bill would modify FDIC powers to permit it also to act when
it finds that severe financial conditions exist which threaten
the stability of a significant number of insured banks and it
is probable that any assistance to one of these threatened banks
will substantially reduce the risk of loss or avert a threatened
loss to the FDIC.
This new test for assistance provides the FDIC
with the needed flexibility to react to severe financial conditions as they arise.
Unlike the current test which focuses
exclusively on the essentiality of a single failing institution,
the proposed new test focuses on severe financial conditions
affecting the stability of a significant number of insured banks.
Significance may be measured not only in terms of the total number
of institutions, but also in terms of the total resources of the
threatened institutions.
In every instance, FDIC could provide
assistance only where such action "will substantially reduce the
risk of loss or avert a threatened loss to the Corporation".
Essentially, this means that to qualify for assistance a bank
must be among a significant number of banks whose stability is
threatened by severe financial conditions, there must be a clear
threat that without assistance the bank will fail, and it is
probable that assistance will be "substantially" less expensive
to the FDIC than other methods of handling the potential fail* lure.
15
-10In addition to the two basic FDIC provisions, the proposed
legislation makes related changes in our law to make the total
process more workable.
(A).
These are:
A provision that would clarify that foregone earnings
resulting from FDIC loans to insured institutions are insurance
losses.
Currently, FDIC may deduct from assessments received
from insured banks any insurance losses it experiences before
calculating the proportion of the assessments to rebate to the
banks.
For example, in a typical purchase and assumption trans-
action, that portion of projected losses not recovered by the
purchase premium would be established as a reserve account and
charged against assessment income.
In other words, the FDIC
would experience an insurance loss that may be deducted from
assessments.
A below-market-rate loan also would result in
a loss to the FDIC of the difference between what FDIC could
earn on the funds if left in FDIC's portfolio and what it is
earning from the loan.
This opportunity loss is no different
from a loss arising from a P&A.
The structure of the trans-
action should not determine whether a loss can be recognized
for insurance fund purposes.
The FDIC seeks to clarify that
this opportunity loss also is deductible from assessments.
The FDIC is totally self-funded —
that is, funded by bank
assessments and interest income rather than by public monies.
This amendment will facilitate that result continuing.
(B).
A provision that would broaden the.field of insti-
tutions which may purchase the assets and assume the liabilities
of a failed bank.
In addition to FDIC-insured banks, under the
16
-liproposal associations or banks insured by the Federal Savings
and Loan Insurance Corporation would become eligible bidders.
BUDGETARY PROBLEMS
We are fully aware of the budget problems facing our
government and we believe our proposed legislation will minimize the budgetary impact of future bank failures.
While we
have a separate fund, every expenditure of the FDIC represents
a Federal expenditure and has a budgetary impact.
We believe
the powers we are asking for will result in a .smaller outlay
and lower cost to the FDIC than if we are forced to use only
the alternatives now available to us.
By minimizing FDIC's
costs, we will, in turn, minimize the potential budgetary
impact of future failures.
NEED TO ACT NOW
We are talking today about emergency legislation to meet
a specific need.
The Congress will also be considering broad,
comprehensive and certainly controversial legislation to
greatly expand the authority of thrift institutions with commercial bank powers and to address such questions as due on
sale clauses, insurance limits, usury ceilings, plus possibly
export trading companies and other matters.
We urge you to keep the issues separate:
act now on the
limited emergency bill needed now; deliberate and act later on
the more comprehensive long term legislation.
17
-12THE STATE OF THE FDIC
Both the financial and human resources of the FDIC
remain strong, and we believe capable of dealing with any
foreseeable eventuality, given the requisite statutory flexibility.
Net income to our $11.5 billion insurance fund last
year topped the billion dollar mark for the first time with a
record $1.2 billion gain.
$1.3 billion.
This year we project net income of
We also are entitled to borrow $3 billion from
the Treasury if needed, although we do not anticipate it will be.
Our major resource is our corps of 3,500 skilled and
dedicated employees who remain committed to fulfillment of our
statutory mandate of promoting the safety and soundness of the
banking system while at the same time continually seeking ways
to do our job more efficiently.
The Corporation is well managed.
In 1979 our administrative expenditures increased just 3.4 percent, compared to 9.5 percent Government-wide.
In 1980 our
increase was 10.7 percent, compared to 17.3 percent throughout
Government.
Our 1981 outlays are well below our budget. One
example of the effort of our people to improve efficiency is
in the area of travel expenditures.
Our staff will travel an
estimated 16 million miles to carry out their bank examination
duties in 1981, a reduction of 12 percent from 1980, which was
itself a reduction of nine percent from 1979.
We are able to
achieve these savings by more careful scheduling of examinations
and by more efficient car pooling, and a spirit of cooperation
from our work force.
18
-13Supervisory Innovations:
Some examples of supervisory innova-
tions we have undertaken in recent years are as follows: (a)
our Division of Bank Supervision and the Division of Management
Systems and Financial Statistics developed a computerized
system, which we call our Integrated Monitoring System, for
the primary purpose of monitoring the activities of banks
between examinations to help us decide where best to allocate
our examiner time and resources.
With this system we have
been able to reduce the number of examinations conducted.
(b) the development of a modified examination concept, which
provides for the review of the safety and soundness essentials
of a well managed bank without requiring the comprehensive
detail of a full-scope examination. This program has enabled
us to reduce the time required to perform most examinations.
(c) in cooperation with individual States, we have significantly expanded the divided examination program so that we
presently participate with 20 States in divided examination
arrangements covering 3,400 banks, just over one-third of
all insured State nonmember banks with resultant substantial
savings.
(d) last year our Division of Bank Supervision
developed streamlined common application forms.
These are
now in joint use by the Corporation and 22 States, thereby
requiring a bank to complete only one form —
a form that
requires only essential information for any particular application.
This effort, together with closer cooperation with the
State in the processing of applications, has enabled us to
19
-14render more expeditious decisions on these applications and
reduced the time required by banks to complete the application.
Bank examination is the heart of our supervisory program
to promote the safety and soundness of the banking system.
The FDIC will continue to exercise a strong bank examination
function.
In 1981 we expect to conduct 5,800 safety and sound-
ness examinations.
Recent economic circumstances have created new and serious
problems for thrift institutions, including the insured mutual
savings banks which we supervise.
Late last year we established
an ongoing project team to monitor conditions in the thrift
industry and develop strategies and policies for addressing the
situation.
We have increased our supervision of these institu-
tions through increased examinations and visitations, more
timely and thorough reporting of financial developments by the
banks to the FDIC, and more frequent meetings and discussions
with the trustees of those institutions experiencing difficulties.
This has placed added burdens upon our resources; however, we are
able to meet the challenge largely because of our efforts to
develop a total supervisory program which has the built-in
flexibility to handle such situations when they arise.
EXPERIENCE OF 1980
The year 1980 was marked by substantial turbulence in
the nation's economy and credit markets.
Output and employ-
ment declined substantially in some vital sectors of the
economy.
The housing and auto industries were particularly
20
-15hard hit.
Inflation, as measured by indexes of consumer and
producer prices, continued to soar at double-digit rates.
These developments in the economy contributed to instability
in the financial sector, as reflected most notably in the
movement of interest rates.
The pattern of interest rate changes last year was unprecedented in recent history, both with respect to the magnitude
and frequency of change.
The prime rate, for example, rose
from 13.25 percent to a record 20 percent, decline^ to less than
11 percent and ended the year at a new record level of 21.5 percent.
These wide fluctuations and the unprecedented levels to
which interest rates rose imposed stresses on the economy and
the banking industry.
The high interest rates contributed to
a substantial growth in money market mutual funds during the
year.
During the first half of this year, we have seen a slight
reduction in the inflation rate and, during the second quarter,
some evidence of a slowing in the rate of economic activity.
Nevertheless, interest rates have remained at or near record
levels, thereby providing an uncomfortable environment for
some commercial banks and most thrift institutions.
MUTUAL SAVINGS BANKS
The mutual savings banks problem is centered in New York
City but not limited to that city.
Higher interest rates have
significantly increased the cost of savings bank deposits.
While yields on savings bank earning assets have risen, they
21
-16have done so much more slowly than deposit costs.
Assets are
heavily concentrated in long-term, fixed-rate mortgages and
bonds which turn over slowly.
The problem has been exacerbated
by slow deposit growth resulting from such causes as a low personal savings rate and increased competition from money market
funds and market instruments.
These conditions have severely
limited savings banks' ability to acquire higher-yielding assets.
Indeed, many savings banks are forced to use funds generated
from mortgage amortization payments to finance deposit outflows
and operating losses with little left over to invest in higher
yielding assets available in today's market.
Last year, FDIC-insured mutual savings banks in the
aggregate lost money.
The loss amounted to about 0.17 percent
of average assets compared with net income of about 0,45 percent of assets in 1979 and 0.59 percent in 1978.
not evenly spread throughout the country.
The loss was
New York City savings
banks, which account for about 40 percent of the deposits of
FDIC-insured thrift institutions, lost about 0.62 percent of
average assets last year.
However, the rest of the industry
had net income of about 0.17 percent.
The weaker performance
of many of the New York City savings banks reflects a combination of factors, the most significant being inflation and the
resultant high interest rates, but also including past restrictions on permissible lending, past restrictive usury ceilings,
unfavorable State and city tax treatment, relatively low mortgage activity, and a high degree of competition from large
money center institutions and money market funds.
22
-17During the first half of this year, savings bank earnings
have further deteriorated —
that is, losses have increased.
The FDIC has been collecting monthly income and deposit data
from those savings banks with deposits of $500 million or more
in order to monitor their performance closely.
These 79 insti-
tutions account for about 75 percent of all savings bank
deposits.
During the first five months of 1981, only 14 of the
large savings banks had positive net income and by May only 11
had positive operating income.
Overall, these 79 savings banks
lost a net $400 million even after taking account of Federal
tax credits and security gains from very selective asset sales.
If this loss were annualized, it would amount to 0.82 percent
of assets.
of the loss.
Savings banks in New York City accounted for much
On an annualized basis, their loss for the first
five months of this year was over 1.3 percent of assets and
for the month of May, the annualized loss was 1.55 percent
of assets.
It should be noted that smaller savings institu-
tions not included in our monthly survey generally are doing
better than the larger institutions though their performance
has also deteriorated this year.
Interest rate and deposit flow data for June suggest that
savings bank performance that month was at least as bad as in
May.
Savings bank earnings during the balance of the year
will be importantly affected by interest rates.
If rates
remain constant, or if they decline only slightly, deposit
costs will continue to rise as low-cost passbook accounts and
23
-187-1/2 and 7-3/4 percent certificates shift into higher-cost
deposits or leave institutions altogether.
There still remains an extremely large pool of mutual
savings t>ank capital available to sustain the industry for a
considerable period of years, although individual institutions
may well be troubled earlier if the present inflation and
interest rate environment continues.
If interest rates decline quickly and markedly and remain
low for a sustained period, most savings banks should be able
to adjust portfolio returns to bring them into line with the
market and make appropriate adjustments to attain a profitable
position. Savings banks then would have the opportunity to take
advantage of the broadened lending powers authorized under the
Depository Institutions Deregulations and Monetary Control Act
of 1980 and State laws to reduce their exposure to future
interest swings.
Thus far, prevailing financial market con-
ditions and other factors have made it difficult for savings
banks to take advantage of these broadened powers to any significant degree.
If unfavorable conditions persist in financial
markets for a prolonged period, then some savings banks are
likely to need assistance if they are to continue to operate.
Since we cannot predict the future course of interest
rates or other variables, we are unable to predict, as you
requested, if any large savings banks face the prospect of
failure or when such a prospect might begin to materialize.
24
-19CONDITION OF INSURED COMMERCIAL BANKS
Despite the conditions that prevailed in financial
markets throughout last year and the sharp drop in economic
activity during the second quarter of the year, most commercial banks performed quite well in 1980.
In the aggregate,
net income and assets grew by 10 percent.
Despite our earlier concerns and those of many financial
market observers regarding the position of smaller commercial
banks, most small banks —
$100 million —
those with deposits of less than
performed quite well in 1980.
We should note, however, that smaller banks have experienced
a sizable transfer of funds from low-cost deposits to money
market certificates and other more expensive deposits. Also,
many small banks hold large amounts of mortgages and other
long-term assets that would prevent them from raising their
return on assets sufficiently in the short run to compensate
for increased money costs.
Apparently, however, this was
not a problem in 1980.
For 1981, in addition to the rising costs of time and
savings deposits, universal NOW accounts have also put pressure
on bank costs.
Smaller banks, with a larger concentration in
retail deposits, seem more vulnerable to the increased costs
and competition associated with NOW accounts.
Another factor
that has become increasingly important is competition from
money market funds. Growth in retail time and savings
deposits at commercial banks has slowed markedly this year,
although not as dramatically as at thrifts, and competition
25
-20from money market funds undoubtedly played a very important
role in this development.
Again, small banks with a greater
emphasis on retail deposits may be more affected by this
development.
In assessing developments thus far in 1981, we are handicapped by the availability of data, particularly for small
banks.
We are just beginning to process mid-year reports which
should give us a better reading on their performance thus far
in 1981.
We are able to make some general observations based
on income reports for the first quarter of 1981, which are filed
by banks with assets of $300 million and over, and from published
financial statements of banks, although these tend to be more
available for the larger, publicly traded institutions.
First quarter data for the larger banks suggest that
they were able to maintain net interest margins despite the
rising costs of deposits.
Returns on assets appear to approx-
imate those realized in 1980 and published financial reports
indicated that year-to-year earnings improvement between the
first quarter of 1980 and the first quarter of 1981 approximated increases in assets.
For the second quarter of 1981, we look for a mixed performance for larger commercial banks.
Comparing the second
quarter of 1981 to the second quarter of 1980 may well show
almost as many minuses as pluses.
To some degree, this appears
to reflect the fact that the second quarter of 1980 was a very
strong quarter for large banks.
When interest rates declined
rapidly in the second-quarter of 1980, reduced money costs
26
-21actually widened interest margins at the money center banks.
That appears to be showing up now in the form of unfavorable
year-to-year comparisons.
As I indicated, we do not have as precise a reading on
the performance of smaller commercial banks.
Weaker deposit
performance and some of the other developments that I have
mentioned suggest that 1981 may not be quite as good a year
for small banks as 1980.
However, the information we have
received, including the comments from our various regional
offices, indicates that most small banks continue to be
performing well.
They apparently have been less vulnerable
to interest rate risk, at least as a group, than anticipated.
We must remain alert to any continued instability in
the economy, further competition for bank and thrift funds
from the unregulated sector of the financial markets, and the
weakened condition of other types of financial institutions
which will test the capabilities of bank managers, regulators,
and legislators throughout the year.
CONCLUSION
The banking scene today is fast-changing.
We at the
FDIC remain firm in our commitment to the people in monitoring
the safety and soundness of the banking system.
We believe
that the situation today warrants the revision in the tools of
our trade that we have outlined.
We urge your quick action.
27
TEXT OF LEGISLATION TO ACCOMPANY STATEMENT ON STATE OF BANKING INDUSTRY
AND FDIC ABILITY TO HANDLE PROBLEMS
A BILL
To provide flexibility to the Federal Deposit Insurance Corporation to deal with
financially distressed banks.
Be it enacted by the Senate and House of Representatives of the United
States of America in Congress assembled,
ASSISTANCE TO INSURED BANKS
SEC. 1.
Section 13 (c) of the Federal Deposit Insurance Act (12 U.S.C.
1823(c)) is amended to read as follows:
" (c) (1)
In order to reopen a closed insured bank or, when the Corpora-
tion has determined that an insured bank is in danger of closing, in order to
prevent such closing, the Corporation, in the discretion of its Board of Directors,
is authorized to make loans to, or purchase the assets of, or make deposits in,
such insured bank, upon such terms and conditions as the Board of Directors may
prescribe, when in the opinion of the Board of Directors the continued operation
of the bank is essential to provide- adequate banking service in the community.
" (2)
VJhenever severe financial conditions exist which threaten the sta-
bility of a significant number of insured banks, the Corporation, in the discretion of its Board of Directors, is authorized to make loans to, or purchase the
assets of, or make deposits in, any insured bank so threatened, upon such terms
and conditions as the Board of Directors may prescribe, if it is prcbable such
.action will substantially reduce the risk of loss or avert a threatened loss to
the Corporation.
" (3)
Any loans and deposits made pursuant to the provisions of this para-
graph may be in subordination to the rights of depositors and other creditors.".
28
PURCHASES OF INSURED BANKS
SEC. 2.
(a)
Section 13(e)' of the Federal Deposit Insurance Act (12 U.S.C.
1823(e)) is amended to read as follows:
"(e)(l)
Whenever in the judgment of the Board of Directors such action will
reduce the risk of loss or avert a threatened loss to the Corporation and will
facilitate a merger or consolidation of an insured bank with another insured depository institution or will facilitate the sale of the assets of an open or closed
insured bank to and assumption of its liabilities by another insured depository
institution,
the Corporation may, upon such terms and conditions as it may deter-
mine, make loans secured in whole or in
part by assets of an open or closed insured
bank, which loans may be in subordination to the rights of depositors and other
creditors, or the'Corporation may purchase any such assets or may guarantee any other
insured depository institution against loss by reason of its assuming the liabilities
and purchasing the assets of an open or closed insured bank.
Any insured national bank
or District bank, or the Corporation as receiver thereof, is authorized to contract
for such sales or loans and to pledge any assets of the bank to secure such loans.
(2)(A)
Whenever an insured bank that had total assets equal to or
greater than 0.12 percent of aggregate assets in domestic (U.S.) offices of insured banks (as determined from the most recently compiled Reports of Condition
filed by insured banks) is closed and the Corporation is appointed receiver,
•then", the Receiver may, in its discretion and upon such terms and conditions as
it may determine, and with such approvals as may elsewhere be required by any
State or Federal courts and supervisory agencies, sell assets of the closed bank
to and arrange for the assumption of the liabilities of the closed bank by an
insured depository institution located in the same State as that in which the
closed bank was chartered but owned by an out-of-State bank or bank holding company.
Notwithstanding subsection (d) of Section 3 of the Bank Holding Company
29
Act of 1956 or any other provision of law, State or Federal, the acquiring
institution is authorized to be and shall be operated as a subsidiary of the
dut-of-State bank or bank holding company; except that an insured bank may
operate the assuming institution as a subsidiary only if specifically authorized
by law other than this paragraph.
(B)
In determininq whether to arrange a sale of assets and assumption
of l i a b i l i t i e s of a closed insured bank under the authority of. this paragraph
(2), the Receiver may solicit such offers as is practicable from any prospective
purchasers i t determines, in i t s sole discretion, are both qualified and capable
of acquiring the assets and the l i a b i l i t i e s of the closed bank.
(i)
If, after receiving offers, the highest acceptable offer is from
a subsidiary of an out-of-State bank or bank holding company, the Receiver shall
permit the highest acceptable offeror of any existing in-State insured depository Institutions and subsidiaries of in-State bank holdinq companies to submit
a new offer for the assets and l i a b i l i t i e s of the closed bank.
If this institu-
tion reoffers a greater amount than the previous highest acceptable offer, then
the Receiver shall sell the assets and transfer the l i a b i l i t i e s of the closed
hank to that institution.
(ii)
If there is no acceptable offer received from an existinq in-
State depository institution or subsidiary of an in-State bank holding company,
or if there is no reoffer greater than the highest acceptable offer, then the
Receiver shall permit the highest acceptable offeror of the subsidiaries of the
30
insured banks chartered in States adjoininq the State in which the closed bank
vas chartered and bank holdina caTipanies whose banking subsidiaries' operations
are principally conducted in States adjoining the State in which the closed bank
was chartered (if its offer was not the hiqhest received by the Receiver) to
irake a new offer for the assets and liabilities of the closed bank. If this
subsidiary reoffers a greater anount than the previous highest acceptable offer
then the Receiver shall sell the assets and transfer the liabilities of the
closed bank to that institution.
(iii) If no offer under subparagraphs (i) or (ii) is received which
exceeds the original highest acceptable offer, then the Receiver shall sell the
assets and transfer the liabilities of the closed bank to the hiqhest acceptable
offeror.
(C) In jnakinq a determination to solicit offers under subparagaraph
(B), the State bank supervisor of the State in which the closed insured bank was
chartered shall be consulted. The State bank supervisor shall be given a rea<
sonable opportunity, and in no instance a period of less than twenty-four hours,
to object to the use of the provisions of this paragraph (2). If the State
supervisor objects, the Receiver may use'the authority of this paragraph (2)
only by a unanimous vote of the Board of Directors. The Board of Directors
shall provide to the State supervisor, as soon as practicable, a written certification of its determination.
31
(D) The Receiver shall not make any sale under the provisions of this
paragraph (2) —
(i) which would result in a monopoly, or which would be in fur-
therance of any combination or conspiracy to monopolize or to attempt to monopolize the business of banking in any part of the United States; or (ii) whose
effect in any section of the country may be substantially to lessen competition,
or to tend to create a monopoly, or which in any other manner would be in
restraint of trade, unless it finds that the anticompetitive effects of the proposed transaction are clearly outweighed in the public interest by the probable
effect of the transaction in meeting the convenience and needs of the community
to be served.
(E) Nothing contained in this paragraph (2) shall be construed to
limit the Corporation's powers in paragraph (1) to assist a transaction under
this paragraph.
(3) As used in this subsection —
(i) the term "Receiver" shall mean
the Corporation when it has been appointed the receiver of a closed insured
bank; (ii) the term "insured depository institution" shall mean an insured bank
or an association or bank insured by the Federal Savings and Loan Insurance
Corporation; (iii) the term "existing in-State insured depository institution"
shall mean an insured depository institution that is chartered in the same State
as the State in which the closed bank was chartered; (iv) the term "in-State
bank holding company" shall mean a bank holding company whose banking subsidi-.
aries' operations are principally conducted in the same State as the State in
which the closed bank was chartered; and (v) the term "out-of-State bank or bank
32
holding coirpany" shall mean an insured bank having its principal place of banking business in a State other than the State in which the closed bank was
chartered or a bank holding cornpany whose banking subsidiaries1 operations are
principally conducted in a State other than the State in which the closed bank
was chartered.1*
(b) The provisions of paragraph 2 of section 13 (e) of the Federal Deposit
Insurance Act shall cease to be effective five years fran the date of its enactment. The expiration of the effectiveness of section 13 (e) (2), however, shall
have no effect on the continued legality of any sale or operation authorized
while it was effective.
33
AGREEMENTS DIMINISHING THE
RIGHTS OF THE CORPORATION
SEC. 3. Section 13 of the Federal Deposit Insurance Act is amended by adding
at the end thereof the following new subsection:
" (h) No agreement which tends to diminish or defeat the right, title
or interest of the Corporation in any asset acquired by it under this section,
either as security for a loan or by purchase, shall be valid against the Corporation unless such agreement (1) shall be in writing, (2) shall have been executed by the bank and the person or persons claiming an adverse interest thereunder, (3) shall have been approved by the board of directors of the bank or its
loan conmittee, and (4) shall have been, continuously, fran the tire of its
execution, an official record of the bank."
34
FDIC ASSESSMENTS
SBC. 4. The third sentence of section 7(d) (1) of the Federal Deposit
Insurance Act (12 U.S.C. 1817(d) (1)) is amended —
(a) by striking out "and" the second place it appears; and
(b) by inserting before the period at the end thereof the following:
"; and (4) any lending costs for the calendar year, which shall be the difference
between the rate of interest earned, if any, frcm each loan made by the Corporation pursuant to section 13 after January 1, 1981 and the Corporation's average
investment portfolio yield for the calendar year.".
THE BANK HOLDING CCMPANY ACT OF 1956
SEC. 5. Section 3(d) of the Bank Holding Company Act of 1956 (12 U.S.C.
1842 (d)) is amended by adding after, the word "application" the following:
"(except an application filed as a result of a transaction to
be accomplished under section 13 (e) (2) of the Federal Deposit
/ Insurance Act (12 U.S.C. 1823(e) (2))".
35
The CHAIRMAN. NOW please proceed, Mr. Pratt.
STATEMENT OF HON. RICHARD T. PRATT, CHAIRMAN,
FEDERAL HOME LOAN BANK BOARD
Mr. PRATT. Thank you, Mr. Chairman, Mr. Stanton, and members of the committee.
I appreciate the opportunity to appear today on behalf of the
Federal Home Loan Bank Board to testify concerning monetary
policy and the present and projected conditions of the thrift industry. I will make a short opening statement, and ask that my
testimony be incorporated into the record.
The CHAIRMAN. Without objection, so ordered.
Mr. PRATT. First, we at the Federal Home Loan Bank Board
support the Federal Reserve and the monetary policy which it has
pursued. In our opinion, the Federal Reserve has done as good a job
as is possible, given the present circumstances, to assure that over
the long run, we are likely to have a low and stable level of
interest rates in this country, and one in which thrift institutions
can survive and prosper.
The present situation in which we find ourselves, which in the
last few years, has been characterized by a high level of inflation,
stemming from a variety of sources, has caused substantial problems, as you are all aware, for the thrift industry. This industry,
was of course structured historically on the basis of making long
term, fixed-interest-rate loans to home purchasers for the purpose
of housing America.
For many years, as a result of stable economic circumstances at
the time, they were able to obtain short-term funds, lend them long
term, and pick up a small margin by intermediating over this yield
curve. However, with the intervention of substantial inflation,
these institutions have found themselves with 6-, 7-, and 8-percent
interest rate loans still on their books, while the cost of new
money, as we know, has exceeded 14 and 15 percent; and for
wholesale funds, it may exceed 20 percent.
We believe that, given the changing circumstances of the economy, this industry is structurally unsuited to survive under the
present set of economic circumstances and competitive interfaces.
The dictates of this Congress—to wit, that these institutions should
pay open market competitive interest rates for their funds—have
made the current structure, which is highly restrictive on the asset
side and which precludes these institutions from competing on a
fair and equal basis with other financial institutions, one which
will guarantee the lack of thrift survivability and the lack of home
finance money in this country.
A drop in interest rates, of course, would have a tremendous
short-run impact in improving the position of all financial institutions today, especially the thrift institutions, which the Bank Board
regulates. However, despite that fact, I see no clear prescription for
the Federal Reserve which would automatically lead to an immediate lowering of interest rates.
It appears to us that the factors and the policy which they have
been following are best suited to accomplish that objective. From a
policy perspective, the current state of the thrift industry suggests
to us three basic things:
36
First, the efforts of the administration and of the Federal Reserve to bring inflation under control must be allowed to work. The
ultimate short-run solution is the lowering of interest rates and
returning to a position where financial intermediation, from short
to long again, makes some sense.
Second, as a means of crisis management, we believe it is vital
that the Congress provide the FSLIC with certain additional tools.
One of the most important of these would be to empower us to
allow FSLIC-insured institutions in financial difficulty to merge
with any other insured savings and loan or Federal savings bank,
or be acquired by any savings and loan holding company.
This would involve an override, in extraordinary circumstances,
of various State and Federal laws that are designed to inhibit the
interstate spread of financial institutions. Such laws, given the
diminished number of savings and loans interested in or capable of
participating in FSLIC-assisted mergers, are having the effect of
significantly increasing the cost of such mergers, and could lead to
unnecessary liquidations.
Another step would be to streamline our conservatorship and
receivership powers. The present approach of awaiting State action
is proving awkward and cumbersome. The current circumstances,
however, obviously put a premium on prompt resolution of problem
cases. In light of present conditions, we are convinced that legislation embodying these provisions, as well as those FSLIC-related
measures we described in the formal statement, would be enormously helpful in conserving FSLIC resources both in terms of
money and people.
The third policy direction in which the present situation points is
that of restructuring. Thrifts currently are in an essentially untenable situation, having undergone abrupt de facto deregulation of
their liability side without corresponding deregulation of the asset
side. As presently constituted, the industry is simply too vulnerable
to volatile economic conditions, lacking the asset side empowerments to compete successfully through all phases of the economic
cycle.
The Bank Board's restructuring proposals, which are outlined in
detail in my formal statement, are intended to insure that thrift
institutions can function over the long term as viable members of
the financial community. By speaking of the long term, however, I
do not wish to imply that congressional action can safely be delayed, but to indicate instead that our proposals would insure the
long-term presence of thrift institutions. The factors threatening
that presence are operating now and it is imperative that Congress
act rapidly to counter them.
That some of the powers that we propose, by their nature and as
a consequence of the debilitated state of the industry, will have a
certain lag time in their effectiveness, argues particularly strongly,
in our view, in favor of quick congressional consideration. If Congress does not act in the short run to address this matter, there
will be no long run for a very substantial segment of the thrift
industry.
We realize that the steps we are urging point toward a substantial breakdown in the legal differences between the powers granted
to thrifts and banks and will generate considerable concern regard-
37
ing the future of housing finance. While some thrift institutions
could be expected to turn away from mortgage finance, we believe
that the industry's expertise in the area, coupled with the ability to
make flexible rate loans and the prospect of great housing demand
over the rest of this decade, would result in the majority of thrifts
continuing as housing specialists.
Unless Congress is willing to provide comprehensive and effective controls, however, the level of this specialization must be
determined by each individual institution's evaluation of economic
opportunities. To continue with force specialization, given the current state of affairs, simply would be to risk the relatively rapid
elimination of very large numbers of thrift institutions.
Mr. Chairman, this concludes my remarks. I would be pleased to
answer any questions.
[Mr. Pratt's prepared statement, on behalf of the Federal Home
Loan Bank Board, follows:]
38
STATEMENT
OF
RICHARD T. PRATT
CHAIRMAN, FEDERAL HOME LOAN BANK BOARD
Mr. Chairman, Members of the Committee, I appreciate the
opportunity to appear today on behalf of the Federal Home Loan
Bank Board to testify concerning monetary policy and the present
and projected condition of the thrift industry.
In addition to
addressing these issues, my statement, as you requested, will deal
with the contingency planning and resources of the Federal Savings
and Loan Insurance Corporation and will contain, as well, proposals
for statutory changes that we believe are needed to permit the
Corporation to deal more effectively with periods of economic stress
such as we currently are experiencing.
We also will outline a
number of legislative steps that the Bank Board is convinced are
essential to help thrift institutions through their current troubles
and remain viable thereafter through all phases of the economic cycle.
INTEREST RATES AND S&L PROFITABILITY
The financial viability of S&Ls is acutely affected by the
state of financial markets because of an extreme sensitivity to
cyclical and secular movements in interest rates. Fluctuations in
open market interest rates that would be considered relatively
modest in today's financial environment can cause substantial
swings in thrift profitability.
The underlying cause of this
profit volatility is the asset-liability maturity imbalance of
thrifts.
The average maturity of assets held by thrifts—pre-
dominantly fixed-rate, long-term mortgages—greatly exceeds the
average maturity of S&L liabilities—predominantly six-month Money
Market Certificates (MMCs).
This maturity imbalance causes thrifts'
cost of funds to fluctuate more widely than their asset yields.
Consequently, profitability also fluctuates widely.
Maturity imbalance was an inconsequential problem in the
pre-1966 era when interest rates were extremely stable and inverted
yield curves were unknown.
Beginning in 1966, a more volatile
39
financial environment" emerged, but S&Ls were sheltered from that
environment by the imposition of fixed interest rate ceilings on
deposits.
Until June of 1978, when the MMC was introduced, thrifts'
cost of deposits did not fluctuate cyclically, in contrast to open
market rates. Thus, thrifts did not experience the extreme profit
volatility from which they currently are suffering.
The June 1978 introduction of the MMC—designed to moderate
disintermediation problems caused by competition from Treasury
bills and the newly emerging money market fund industry—gave
thrifts more stable deposit flows, but more volatile profitability.
The MMC transformed the S&L liability structure from a significant
reliance on long-term fixed-rate deposits to short-term market-indexed
deposits.
Additionally, the removal of limits on thrift usage of
large certificates of deposit ($100,000 and over) led to substantially
greater reliance on those short-term CDs for funds. Thus, the
maturity imbalance problem has been intensified substantially in
the past few years.
The increase in thrift sensitivity to open markets fluctuations
has coincided with an increase in the degree of volatility of open
market rates.
In 1978—a year of extreme rate volatility relative to
pre-1978 standards—the 91-day Treasury bill rate fluctuated in
the 6 1/2 percent to 9 percent range.
In 1980, however, weekly
average T-bill rates varied from less than 7 percent to almost 17
percent.
This increased rate volatility has occurred for a number of
reasons.
They include the change from fixed-rate to market-indexed
deposit rate ceilings, the October 1979 revision of monetary policy
procedures to emphasize monetary aggregates more than interest rates,
40.
the inflationary shocks caused by extremely large oil price increases in 1979, the imposition and removal of a credit control
program in 1980, and the substantial swings in the pace of real
economic activity.
Accordingly, thrifts 1 profitability problems are the result
of the interaction of the maturity imbalance of the assets and
liabilities of S&Ls and the volatility of open market interest
rates.
The increase in maturity imbalance and interest volatility
in recent years has had the consequence of increasing thrift profit volatility.
Exhibits 1 and 2 illustrate the degree of profit
volatility which S&Ls have experienced recently.
Exhibit 1 shows
that both interest rates and thrift profitability have become
more volatile over the past decade.
Exhibit 2 illustrates this
volatility on a monthly basis over the past year and a half.
The present dismal profitability characterizing the thrift
industry is caused by the current high level of interest rates.
If interest rates stay at present levels for the rest of this
year, the S&L industry will record 1981 after-tax operating losses
of $4 to $5 billion.
This poor profitability performance is wide-
spread; at present, over 74% of the firms in the industry are
experiencing losses.
We must emphasize, however, that the industry
overall has a strong net worth position of almost $31 billion.
MONETARY POLICY
While if interest rates were to drop by several hundred
basis points, the losses projected for S&Ls would be substantially
avoided, we do not believe that such a relationship between losses
41
and interest rates can be translated into any specific prescription
for monetary policy.
Although it is clear that the Federal Reserve
can exert control over narrowly defined monetary aggregates, its
ability to control interest rates is quite restricted. In our
view, the primary determinant of interest rates is the pace of
economic activity.
This is not to suggest that the Federal Reserve has no effect
upon the economy.
The current economic environment is the result
of the interaction of a myriad of forces, including the rate of
monetary expansion permitted by the Federal Reserve in past years.
Our concern, however, is the level of interest rates at present
and in the near future. While a decline in interest rates would
provide significant benefits to the thrift industry in the shortrun, the long-run result would be devastating to thrifts if such
a decline in rates were engineered by a rapid rate of monetary
growth which led to renewed inflationary pressures and substantially higher interest rates than at present. Thus, to the extent
that the current slow rate of monetary growth and high real rates
of interest are necessary to cure our inflation problems, we fully
support the current monetary policy posture taken by the Federal
Reserve.
Apart rrom the issue of the general level of tightness of
monetary policy, there has been a concern raised over the Federal
Reserve's revised operating procedures adopted in October 1979, whereby the Federal Reserve places greater emphasis on managing monetary
\
aggregates and permits the federal funds rate to fluctuate over a
wider band. .Whereas the Federal Reserve formerly specified a 75
j basis point band for federal funds, its policy directive currently
specifies a 500 basis point band. The result of this revised
42
procedure has been to allow increased interest rate volatility.
As was mentioned previously, however, the rate volatility of the
past couple of years has been caused by a number of other factors
as well as monetary policy procedures.
To the extent that the post-October 1979 procedures have
increased interest rate volatility, they have generated difficulties
for thrifts with regard to operations.
Standard business practices
in housing finance were developed in a stable interest rate environment which are not appropriate in the current economic environment.
The traditional practice of offering stand-by commitments for fixedrate long-term loans can be risky in a volatile rate context. Mortgage
sellers tend to deliver below-market loans to thrifts when rates
rise, but to seek better opportunities elsewhere when market rates
decline. Additionally, because of the sharp increase in interest
rate volatility that occurred after October 1979, the fees charged
by thrifts offer inadequate compensation for the risk exposure that
those institutions have endured.
The more volatile rate environment has also created problems
on the deposit side. Thrifts have been experiencing significant
volumes of premature withdrawals from certificate accounts because
early withdrawal penalties have been inadequate.
The adequacy
of early withdrawal penalties as set by the Depository Institutions
Deregulation Committee is a significant concern for longer-term
certificates. For example, the current early withdrawal penalty of
six-months interest on a four-year certificate provides sufficient
protection against early withdrawal only if open market rates rise
less than about 150 basis points—a relatively modest amount in
today's market.
43
DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE
At this point, I would like to make some observations with
regard to the Depository Institutions Deregulation Committee.
While the Bank Board fully supports the ultimate goal of the DIDC—
that is, the deregulation of deposits—it should be stressed that
thrift institutions are more adversely affected by deregulation
than are commercial banks; indeed, one of the banking industry's
most important profit centers, corporate checking, was totally
excluded from the rate decontrol process, enjoying a statutory
prohibition on the payment of interest.
The Bank Board's primary concern is related to the continued
erosion of the rate differential.
In the view of the Bank Board,
removal of much of the rate differential on MMCs in May 1980 was
precipitous.
It has proven to be injurious to thrifts with regard
to their retail savings base. We believe that it should not have
been considered at such an early state in the DIDC's existence.
As a result, since May 1980 the proportion of thrift liabilities consisting of large denomination time deposits (over $100,000)
and reverse repurchase agreements has increased significantly.
There is a concern over the potential liquidity problems that may
develop if thrifts' currently poor earnings performance impedes
those institutions from rolling over these partially insured
deposits.
While portfolio liquidity is currently high at most
thrifts, weakness in deposit flows accompanied by the public's
concern about their earnings performance may strain their liquid
asset holdings. We believe that reinstatement of the rate
44
differential would enlarge the flow of MMC deposits to thrifts
and help offset their dependence on CDs, repurchase agreements,
and the necessity of using Federal Home Loan Bank advances to
shore up liquidity.
Present evidence suggests that to sell large CDs, thrift
institutions normally have to pay a 25-50 basis point premium over
the commercial bank rate. In recent weeks, however, thrifts have
had to pay rates 100 (on 30-day CDs) to 200 (on 90-day CDs) basis
points higher than commercial banks to obtain CD funds.
Currently, there is no evidence of a widespread inability
of thrifts to sell large CDs. However, there appear to have been
instances of rollover problems, which may portend further difficulty in the future. This potential problem is concentrated
in a relatively small number of large institutions. Exhibit 4
indicates that, as of April 1981, 301 S&Ls (representing 13.6
percent of the industry's assets) had large CD balances which
exceeded 15 percent of their assets. These associations had
$17.6 billion of large CDs, out of an industry total of $42 billion.
We estimate that, if the MMC differential had not been removed,
S&Ls would have had $48 billion in additional funds from MMCs and
therefore would not have had to take on the large proportion of CDs.
FSLIC OPERATIONS
As you are aware, the adverse conditions currently besetting
the industry have led to an enormous increase in the workload of
the FSLIC, with problem cases rising from 79 in December 1979 to
approximately 263 as of the end of May.
At our FY 1982 appropria-
tions hearings, we testified that FY 1980 was the busiest year
in the FSLIC's history, with 9 cases being completed and a
total cash outlay of more than $1 billion.
FY 1981 already has
45
involved approximately that amount of effort and expenditure,
and clearly will see a new record set for outlays and number of
cases completed.
If there is no improvement in the economy, FY
1982 will be even worse.
Looking at the situation from a calendar
year perspective, the FSLIC in the first six months of CY 1981 has
participated in 8 assisted mergers and a liquidation, versus a total
of 11 problem cases resolved in CY 1980.
It should be noted that the FSLIC's insurance fund currently
has a book value of over $6.5 billion and a market value of approximately $5 billion, and realizes an annual income of about $1 billion.
With respect to contingency planning, our focus basically
has been to ensure, first, that the fund is utilized in a manner
i
consistent with the projected magnitude of the problem with which
we are dealing and, second, that we have adequate personnel resources
to discharge our responsibilities.
Concerning use of the fund,
a significant amount of planning has resulted from the fact that
the earnings pressures the entire industry is experiencing are
reducing the ability of many insured institutions to absorb other
institutions in danger of default.
For this reason, the'FSLIC is
developing plans to provide direct financial assistance in appropriate cases so that an orderly resolution of the institution's
problems can be sought and liquidation and payment of insurance
can be avoided.
It should be emphasized, however, that direct
financial assistance by itself does not solve the problems of
insured institutions in danger of default, it merely postpones
them, providing time to the FSLIC to seek pther resolutions of the
situation.
Moreover, direct FSLIC assistance will not be provided
until the board of directors of the recipient association has
provided the FSLIC with a merger resolution! and a strict operating
agreement.
46
In the area of staffing, the FSLIC's needs are under constant
review, and we are adding personnel where appropriate. Fortunately, the FSLIC has available a large staff reservoir in the form
of the supervisory staff and examiners of the Bank Board's Office
of Examinations and Supervision. The FSLIC has held training
sessions for selected groups of these people, who will be extremely
helpful in assisting with its workload.
It should be borne in
mind, as a general matter, that the OES function always has been
fully oriented toward protection of the FSLIC, and is designed to
focus its resources on insurance risk cases as they evolve. Another
possible source of win-houseH support, of course, is represented
by the Federal Home Loan Bank System.
Finally, we are confident
that we could obtain valuable aid from the staffs of the various
state thrift supervisory bodies.
We are aware that one particular area of concern has been the
FSLIC's ability to cope with liquidations of institutions involving
payouts of insurance. Because such occurrences historically have
been infrequent, the FSLIC has not retained a full staff for the
sole purpose of making payouts to insured depositors*
The FSLIC
still does, however, have a full time staff to administer insurance
payouts.
This staff has license to conscript personnel from other
offices of the Bank Board, can retain many of the employees of the
defaulted institution, and has authority to hire temporary help in
the community where the payout is taking place.
NEED FOR ADDITIONAL TOOLS FOR FSLIC
There are a number of legislative steps that, if taken, would
greatly enhance the Corporation's ability to carry out its responsibilities in a cost-effective manner. Given the enormous pressures
47
-
IO
-
on the insurance fund, and the direct connection we perceive between
the integrity of the fund and public confidence in the financial
system generally, we believe the importance of removing barriers
to low-cost resolutions of problem cases cannot be over-stated.
1.
Emergency Interstate Mergers and Acquisitions.
Most fundamentally, we believe that the FSLIC, when adverse
financial conditions exist such as those we currently are experiencing, should be empowered to authorize any FSLIC-insured institution
in danger of default to merge with any other FSLIC-insured thrift,
or to be acquired by such an institution, or by any savings and
loan holding company.
This, of course, would involve overriding,
inter alia, state laws barring interstate branching of financial
institutions and the prohibition in the Savings and Loan Holding
Company Act against S&L holding companies acquiring control of
insured institutions in more than one state.
Under normal circumstances, these laws do not impinge unduly on
the FSLIC's operations, for generally there is adequate home state
interest in bidding for the privilege of participating in an assisted
transaction.
At present, however, as I have indicated, the extremely
widespread nature of thrift distress has diminished substantially
the pool of thrift institutions willing to consider such participation.
Moreover, those thrift institutions that are interested are not evenly
distributed throughout the states. The result thus far often has
been to generate unnecessarily high demands for financial assistance
in mergers. Furthermore, it could lead in the future to otherwise
unnecessary liquidations, which would be undesirable, in that
liquidations as a rule are more costly than assisted mergers,
48
-ndeprive the affected community of needed financial services, and
shake confidence in the financial system.
The problem of unnecessary
liquidation is of particular concern with regard to those thrifts
which are or are among the largest in their state, for such institutions, by virtue of their size, basically are foreclosed from
merging in-state, and the process of liquidating them would place
unusual strains on the FSLIC, as well as attracting intense and
highly detrimental publicity.
By giving us this authority. Congress would vastly increase
the universe of institutions potentially able to acquire a troubled
thrift, thus injecting a greater degree of competitiveness into
the assisted merger bidding process, and reducing the amount of
FSLIC financial assistance required to induce the transaction.
Concomitantly, it would avoid the development of a pattern of
liquidations occasioned as a result, not of selection of the least
costly of alternative approaches, but as a side-effect of state
and federal laws fashioned to limit the spread of financial institutions across state borders.
In our view, it would be extremely
poor public policy to permit the operation of these laws to erode
the strength of the FSLIC.
Recognizing the strong feelings sur-
rounding the interstate issue, however, we would have no objection
to a requirement that exercise of this authority be contingent
upon a reasonable effort to seek in-state partners of the same
type before pursuing more unconventional arrangements, subject to
the paramount need to minimize the cost of transactions to the FSLIC.
49
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2.
Emergency Federal Stock Charters.
A second and similar empowerment we seek, and one that likewise
would override other provisions of law, would be the power to
authorize any mutual thrift to obtain a Federal stock charter, as
long as that institution is in receivership, has contracted to receive
FSLIC financial assistance, or is under threat of instability
because of severe financial conditions.
This would greatly facili-
tate the salvaging of troubled institutions, for, by transforming
them into a stock format, we would make them more capable of
attracting private capital as well as more structurally amenable
to merger with a stock association.
3.
Improvement of FSLIC Conservatorship and Receivership Powers.
The third area in need of revision is that of the FSLIC's
conservatorship and receivership powers. At present, the FSLIC is
the sole body eligible to be conservator or receiver of a Federal
association, but must await state action with respect to assuming
such power over a state association.
That state action is the
appointment by the appropriate state authority of FSLIC or some
other entity as conservator, receiver or other legal custodian.
Where the FSLIC is not the appointee, the Bank Board may
appoint it as receiver, but not conservator, after the state has
closed the institution or after the expiration of a 15-day
period—provided circumstances exist that would justify such
an appointment in the case of a Federal association, and a
depositor has been unable to obtain withdrawal of his account
in whole or in part. This procedure is proving very awkward and
50
time-consuming under current circumstances, which place a high
premium on our ability to deal with failing associations on a
smooth and rapid basis.
The Bank Board believes that authority must be given us to
appoint the FSLIC as conservator or receiver of a state-chartered
insured institution regardless of any state action, provided the
Bank Board determines that the institution is in an unsafe or
unsound condition to transact business, has substantially dissipated its assets, or has assets less than its obligations. The
provision we envision would not eliminate state action in this
area, but would provide a supplemental vehicle for safeguarding
the enormous federal financial interest at stake in cases involving
troubled insured institutions. We believe this interest is of
sufficient national importance to justify the relatively modest
streamlining of the current law that we are suggesting.
NEED FOR ADDITIONAL TOOLS FOR THRIFTS
Beyond the issue of additional tools for the FSLIC, the Bank
Board believes there is an urgent need for legislation that would
help thrift institutions to weather their present problems and
remain viable thereafter through all phases of the economic cycle.
1. All Savers Bill.
With respect to short term relief, I wish to voice at this
point the Bank Board's help that the All Savers bill would assist
in the resolution of the industry's problems.
51
- 14 -
The bill is designed essentially to provide a temporary reduction
of depository institutions' cost of funds through allowing depositors
to earn tax-free interest on certain deposits. We realize that
the All Savers proposal is not perfectly tuned and would deprive
Treasury of considerable revenue. Nevertheless, we believe it
would have a significant ameliorative effect on thrift earnings
during what promises to be a very difficult period for those institutions and for the FSLIC.
2.
Bank Board Proposals.
The Bank Board's proposals are intended to ensure that thrift
institutions can function over the long term, through the downs
as well as the ups in the economic cycle, as viable members of
the financial community.
By speaking of the "long term" however,
I do not wish to imply that action on lifting these constraints
can safely be delayed, but to indicate instead that our proposals
would ensure the long-term presence of thrift institutions.
The factors threatening that presence are operating now, and
it is imperative that Congress act rapidly to counter them. We
specifically refer to the fact that thrift institutions' liability
side has undergone rather abruptly a de facto process of deregulation, without a corresponding deregulation of their asset side.
That some of the powers we will propose, by their nature and as a
consequence of the debilitated state of the industry, will have a
52
- 15 -
certain lag-time in their effectiveness, argues particularly
strongly, in our view, in favor of quick Congressional consideration.
If Congress does not act in the short run to address this matter,
there will be no long run for a very substantial segment of the
thrift industry.
a. Corporate Checking Power.
As a first step, we urge that the Home Owners' Loan Act be
amended to allow all federal associations to offer demand deposits
to any customer.
This, of course, would permit thrifts to penetrate
the corporate checking market that now is the unique and highly
profitable preserve of the commercial banking industry.
The ad-
ditional transaction account authority we seek would help thrifts
reduce their cost of funds and enhance their ability to attract
corporate loan customers, as well as increase competition generally
for accounts of this kind.
Because the mechanics of handling
demand deposits are no different from dealing with NOW accounts,
thrifts and their customers could begin to realize the benefits of
this empowerment at once.
From an equity standpoint, there can be
no serious complaint from the banking industry, given the practical
elimination of the system of savings deposit preferences formerly
biased in favor of the thrift industry.
While retention of the
statutory requirement that demand deposits be interest-free would
be helpful to thrifts, given their current state, we would have no
objection to bringing such accounts under DIDC jurisdiction for
purposes of rate decontrol.
b.
Broadened Real Estate Investment Powers.
Second, we believe the HOLA should be amended to provide
federal associations with greatly broadened real estate investment
authority.
Real estate is the field thrifts are most familiar
53
- 16 -
with, and liberalization in this area could be expected, consequently,
to generate positive earnings results in a relatively short period
of time. What we specifically suggest is that federals be allowed
to invest more broadly in non-residential, as well as residential,
real estate, and that they be authorized to make real estate equity
investments equal to 10 percent of their assets.
This would facili-
tate involvement in such profitable investment fields as real estate
acquisition and development and commercial construction.
The
ability of California-chartered S&Ls to engage in land development
has been instrumental in allowing many institutions so involved to
remain in the black even under the present difficult environment.
To provide institutions with adequate flexibility with respect to
the structuring of their business transactions, we believe this
authority should not be circumscribed by statutory first lien, PNI
or loan-to-value limits.
c#
Commercial Lending
Third, we urge that federal thrift institutions be free to
make loans for purely commercial or agricultural purposes.
Such
authority would go hand-in-hand with development of thrift demand
deposit authority, and would provide thrifts with increased portfolio
flexibility.
By broadening thrifts' investment options, such power
would enable them to reduce their vulnerability to volatile
economic conditions.
While full exploitation of this empower-
ment would not happen quickly, thrifts nevertheless could be expected to make some helpful initial inroads with regard to the
housing-related businesses that they currently serve,
d.
Expanded Consumer Lending
Fourth, the Bank Board believes that federals should have
power to make consumer loans without being subjected to the current
54
- 17 -
20 percent of assets restriction affecting such investments. Moreover, this power should be extended to the making of loans for
inventory financing purposes, an option not currently open to
federal S&Ls, and the lack of which is significantly affecting
their ability to build up a reasonable volume of consumer credit
business.
Because of this direct relationship, the inventory fi-
nancing issue should be considered separately from that of extending
commercial loan authority.
e.
Equipment Leasing.
Fifth, the Bank Board favors giving federals authority that
would enable them to engage in the equipment leaving business,
which has proven to be a major and profitable activity for many of
the commercial banks with which thrifts must compete. The leasing
function would offer a means to attract new customers or provide
more services to existing customers. Moreover, leasing carries
favorable tax implications because of the investment tax credit
and the ability to depreciate the equipment.
f.
increased Service Corporation Investment.
Sixth, we support allowing federal associations to invest a
greater amount in their subsidiary service corporations, which
have emerged as important profit centers for many institutions.
By increasing the current 3 percent of assets limitation on such
investment to 5 percent, Congress would permit enhanced involvement in profitable land development activities, for example, that
an institution might not wish to engage in directly.
g.
Freedom to Choose Stock or Mutual Form of Organization.
Seventh, we believe that Congress should allow thrift in-
stitutions and their organizers flexibility in electing their
form of organization.
In our view, the Bank Board should be able
55
- 18 -
to grant de novo charters to federal savings banks, not just Federal
S&Ls, and all federal thrift institutions should be able to exist
in the stock or the mutual form.
Likewise, where state law permits,
state-chartered thrifts should be free to convert directly to any
form of federal thrift association they regard as most suitable to
their needs.
As you are aware, the main practical consequence of such a
change in current law would be to increase the number of institutions that could obtain stock charters. We believe this
development would be beneficial for a number of reasons. For
one thing, stock institutions under current economic circumstances
are more attractive to organizers than are mutual associations.
This is evidenced by the fact that, in 1980, of the 68 applications
for insurance of accounts approved by the Bank Board, only 8 were
from mutuals, and that, since 1977, there have been 145 new stock
S&Ls chartered, as against 57 mutuals. The attractiveness of the
stock form results from the enhanced competitiveness permitted by
the equity base with which stock institutions begin their corporate
existence; by contrast, mutual S&Ls find it quite difficult to
build their equity fast enough during their early years of operation.
In its current state, therefore, federal law artificially
is restricting entry of new institutions, despite a need for new
entrants as a means of countering the long-term constriction in
the number of thrift institutions otherwise implied by the current
wave of consolidation in the industry.
Of course, the ability to raise equity that makes the stock
form more feasible for organizers of new institutions also makes
conversion of existing mutual institutions to stock associations
a beneficial option.
Conversions, by infusing new capital into
56
- 19 -
institutions, allow continued growth, and permit greater community service.
As a final matter, allowing expanded access to stock charters
would be of benefit to the PSLIC, in that stock institutions,
because of their equity cushion, have greater resistance to failure,
particuarly in the vulnerable early years. Moreover, the stock
form, in the event failure does occur, lends itself more readily
to mergers and other non-liquidating solutions than does the
mutual form.
For instance, a holding company can acquire a failing
stock S&L, but not a mutual institution,
h.
Expanded "Leeway" Authority.
Eighth, it is necessary, in our opinion, to provide improved
"leeway" authority for federal associations. Leeway power simply
is the ability to make investments that otherwise would not be
in accordance with statutory limits. At present, such authority
for federals is restricted to 5 percent of assets, and must be
used for residential or farming purposes. We believe 10 percent
would be a more realistic figure, and that the nature of investments under the provision should be statutorily unrestricted
subject, of course, to Bank Board regulatory authority.
—
The advan-
tage of effective leeway power is that it would give important
flexibility to thrifts that they could use to take advantage of
promising business opportunities not falling within normal investment limits.
In addition to aiding profitability, this would be
stimulative of new services,
i.
Preemption of State Laws Forbidding "Due-on-Sale" Clauses.
Ninth, and finally, we suggest that a step that would be pro-
ductive of considerable short-term help to thrifts, albeit on a
regional basis, would be for Congress to preempt state laws banning
57
- 20 -
the exercise of so-called
M
due-on-sale" clauses.
These clauses
have become standard provisions in mortgage contracts as a result
of the desire of lenders to protect themselves against the effects
of persistent inflation.
Essentially, they allow the lender to
call a mortgage loan when the borrower sells the underlying security
property, thus helping to ensure that the institution's mortgage
portfolio yield can support payment of competitive rates to savers.
Of course, borrowers who are selling their homes
dislike
due-on-sale clauses, for the ability to pass on a sub-market mortgage to a potential purchaser is a very valuable selling aid, and
can allow a higher purchase price.
This dislike has been translated
into effective political action in a number of states, resulting in
passage of laws forbidding the exercise of due-on-sale clauses.
The predictable result for institutions affected by such prohibitions has been a lengthening in the average lifespan of the
low-yield loans that are currently having such an adverse impact on
thrift earnings.
In effect, institutions subject to these laws are
having their laboriously accumulated net worth appropriated to provide
unbargained-for windfalls to a small group of home sellers and
purchasers.
Under the circumstances, when that net worth is being
drawn upon to ensure the very survival of the industry, the Bank
Board believes it would be in the overall public interest for
Congress to assure that the borrowers who agreed to contracts
containing due-on-sale clauses honor those agreements.
CONCLUSION
To summarize my remarks, the thrift industry has been
brought to a point of crisis by our nation's inability to cure
our longstanding problem of excessive inflation, accompanied by
high, and recently quite volatile, interest rates.
This crisis
58
- 21 -
is placing unprecedented strain on the FSLIC, and, from a crisismanagement standpoint, we believe it is vital that the Congress
provide the FSLIC the additional tools we have outlined.
Under
present conditions, we are convinced they would be enormously
helpful in conserving FSLIC resources, both in terms of money and
people; and, the signficance of these tools would increase geometrically
in the event of worsening interest-rate conditions.
Passage of
the All Savers bill also would provide valuable short term aid to
the FSLIC by reducing thrifts' cost of money and improving their
liquidity.
In order to ensure that the present crisis, once bridged, does
not recur, we likewise strongly urge that Congress provide authority
for a protective restructuring of the thrift industry along the
lines we have outlined.
As presently constituted, the industry is
simply too vulnerable to volatile economic conditions, lacking the
asset-side empowerments that it must have to compete successfully
through all phases of the economic cycle.
We realize that the steps we are urging point toward a substantial breakdown in the legal differences between the powers
granted to thrifts and banks, and will generate considerable concern regarding the future of housing finance. While some thrift
institutions could be expected to turn away from mortgage finance,
we believe the industry's expertise in the area, coupled with the
ability to make flexible rate loans and the prospect of great
housing demand over the rest of this decade, would result in the
majority of thrifts continuing as housing specialists. Unless
Congress is willing to provide comprehensive and effective economic
59
- 22 -
controls, however, the level of this specialization must be determined
by each individual institution's evaluation of economic opportunities.
To continue with forced specialization, given the current state of
affairs, simply would be to risk the relatively rapid elimination
of very large numbers of thrift institutions.
Mr. Chairman, this concludes my remarks.
I will be pleased
to answer any questions you may have.
NOTEs In accordance with 12 U.S.C. § 250, this statement has not
been reviewed outside the Federal Home Loan Bank Board, and does
not necessarily reflect the views of the President.
60
Exhibit 1
YEARLY AVERAGE OF 3 MONTH TREASURY BILL MARKET YIELDS AND
NET INCOME TO AVERAGE ASSETS AT DEPOSITORY INSTITUTIONS
Percent
13.0
3 Month Treasury Bill Market Yields
16.0
14.0
12.0
10.0
8.0
6.0
4.0
I
1 I
I
1970
I I
I
1975
I
2.0
1980
1.4
Net Income to Average Assets at Thrifts
1.2
1.0
0.8
S&Ls
0.6
0.4
0.2
I
1 1
0
Net Income to Average Assets at Commercial Banks
by Asset Size
less than $100 m:
1.2
1.0
Total CBs_
__
$1 billion, and .ovar
o.a
6.6
0.4
0.2
I
1970
I
I I
I
1975
I
0
1980
Exhibit 2
Comparison of 6-Month Treasurv Bill Rate
and S&L Monthly Profitability (ROA)
S&L Monthly
Profitability
(basis points)
Treasury
Bill Rate
(Percent)
15 -
-
60
.
20
14 -
13 -
12 •
. -20
11 -
\
-40
10 -
\
• -60
\
S&L
Profitability
0
1980
J
' F
'
1981
-80
62
Exhibit 3
Depository Institution Shares of MMC Flows
Pre-March 1979
Total
MMC
Flows
$119.8 bil
100%
S&L
$ 64.6 bil
53.9%
MSB
$ 19.2 bil
16.0%
CB
$ 36.0 bil
30.1%
March, 1979 through May, 1981
Total
MMC
Flows
$341.1 bil
S&L
$135.9 bil
39.8%
MSB
$ 34.7 bil
10.2%
CB
$170.5 bil
50.0%
Exhibit 4
Short-Term Borrowing and Liquidity of
Associations Heavily Dependent on Large
Denomination Time Deposits, April, 1981
Ratio to Total Assets
Large CD-to-Assets
Number of
Associations
Total
Assets
Large
CDs
Large
CDs
Outsideb
Borrowing
Cash &
Securities
38.7%
4.4%
10.1%
* 30% or more
60
25 to 30
42
7.0
1.9
27.2
3.2
5.9
20 to 25
74
20.7
4.4
21.2
5.8
8.1
15 to 20
125
49.7
8.3
16.7
5.2
8.9
85.1
17.6
301
$
7.7 bil
$3.0 bil'
Large CDs are those with a denomination of $100,000 or more.
Outside borrowings are non-deposit sources of funds, not including Federal Home Loan Bank advances;
about 90% of these funds are raised through reverse repurchase agreements with institutional lenders.
Includes all types of marketable securities, including those not considered "eligible liquidity" by
the FHLBB.
64
The CHAIRMAN. Thank you. Now we will hear from Chairman
Connell of the National Credit Union Administration Board.
STATEMENT OF HON. LAWRENCE CONNELL, CHAIRMAN,
NATIONAL CREDIT UNION ADMINISTRATION BOARD
Mr. CONNELL. Thank you, Mr. Chairman. I am pleased to appear
before your committee and to discuss monetary policy, how it has
affected the condition of credit unions currently and in the future.
I think our testimony will show that credit unions have encountered difficult situations during the past few years. Nonetheless, it
is our opinion that during this period adjustments have been made
both by credit unions and our agency, which have enabled us to
continue to bring credit union services to the membership in the
future. However, Mr. Chairman, I must point out that should interest rates persist for an extended period at excessively high levels,
there are a number of larger credit unions with an excess of longer
term securities that might encounter severe operating difficulties
and would represent a substantial liability to the National Credit
Union's share insurance fund.
In October 1979, as we all know, Mr. Chairman, the Federal
Reserve adopted a new operating procedure which placed more
weight on controlling the supply of bank reserves and less on
limiting short-run movements in the Federal funds rate. I think
that these policies necessarily have resulted in the persistently
high and more volatile interest rates which the economy has experienced during the past 1V2 years.
Although credit unions have had the authority to offer a wide
variety of savings instruments and services, the continuous presence of inflation and high and volatile interest rates has caused a
greatly reduced rate of growth during the early part of the year.
Also, credit unions have experienced continuing earnings pressures
like other types of thrift institutions. Additionally, the doubling of
oil prices since 1978 has severely affected the U.S. automobile
industry, resulting in plant closings and worker layoffs.
Older industrial plants facing competition from new and modern
facilities in the Sun Belt and abroad have been forced to close.
When these plants close, affiliated credit unions lose their sponsor,
common bond, and often their existence, unless they merge or
convert to a community-type charter.
Credit unions are also especially affected by economic policies. In
terms of the 1980 experience, credit union growth was adequate
but volatile during the year. On the other hand, the lending experience of credit unions was the worst since 1942 to 1944. Loans
outstanding have declined by some $2.2 billion, or 7 percent.
Because of the cost of funds increasing in 1980, essentially credit
unions' capital deteriorated as they were required to draw on their
accumulated reserves to cover the higher cost of money and operating costs. As our statement indicates, the problems of credit unions
and liquidations increased in 1980 and continued to do so in 1981,
and we attribute the larger dollar figure, essentially, to larger
credit unions with problems with long-term securities.
However, we should note that during this period of time the
expenses of the insurance fund were able to be met by the income
of the fund, and principal was not used at all. Like my colleague,
65
Mr. Sprague, I would say that we strongly endorse and request
that the committee consider the provisions of the regulators7 bill
that were presented earlier to Congress. In addition, as with Mr.
Pratt, we have suggestions for regulatory tools such as conservatorship authority, tax exemption for the central liquidity facility
which has been around for some time, and a number of additional
operating powers.
Mr. Chairman, in my abbreviated statement I would like to
recognize two aspects of the proposed legislation that I think are
especially important. One is the expanded powers for savings and
loan associations and mutual savings banks, as proposed by the
Federal Home Loan Bank Board. I want to say that I fully support
this effort. In Connecticut where I was bank commissioner, for
example, the broader powers of State-chartered savings and loan
associations and mutual savings banks have greatly contributed to
their ability to weather the turbulent times of the past several
years.
As far as the controversial industry acquisitions interstate provisions of the regulators' bill, a number of people have expressed
concern that smaller institutions will disappear and we will be left
with a limited number of giant banks operating free from geographic constraints across the country. I do not share this concern,
because I believe that any such monopoly power would not occur as
long as credit unions can provide a viable alternative for the consumer.
The Canadian banking system is often cited as an example of
what could happen in the United States with interstate mergers
and so on; a handful of banks with thousands of branches across
the Nation. I do not believe this would happen in the United States
anyway, because of our greater population and more extensive
economic development. But even if it did occur, credit unions would
fill any void that would develop, and this has actually happened in
Canada where credit unions have 14.9 percent of total deposits,
while in the United States they have only 4.9 percent of just
consumer deposits.
Indeed, there is a similar example in the United States. The
State of Rhode Island is considered a concentrated banking market.
However, in that unique State, credit unions account for 18 percent
of consumer savings as compared to 5 percent nationally. Moreover, 75 percent are community-type credit unions in Rhode Island
as compared to only 4 percent in the remainder of the United
States.
As plants close around the country, many credit unions will
convert to community charter, community common bond, and
indeed, the movement is underway. Thus, we look upon the structure of a successful U.S. credit union movement to more reflect
what exists in Rhode Island that actually what exists in the Nation
as a whole today.
In summary, Mr. Chairman, with monetary policy as the only
tool to fight inflation and with the U.S. industrial plants facing
closing or change in location, credit union management, like all
others, will be severely challenged in the years ahead. As a regulatory agency, we are actively and aggressively reviewing and changing examination procedures and restructuring our policies to pro-
66
vide at the same time stronger oversight remedial actions and
maximum operating flexibility, as reflected in our deregulatory
efforts.
I ask that the committee act favorably toward our request for
additional statutory provisions and regulatory tools to meet the
demands of the future.
This is my abbreviated statement. If you would include my full
statement, I would be happy to answer any questions.
The CHAIRMAN. Without objection, so ordered.
[Mr. Connell's prepared statement, on behalf of the National
Credit Union Administration, follows:]
67
STATEMENT OF
LAWRENCE CONNELL
CHAIRMAN, NATIONAL CREDIT UNION ADMINISTRATION BOARD
Mr. Chairman, Members of the Committee, I am pleased to appear before you
this morning during the Committee's hearings on monetary policy to present the
views of the National Credit Union Administration regarding the effects of
current and projected monetary policy on the condition of credit unions and
their ability to adjust to a variety of economic conditions.
At the present time, the National Credit Union Administration has some
12,300 Federal credit unions which it charters, insures, and supervises.
Further, we are currently providing Federal insurance coverage to about 5,000
state chartered credit unions. The total assets of these insured credit unions
is $62 billion and 40 million members are being served by them. When nonfederally insured credit unions are included, there are a total of 21,500 credit
unions, 46 million members, and over $73.5 billion in assets.
Our testimony will show that credit unions have indeed encountered severe
financial situations during the past few years and a number of actions have been
necessary to assist in the overall maintenance of stability.
Nevertheless, it
is my opinion that during this period, adjustments have been made by both the
credit unions and NCUA which should enable us to continue to bring credit union
services to the membership in the future. However, Mr. Chairman, I must point
out that should interest rates persist for an extended period at excessively
high levels, there are a number of larger credit unions with an excess of longer
term securities that might encounter severe operating difficulties and would
represent a substantial liability to the National Credit Union Share Insurance
Fund.
Before I detail the present condition of credit unions, let me focus on
68
contingency planning for a moment.
I believe that two of the most important
components of contingency planning are education and flexibility. At NCUA, we
make every effort to communicate to each credit union information which we
believe is timely and useful. This is done through our examiners, our regions,
in "letters to all credit unions," in news releases, and in speeches. The
subjects range from the detection of the beginnings of certain unsafe practices
in a few credit unions to assistance in program development.
With regard to flexibility, our effort is two-fold:
first, we try to
enhance the operating flexibility of the credit unions themselves to the maximum
extent consistent with safety and soundness.
In this context our deregulatory
effort of the past year was designed to afford credit unions wide latitude in
both lending and savings.
Second, we seek to maximize the regulatory
flexibility of the agency itself as conditions warrant.
In this context we
sought and received stronger enforcement powers, a Central Liquidity Facility,
the restructuring of the agency, an increase in loan rates for credit unions,
and are currently seeking authority for conservatorship, mergers of dissimilar
common bonds, authority for the CLF to loan to the share insurance fund and a
reassessment of the size of the emergency back up line for the Share Insurance
Fund.
I will amplify these points later in discussions of regulatory actions
and of the regulators bill (emergency legislation).
Monetary Policy
Monetary policy has faced a challenging course during 1980 and 1981.
Turbulent swings in economic activity and financial conditions complicated the
execution of monetary policy.
As the pace of economic and financial activity
69
plunged and recovered during this period, the money stock and the level of
interest rates showed large fluctuations. Despite the short-run variability,
however, growth of the narrowly defined monetary aggregates for the year as a
whole (after adjustment for the nore rapid than expected growth of interestbearing transaction accounts) was close to the upper limits of the Federal
Reserve*8 annual target ranges, while the broader money measures exceeded their
top limits by a small margin.
Bank credit growth was well within its target
range for the year.
The basic goal of monetary policy has been to reduce inflation by gradually
lowering monetary growth.
In pursuit of this goal, the Federal Reserve adopted
a new operating procedure in October, 1979 that has placed more weight on
controlling the supply of bank reserves and less on limiting short-run movements
in the Federal funds rate. These policies have been partly responsible for the
persistently high and more volatile interest rates which the economy has
experienced during the past year.
Except for a four month period during the
1980 recession, interest rates have been in the double digit range. For 12 of
the last 18 months, money market rates have exceeded 12%.
The Federal Reserve reported to Congress in February, 1981 that it would
continue its policy of combatting inflation by gradually reducing the growth
rates of the monetary aggregates. However, they projected at that time that
inflation would only ease slightly in the near term.
Because of this and the
large budget deficits in prospect for the year, they anticipated continued
strong demands for money and credit, and relatively high interest rates for some
time to come.
70
General inflationary pressures and the recent recession have had a special
effect on credit union operations. Additionally, the doubling of oil prices
since 1978 has severely affected the U.S. autonobile industry resulting in plant
closings and worker lay-offs. Older industrial plants, facing competition from
new and modern facilities in the sunbelt and abroad, have been forced to dose.
When plants dose, affiliated credit unions lose their sponsor, common bond, and
their existence unless they merge or convert to a community type charter.
Credit Union Conditions
Mr. Chairman, the past year has been a challenging one for credit unions*
Although credit unions had the authority to offer a wide variety of savings
instruments and services, the continuous presence of inflation and high and
volatile interest rates caused a greatly reduced rate of growth during the early
part of the year. Credit unions also experienced continuing earnings pressures
and erosion of capital.
Lastly, I would again emphasize that credit unions are
uniquely affected by plant closings and deterioration within a particular
industry.
Savings and Assets
From January to April, 1980, Federal credit union savings grew at an annual
rate of less than 1.3%.
However, the second quarter recession which brought on
a sharp drop in credit demand caused interest rates to fall rapidly.
With the
decline in interest rates, growth in credit union savings rebounded sharply and
accelerated to annual rates as high as 50% during June and July.
Although these
high rates of growth were not sustained for the rest of the year, credit union
savings did grow more in 1980 than in the preceding year (Table 1).
4
This
71
resulted in Federal credit unions growing as fast as commercial banks and faster
than other institutions in the consumer savings Market.
Federally chartered
credit union savings grew 13.92 and state credit unions grew by 10Z.
Consequently, credit unions maintained their share of total consumer savings at
4.9Z (Table 1).
Growth in credit union assets also reflected substantial improvement over
1979*8 performance.
Since the Increase in savings and liquid assets allowed
sone credit unions to reduce their indebtedness, asset growth was somewhat
slower than the growth in savings. Nevertheless, the 9.9% growth rate in assets
was more than twice as fast as the 4.9% growth recorded in 1979.
Unlike the improvement in savings and asset growth during the year, credit
union lending declined.
Although Federal credit unions had an ample supply of
loanable funds, loan demand remained low for the entire year. As a result, in
1980 Federal credit union loans outstanding declined by some $2.2 billion or
7.7% (Table 2 ) .
Not since the war years of 1942-1944 when national mobilization
disrupted credit union fields of membership have loans outstanding at credit
unions declined.
The slowdown in lending activity of the last two years has
caused credit union's share of consumer installment credit to decline markedly
from 16.7% at year-end 1978 to 14% at year-end 1980.
(Table 3 ) .
Contributing
to this slowdown is the practice within the automobile industry to offer
manufacturer-subsidized financing via their captive finance companies thereby
permitting automobile dealers to offer their customers below market rate car
loans•
72
Liquidity
Although many credit unions experienced considerable liquidity pressures
early in the year as record high, interest rates caused savings outflows,
liquidity improved during 1980 as credit union savings increased rapidly after
mid-year when market Interest rates declined.
The credit unions used the inflow
of savings to reduce their borrowings and increase their short-term investments,
thereby improving liquidity.
Consequently, the loan to savings ratio fell to
72.7% at year-end 1980 from the year earlier level of 90.9%.
Capital
Federal credit union capital —
loss reserves and retained earnings —
as a
percentage of total assets has declined in recent years. From a level of 6.9%
in 1975, the capital to asset ratio fell to 6.2% at year-end 1979. However, the
capital ratio held steady for most of the year and dropped only slightly to 6,0%
by year-end.
In earlier years, the decline in capital was the understandable
result of loan portfolios growing faster than earnings were retained and also a
change in the law reducing the amount of required transfers to the statutory
reserve account. More recent capital declines, however, are the consequence of
many Federal credit unions being forced to curtail earnings retention altogether
or to draw upon accumulated capital to cover higher operating and dividend
expenses.
Though credit union capital has diminished somewhat over time, risk assets
(or loans) as a proportion of total assets have declined at a faster rate. As a
consequence, the ratio of capital to risk assets has been rising.
This appears
to leave credit unions momentarily in a more financially secure position.
6
73
Earnings
The historically high interest rates of 1980 substantially affected credit
union earnings.
In 1980, money market certificate rates rose from 11.7% in
January to over 15Z in March.
Faced with potential large share outflows as
meaber8 responded to the high yields available on money market instruments,
Federal credit unions and many state credit unions were compelled to offer share
certificates at rates that at times exceeded credit union loan interest rate
ceilings.
P.L. 96-221 did authorize an increase in the Federal loan rate ceiling to
15% in April of 1980. However, at the very same time when credit unions were
forced to offer historically unprecedented high dividend rates to retain funds,
loan demand fell dramatically as a result of the recession.
Therefore, Federal
credit unions were limited In their ability to take advantage of the necessary
relief the 15% ceiling provided.
In addition, as the recession proceeded, money
market interest rates declined, reducing the rate of return available to credit
unions on other investments. Delinquencies also increased, further eroding
earnings. By year-end 1980, interest rates once again reached the peak levels
of the spring. As a result, earnings of credit unions continued to be squeezed.
To ease earnings pressures on Federal credit unions confronted with record
high money market interest rates, the NCUA Board granted an across-the-board
waiver of the reserve transfer requirement for the first quarter and a limited
waiver for the remaining three quarters.
The total effects of 1980 were, therefore, to limit credit union management
flexibility as competition forced credit unions to accomodate the persistently
7
74
high Interest rates. This accomodatlon resulted in a continuing decline in
earnings and credit union capital.
Problem Credit Unions , Liquidations, and the Insurance Fund
NCUA examiners assign an overall rating to Federal credit unions after each
examination. Each Federal credit union is rated excellent, good, fair, weak, or
unsatisfactory —
EWS codes 1, 2, 3, 4, and 5 respectively. A weak or
unsatisfactory rating implies that critical problems exist in any one of a
variety of areas. Federally-insured state chartered credit unions receive a
similar coding based on information submitted by state supervisory agencies.
This information is shown on (Table 4 ) .
While the number of problem credit unions remained basically unchanged from
year-end 1979 to year-end 1980, the total savings in problem credit unions
increased from $1.4 billion to $1.6 billion. This represents a 14% Increase in
the total savings of this group of credit unions. As of May, 1981 total savings
of problem credit unions had Increased to $2.1 billion reflecting a 31% increase
within five months. While some portion of this increase in total savings can be
accounted for by the overall growth in all credit unions, the remainder reflects
a disturbing trend toward an increase in the number of larger credit unions
experiencing problems. The underlying cause for these larger credit unions to
be classified as problem credit unions was Investment of a large part of their
assets in long term government securities.
In this regard, their asset
portfolios were more like savings and loan associations than traditional credit
unions•
75
Since 1971, the first year of Federal Share insurance, 1,153 federallyinsured credit unions have liquidated because of insolvency.
These credit
unions have been generally relatively small in size and have had little impact
of the viability of the share insurance fund.
However, in 1980 we witnessed a
41.4Z increase in the number of insolvent federally-insured credit unions.
These credit unions were 1 on average, larger than those liquidated in previous
years.
(Table 5).
Mr. Chairman, we found that the liquidations of the larger
credit unions were almost directly attributable to the cumulative impact of
persistent pressures of high cost of capital, inability to generate earnings,
disintemediation, and the slowdown in credit union growth. Because these
credit unions were larger, they required a larger commitment of funds to
expedite the payment of member insured savings and completion of the liquidation
process.
As a result, although there was a positive addition to the share
insurance fund balance in 1980, expenses and losses absorbed a much larger
percentage of income than ever before.
The ability to merge such credit unions would greatly ease NCUA's
supervisory burdens while at the same time continue a very valuable service
which would otherwise terminate.
The main obstacle to expeditious merger action
is the prohibition against combining credit unions with unlike fields of
membership. While NCUA in no sense would advocate retreating from the
longstanding principles of field of membership uniqueness, a relaxation of those
requirements in situations involving financially distressed institutions would
be an important stabilization tool. Many State laws already provide for such
mergers and there is evidence that such laws have reduced the incidence of
liquidation of State chartered credit unions.
76
Credit Unions During 1981
Unlike 1980, the interest rate situation in 1981 has seen no extended
period of abatement. The rates, while fluctuating periodically, have remained
consistently higher than has been heretofore experienced.
Credit unions have demonstrated a remarkable resilience and NCUA has
continued to attempt to increase credit union flexibility but the persistence of
the high rates can not be ignored. Although credit union savings have been
retained and even a small growth noted, it has not been done without cost.
While earlier in the year we had expressed some optimism concerning loan demand,
there are signs of a slowdown as rates exert an ever increasing dampening
effect.
Persistent high interest rates reduce the operating margins of credit
unions.
This reduces their ability to cover required reserve transfers,
precludes the building of reserves, and as a result weakens their overall
capital position, With each passing day, the rate paid for savings adjusts
slightly higher maintaining the pressure on credit unions.
Extended high interest rates also severely limit credit union mortgage
activity.
The mortgage powers granted to Federal credit unions in 1977 have
scarcely begun to be used.
On the one hand, credit unions have wisely refrained
from the long term low fixed rate problem of other thrifts. On the other hand,
after being granted some flexibility in structuring mortgage instruments, they
have encountered normal member resistance to high mortgage loan rates. More
generally, high interest rates have precluded credit unions from carrying out
their statutory provisions of "making available to people of small means credit
10
77
for provident purposes . . . . thereby helping to stabilize the credit structure
of the United States"•
Statutory Changes
Returning to the matter of flexibility, Mr. Chairman, 1 would emphasize for
the Committee the necessity for immediate action on increasing both the
regulatory flexibility of NCUA and its Central Liquidity Facility and the
operational flexibility of credit unions in light of anticipated persistent high
interest rates.
With respect to increasing NCUA's regulatory flexibility, I am requesting
that the Committee consider the provisions of the "regulators1 bill" as set
forth in Mr. LaFalce's bill H.R. 4050.
Certainly, in view of the likelihood of
continued high interest rates, the regulators should be afforded this measure.
The main credit union provisions which will minimize the potential cost to the
Share Insurance Fund are:
(1) Permit the Board under, certain emergency situations, to
merge credit unions with dissimilar common bonds.
(2) Clarify the authority of the Board to authorize the purchase
and assumption of the assets, liabilities and federally insured
accounts of an insured credit union by any federally insured
financial institutions.
I am also requesting an increase in NCUA supervisory authority by granting
the agency conservatorship authority similar to that of the other federal
78
financial regulators. Additionally, our operating flexibility would be
Increased with express authority for NCUA investment of operating funds similar
to the authority to invest share Insurance premiums. These and certain
technical amendments are found in Enclosure (1).
To increase the flexibility of the CLF, Mr. Chairman, it is essential that
an oversight in the enabling statute be corrected to ensure that the CLF is
granted a tax exemption similar to those granted to the Federal Home Loan Banks
and the Farm Credit Banks. Additionally, the CLF needs broader authority to
invest in short-term investments strictly for cash management purposes, an
incidental powers authority, and the authority to act as an Agent of the Federal
Reserve System in order to funnel funds to credit unions from the discount
window efficiently through established channels in the event the CLF reaches its
borrowing limits and credit union liquidity needs persist. These CLF amendments
are contained in Enclosure (2).
The last group of amendments, Mr. Chairman, is directed at enhancing the
flexibility of the credit unions. These amendments are in the area of credit
union lending powers while one addresses the matter of inactive accounts. A
general description is as follows and the suggested language is contained in
Enclosure (3):
(1) A grant of authority to NCUA Board to permit variances in
the statutory 30 year maturity limit on first mortgage loans.
(2) The elimination of the restriction on FCU residential real
estate financing which limits sales prices to 150% of the median
price in the geographic area in which the property is located.
12
79
(3) Authority for FCU's to refinance first mortgage loans.
(4) The inclusion of FCU's in Sec. 501 of P.L. 96-221 in order
to avoid possible usury complications when a FCU member prepays
a mortgage loan in full.
(5) The extension of FCU second mortgage loan terms from 12 to
15 year8.
(6) The conforming of FCU practices with those of the secondary
market by permitting FCU's to require that partial prepayments
on mortgage loans be made on the date monthly Installments are
due.
(7) The clear delineation that custodial accounts for loans sold
by FCU's are insured accounts.
(8) The clarification of the authority for FCU's to sell GNMA
mortgage-backed securities.
(9) The extension of "most favored lender" status to Federal
credit unions.
(10) Permit a credit union board of directors to adopt a policy
of terminating the membership of any member who (1) fails to
vote in an annual credit union election for three consecutive
years or (2) falls to either purchase shares or investments or
utilize a loan account with the credit union for three
consecutive years.
80
Credit Union Future
With respect to credit union flexibility, Mr. Chairman, 1
recognize that the discussion of expanded powers for various
financial institutions and of expanded areas of operations often
bring voices of opposition.
concern.
However, 1 do not share this
1 am aware of the intent of the FHLBB to further
expand the powers of the savings and loan associations and 1
fully support this effort.
In Connecticut, for example, the
broader powers of the state chartered savings and loan
associations and mutual savings banks have greatly contributed
to their weathering these turbulent economic times.
With respect to the interstate and interindustry merger
sections of H.R. 4050, some have expressed concern that the
smaller institutions will disappear and we will be left with a
limited number of giant banks operating free from geographic
restraints.
I do not share such concern because I believe that
monopoly power will not occur as long as credit unions can
provide a viable alternative for the consumer. The Canadian
banking system is often sited as an example of what could happen
in the U.S., a handful of banks with thousands of branches
across the nation. While I do not believe such would happen in
the U.S. because of our greater population and more extensive
economic development, even if it did occur, credit unions would'
fill any void that would develop.
This has actually happened in
Canada where credit unions have 14.9 percent of all deposits
14
81
while in the U.S., they only have 4.9 percent of consumer
deposits•
Indeed there is already a similar example in the U.S. The
state of Rhode Island is considered a concentrated banking
market. However, in that unique state credit unions account for
18 percent of consumer savings as compared to the 5 percent
share credit unions have on a national basis. Moreover, unlike
the U.S. credit union movement in general, 77 percent of Rhode
Island credit union deposits are in community type credit
unions.
For the rest of the U.S. only 4 percent of credit union
deposits are in institutions with a community type common bond.
Thus, we look upon the structure of a successful U.S. credit
union movement of the future to reflect that which exists in
Rhode Island.
The U.S. phenomenon of a credit union system with 86% of
its deposits in credit unions with an occupational common bond
is rather unique.
It certainly helped credit unions to grow
over the past ten years, but it may be a weakness in the years
ahead because of instability caused by plant closings. In the
interest of stability, viability, and growth of the credit union
system in this country, I personally would actively support a
change in the overall structure of the credit union system in
this country.
In fact we may be seeing a beginning already.
During the first half of 1981 the NCUA Board has.approved 19
charter amendments converting occupational or associational type
15
82
Federal credit union to community type FCU's. Of the 19
conversion amendments, 3 involved immediate plant closings and
10 more were undertaken due to such reasons as substantial
employee layoffs or reductions in force and/or threatened plant
closures.
In summary, Mr. Chairman, with monetary policy as the only
tool to fight inflation, and with the U.S. industrial plants
facing closing or change in location, credit union management
like all others will be severely challenged in the years ahead.
As a regulatory agency, we are actively and aggressively
reviewing and changing examination procedures and restructuring
our policies to provide at the same time stronger oversight,
remedial actions, and maximum operating flexibility as reflected
in our deregulatory effort.
I ask that the Committee act
favorably towards our request for additional statutory
provisions to meet the demands of the future.
I will be happy to answer any questions you or the
Committee members might have.
83
Table 1
Consumer Savings at Financial Institutions
1974-1980
[Aaouats in billions]
Tear
Total
1974— $691.8
775.8
1975—1976—
885.3
1977—
994.9
1978— 1,098.8
1979— 1,179.2
1980i/- 1,304.9
1974—
1975—|
1976—
1977—
1978—
1979—
1980i/-
100.0
100.0
100.0
100.0
100.0
100.0
100.0
Credit unions
Commercial Savings & loan Mutual savings All
associations
banks
banks
cu's Federal State
Amount
$322.6
347.2
387.4
427.6
471.7
505.5
576.0
46.6
44.7
43.8
43.0
42.9
42.8
44.1
$98.7
$243.0
285.7
109.9
335.9
122.9
134.0
386.8
142.6
431.0
470.2
146.0
511.0
153.5
Percentage Distribution
35.1
36.8
37.9
38.9
39.2
39.9
39.2
14.3
14.2
13.9
13.4
13.0
12.4
11.8
$27.5
33.0
39.1
46.5
53.5
57.5
64.4
$14.4
17.5
21.1
25.6
29.8
31.8
36.3
$13.1
15.5
18.0
20.9
23.7
25.6
28.1
4.0
4.3
4.4
2.1
1.9
2.3
2.0
2.0
2.1
2.2
2.2
2.1
4.7
4.9
4.9
4.9
2.4
2.6
2.7
2.7
2.8
Percent change
1974—
1975—|
1976—
1977—1
10.1
14.3
12.2
12.1
8.9
2.5
7.0
18.3
21.5
20.0
12.1
11.3
7.6
17.6
16.1
20.6
14.1
18.5
11.8
17.6
11.6
16.1
21.3
10.4
18.9
12.4
9.0
15.2
13.4
16.4
10.4
1978—
6.4
15.1
11.4
10.3
6.7
8.0
2.4
7.2
7.3
1979?77.5
9.1
±/
9.8
13.9
12.0
5.1
8.7
10.7
13.9
1980 1/ State credit union data for 1980 are preliminary.
Source: Board of Governors of the Federal Reserve System and the National Credit
Administration.
84
TABLE 2
Major Balance Sheet Data of U.S.
Credit Unions, by Type of Charter, 1974-60
[Anounts in millions]
Total,- gll credit onions
Year
Total
amount
Anouat
Federally-chartered
Change during
Total
period
amount
State-chartered
Change during
Total
period
amount
Total assets
198Oi/-
$31,948
38,013
45,036
53,755
62,348
65,992
72,000
$3,573
6,065
7,023
8,719
8,593
3,644
6,008
24,432
28,168
34,310
41,845
50,269
52,223
48,497
2,673
3,736
6,142
7,535
8,424
1,954
-3,726
14.7
20.9
20.7
21.2
17.6
4.9
9.9
$15,233
17,804
20,640
24,191
27,588
29,524
31,908
$1,427
2,571
2,836
2,551
3,397
1,936
2,384
10.3
16.9
15.9
17.2
14.0
7.0
8.1
14.6
1,621
16.8
2,139
23.1
3,442
23.6
4,323
22.3
5,053
860
-2,197
Members' savings
14.1
1,773
14,371
22.0
3,159
17,530
20.5
3,600
21,130
4,446
21.0
19.0 25,576
4,227
16.5
29,803
15.1
2,028
6.3
31,831
7.4
4,432
13.9
36,263
11.9
are preliminary.
11,702
13,299
15,999
19,211
22,582
23,676
22,147
1,052
1,597
2,700
3,212
3,271
1,094
-1,529
9.9
13.6
20.3
20.1
17.5
4.3
-6.5
13,148
15,522
17,968
20,940
23,715
25,628
28,051
1,234
2,374
2,446
2,972
2,775
1,913
2,429
10.4
18.1
15.8
16.5
13.3
8.1
9.5
12.6 $16,715
19.0 20,209
24,396
18.5
19.4 29,564
16.0 34,760
36,468
5.8
40,092
9.1
$2,146
3,494
4,187
5,163
5,196
1,708
3,624
Loans outstanding
3,007
1974
27,519
5,533
33,052
1975
6,046
39,098
1976
7,418
46,516
1977
7,002
53,518
1978
3,941
57,459
1979—
1/
6,855
64,314
1/ State credit union data
SOURCE:
12.3
15.3
21.8
22.0
20.1
3.9
-8.1
12,730
14,869
18,311
22,634
27,687
28,547
26,350
NCUA Annual Report and Monthly Statistical Release.
85
Table 3
Cotunaner Installment Credit Outstanding
by Type of Lender, 1974-1980
(Aaounts in Billions)
Financial
Institutions
Coomercial Finance
Companies
Banks
Credit
Unions
Miscellaneous^/ Retail-2^
Lenders
Outlets
Amount
1974- $161,990
1975- 171,996
1976- 193,525
1977- 230,564
1978- 273,645
1979- 312,024
1980- 313,435
$144,057
153,795
174,265
207,074
247,658
283,905
284,025
$80,054
82,936
93,728
112,373
136,016
154,177
145,765
$36,087
35,995
38,918
44,368
54,298
68,318
76,756
$21,895
25,666
31,169
37,605
44,334
46,517
44,041
$6,021
9,198
10,450
12,228
13,010
14,893
17,463
$17,933
18,201
19,260
23,490
25,987
28,119
29,410
3.7
11.1
10.6
10.0
10.2
Percentage Distribution
1974197519761977197819791980-
100.0
100.0
100.0
100.0
100.0
100.0
100.0
88.9
89.4
90.0
39.8
91.0
91.0
90.6
49.4
48.2
43.4
48.7
49.4
49.4
46.5
22.3
20.9
20.1
19.5
19.7
21.9
24.5
13.5
14.9
16.1
16.3
16.7
14.9
14.0
5.4
5.4
5.3
5.2
4.8
5.6
9.0
9.0
9.4
Percent Change
9.4
16.2
11.5
19742.1
5.4
5.8
6.2
52.8
17.2
1.5
-.2
3.6
6.2
19756.8
5.8
21.4
8.1
13.6
13.0
12.5
197613.3
22.0
17.0
20.6
15.3
197719.1
19.9
18.8
10.6
6.4
18.7
17.9
21.0
197821.0
19.6
8.2
14.5
25.8
13.4
14.0
4.9
14.6
1979(3/)
17.3
-5.3
12.4
4.6
-5.5
.5
19801/ In 1974, includes mutual savings banks, savings and loan associations and
auto dealers. In other years, includes mutual savings banks, savings and
loans and gasoline companies.
2/ In 1974, excludes 30 day charge credit held by retailers, oil and gas companies,
and travel and entertainment companies. Other years exclude 30 day charge
credit held by travel and entertainment companies and include auto dealers.
V
Less than .5Z.
Source: Board of Governors of the Federal Reserve.
Table 4.*-<-Number and Total Savings of Federally Insured Credit Unions, by Early Warning
Supervisory Categories and Type of Charter, 1979-81
[Amounts in millions]
1979
May 1981
1980
Total
Number of
Total
Number of
Total
Number of
EWS
credit unions
8avlnK8
Federal credit unions
12,803
$30,530
12,520
$36.348
12.327
$36.967
8,553
3,433
817
(2/)
24,165
5,008
1,357
7,942
3,770
585
223
29,037
5,765
1,265
281
7,617
3,844
659
217
28,867
6,090
1,755
255
$16.257
4.954
$18.016
8,168
4,979
2,259
851
1,984
1,639
1,091
240
8,635
5,358
3,088
936
C2/)
Federally-insured State credit unions
Total
4,828
$14.801
4,963
Code 1
2,175
2,011
8,129
Code 2
1,427
1,604
3,737
1,138
1,993
Code 3 — 1,023
210
943
Code A
203
1/ Codes 1 and 2 not broken out separately.
2/ EWS Code 5 introduced during fourth quarter of 1980.
SOURCE: NCUA, Office of Examination and Insurance.
State credit unions not coded.
87
Table 5.—Number and Total Savings at Insolvent
Federally Insured Credit Unions Fiscal Tears, 1971-80*
Total Savings (in thousands)
Year
Number of
Insolvent Liquidations
Amount
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
0
4
50
100
153
128
142
168
169
239
1,366
2,838
5,542
7,527
12,715
14,244
19,011
60,000
*
Average per CD
0
2
.5
2.7
28.4
36.2
58.8
89.5
84.8
112.5
251.0
Fiscal years: Ended June 30th for 1971 to 1975 and September 30th for 1976-1980
NCUA Supervisory Amendments
1.
NCUA Conservatorship Authority.
Sec.
(a) Section 206 of the Federal Credit Union Act (12 U.S.C. 1786)
is amended by redesignating subsections (h) through (o) as subsections (i)
through (p), respectively, and by inserting after subsection (g) the following
new subsection:
"(h)(l) The Board may, ex parte and without notice, appoint itself as
conservator and immediately take possession and control of the business and
assets of any insured credit union in any case in w h i c h —
"(A) the Board determines that such action is necessary to
conserve the assets of any insured credit union or to protect the Fund
or the interests of the members of such insured credit union;
"(B) an insured credit union, by a resolution of its board of
directors, consents to such an action by the Board; or
(C) a credit union terminates its status as an insured credit
union.
"(2) Not later than ten days after the date on which the Board takes
possession and control of the business and assets of an insured credit union
pursuant to paragraph (1), such insured credit union may apply to the United
States district court for the judicial district in which the principal office of
such insured credit union is located, or the United States District Court for
the District of Columbia, for an order requiring the Board to show cause why it
should not be enjoined from continuing such possession and control.
Enclosure (1)
89
"(3) Except as provided in paragraph (2), in the case of a Federal credit
union, the Board nay maintain possession and control of the business and assets
of such credit union and nay operate such credit union until such t i n e —
"(A) as the Board shall permit such credit union to continue
business, subject to such terms and conditions as may be imposed by
the Board; or
"(B) as such credit union is liquidated in accordance with the
provisions of section 207*
"(4) Except as provided in paragraph ( 2 ) , in the case of an insured Statechartered credit union, the Board may maintain possession and control of the
business and assets of such credit union and may operate such credit union until
such t i m e —
"(A) as the Board shall permit such credit union to continue
business, subject to such terms and conditions as may be imposed by
the Board;
"(B) as the Board shall permit the transfer of possession and
control of such credit union to any commission, board, or authority
which has supervisory authority over such credit union and which is
authorized by State law to operate such credit union; or
"(C) as such credit union is liquidated in accordance with the
provisions of section 207.
"(5) The Board may appoint such agents as it considers necessary in order
90
to assist the Board in carrying out its duties as a conservator under this
subsection.
"(6) All expenses incurred by the Board in exercising its authority under
this subsection with respect to any credit union shall be paid out of the assets
of such credit union*
"(7) The authority granted by this subsection is in addition to all other
authority granted to the Board under this Act."
(b)(l) Section 206(b)(2) of such Act (12 U.S.C. 1786(b)(2» is amended by
striking out "subsection (i)" and inserting in lieu thereof "subsection ( j ) M .
(2) Section 206(j)(l) of such Act (12 U.S.C. 1786(j)(l)), as so
redesignated by subsection (a), is amended—
(A) in the first sentence by striking out "subsection (h)(3)" and
inserting in lieu thereof "subsection (i)(3)"; and
(B) in the fourth sentence, by striking out "subsection (i) M and
inserting in lieu thereof "subsection (j)".
(3) The first sentence of section 206(j)(2) of such Act (12 U.S.C.
I786(j)(2)), as so redesignated by subsection (a), is amended by striking out
"subsection (h)(l)" and inserting in lieu thereof "subsection (i)(l)".
(4) The first sentence of section 206(1) of such Act (12 U.S.C. 1786(1)),
as so redesignated by subsection (a), is amended by striking out "(h) w and
inserting in lieu thereof "(i) N .
91
(5) Section 206(•) of such Act (12 D.S.C. 178600), as so redeslgnated by
subsection (a), is amended—
(A) by striking out "subsection (i)" and inserting in lieu
thereof "subsection (j)"; and
(B) by striking out "subsection (h): and inserting in lieu
thereof "subsection (i)".
(6) The section heading for section 206 of the Federal Credit Union Act (12
U.S.C. 1786) is amended by inserting"; taking possession of business and assets"
after "committee members".
2.
Removal of calendar year requirement for GAP.
Sec. 102(f) of the Federal Credit Union Act (12 U.S.C. 1752a) is
amended by striking the words "on a calendar year basis".
3.
Elimination of requirement for partial year premium and rebates.
Sec. 202(c) of the Federal Credit Union Act (12 U.S.C. 1782) is
amended by:
(1) striking all of subparagraphs (3) and (6) and
(2) renumbering subparagraphs (4) and (5) as (3) and (4)
respectively.
4.
Investment of NCUA operating funds.
Section 105 of the Federal Credit Union Act (12 U.S.C. 1755) is amended by
92
adding at the end thereof the following new subsection:
"(e)(l) Upon request of the Board, the Secretary of the Treasury shall
invest and reinvest such portions of the annual operating fees deposited under
subsection (d) as the Board determines are not needed for current operations.
"(2) Such investments and reinvestments may be made only i n —
"(A) interest-bearing securities of the United States;
"(B) securities guaranteed as to both principal and interest by
the United States; or
"(C) bonds, securities, or other obligations of the United States
which are lawful investments for fiduciary, trust, and public funds of
the United States.
"(3) All income derived from such investments and reinvestments shall be
deposited to the account of the Administration described in subsection (d).".
93
CLF Amendments
Sec. 1.
The National Credit Union Central Liquidity Facility Act (12
U.S.C. 1795 et jse^.) is amended by adding the following new section (12 U.S.C.
1795j) at the end thereof:
"Sec. 311.
(a) The Central Liquidity Facility, its franchise, activities,
capital, reserves, surplus, and income shall be exempt from all Federal, State,
and local taxation now or hereafter imposed, other than taxes on real property
held by the Facility to the same extent, according to its value, as other
similar property held by other persons is taxed.
"(b) The notes, bonds, debentures, and other obligations issued by the
Central Liquidity Facility and the income therefrom shall be exempt from all
Federal, State, and local taxation now or hereafter imposed, other t h a n —
"(1) the Federal income tax liability of the holders thereof,
and
"(2) Federal, State, and local gift, estate, inheritance,
legacy, succession, and other wealth transfer taxes.
"(c) For purposes of this section—
"(1) the term 'State' includes the District of Columbia, and
"(2) taxes imposed by counties or municipalities, or by any
Territory, dependency, or possession of the United States shall
Enclosure (2)
94
be treated as local taxes."
Sec. 2. The amendment made by Section 1 above shall take effect on October
1, 1979.
2.
Investments for Cash Management Purposes.
Section 307(a) of the National Credit Union Central Liquidity Facility Act
(12 U.S.C. 1795f(a)) is amended by:
(a) striking the word "and" at the end of paragraph (15);
(b) striking the period ("."*) at the end of paragraph (16), and
inserting "; and" in lieu thereof; and
(c) adding new paragraph (17) as follows at the end thereof:
"(17) make loans not to exceed thirty (30) days in
maturity to banks and other financial institutions and
acquire financial assets for the purpose of effective
cash management."
3•
Authority £»__ act as an Agent of the Federal Reserve System.
Title III of the Federal Credit Union Act (12 U.S.C. 1795-17951) is amended
by adding at the end thereof the following:
"SEC. 312. AGENT OF THE FEDERAL RESERVE SYSTEM. The Facility is
authorized to act upon the request of the Board of Governors of the Federal
Reserve System as an agent of the Federal Reserve System in matters pertaining
to credit unions under such terms and conditions as may be established by the
95
Federal Reserve Board."
4.
Incidental Powers.
Section 307(a) of the National Credit Union Central Liquidity Facility Act
(12 U.S.C. 1795f(a)) is amended by:
(a) striking the word "and" at the end of paragraph (16);
(b) striking the period (".") at the end of paragraph (17), and
inserting "; and" in lieu thereof; and
(c) adding new paragraph (18) as follows at the end thereof:
"(18) to exercise such incidental powers as shall be
necessary or requisite to enable it to carry out
effectively the purposes for which the Facility is
incorporated."
96
Federal Credit Union Lending Amendments
1.
First Mortgage loans - maturity limit.
Section 107(5)(A)(i) of the Federal Credit Union Act authorizes Federal
Credit Unions (FCU's) to make residential mortgage loans provided the maturity
does not exceed 30 years.
It is requested that this be changed to permit a
conventional real estate loan to be paid in 360 months, starting from the date
of the first payment.
This would accomodate those situations where the first
payment is due more than 30 days after the date of disbursement, and would be
more consistent with industry practice.
In addition, we anticipate that the 30 year maturity limit will pose
problems for NCUA as we develop our alternative mortgage regulations.
Our goal
in developing alternative mortgage regulations is to balance the interests of
Federal credit unions and the interests of their members.
One alternative that
we believe should be available to Federal credit unions is to extend the
maturity of an ajustable rate loan, so'as to keep the payments fixed instead of
having increases in the interest rate automatically lead to higher payments.
For example, in its VRM regulation, the Bank Board permits extension of a loan
for up to a maximum of one-third of the original maturity.
In the case of a 30
year mortgage loan, this amounts to an extension to 40 years.
NCUA may
currently lack the statutory authority to permit borrowers and FCU's to use this
option.
Recommended change:
Amend Section 107(5)(A)(i) by inserting the phrase "or such
other limits as shall be set by the NCUA Board" between " . . . not exceeding
thirty years" and "(except that . . . " ) .
Section 107(5)(A)(i) would thus read:
1
Enclosure (3)
97
" . . . not exceeding thirty years or such other limits as shall be set by the
NCUA Board (except that . . .)**
2•
First mortgage loans - 150 per centum of the median sales price.
Section 107(5)(A)(i) permits an FCU to finance the acquisition of a
dwelling only if the sales price of that dwelling is not more than 150 per
centum of the median sales price of residential real property in the
geographical area in which the property is located.
The restriction appears to
have been placed in order to prevent FCU's from financing so-called "luxury
homes."
House Rep.
No. 23, 95th Cong., 1st Sess. 9 (1977).
In practice this
restriction has been found to be very burdensome.
Further, we have found that the limit does not preclude Federal credit
unions from making loans they want to grant, i.e. they are not receiving
applications for loans to finance luxury homes.
It simply is difficult for
FCU's to obtain reliable data and burdensome to comply.
Such information must
generally be obtained either from the Department of Commerce, the Department of
Housing and Urban Development, the Federal Home Loan Bank Board, the Federal
Housing Administration, the National Association of Realtors, or lopal realty
boards.
Recommended change:
Delete from Section 107(5)(A)(i) the phrase "the sales
price of which is not more than 150 per centum of the median sales price of
residental real property situated in the geographical area (as determined by the
board of directors) in which the property is located,".
3.
Refinancing of first mortgage loans.
98
As homeowners accumulate significant equity in their residences, they often
desire to refinance their first Mortgages for various purposes» such as to make
hone improvements or to finance their children's education.
Federal credit
unions nay be inhibited in assisting their members In this fashion, because of
the wording of their existing first mortgage lending authority.
Thus, we
recommend clarification of the authority of an FCU to refinance a member's first
mortgage loan.
Recommended change:
Delete from Section 107(5)(A)(1) the language "which is
made to finance the acquisition o f and insert instead the word "on". Also,
delete the word "for" the first time it appears in that section, and insert
instead the words "that Is or will be".
4.
First mortgage loans - recomputation and refund requirement.
Currently, FCU's may be the only financial institutions in the country that
are subject to interest rate ceilings when granting first mortgage loans.
Section 501 of P.L. 96-221 preempted State constitutions and laws otherwise
limiting the interest rates that could be set on such loans.
This was done in
part because of a Congressional recognition that interest rate ceilings operate
to remove financial institutions from competing in the marketplace.
Not only does a fixed interest rate ceiling have this effect, but in the
case of FCU's additional problems arise due to the fact that Section
107(5)(A)(vii) of the FCU Act provides that the taking, receiving, reserving, or
charging interest greater than is allowed under the Act, when knowingly done,
results in a forfeiture of the entire interest on the loan.
Further, the
borrower has the right to recover any interest paid by bringing a suit against
3
99
the Federal credit union.
Thus, when a first Mortgage loan (with typical front
end charges) is paid before maturity, it appears that the statute requires the
FCU to determine the effective rate of Interest it has received.
(Because of
the combined effect of front end charges and prepayment, the effective rate will
be higher than originally projected unless some adjustment is made related to
the front end charges.)
If this rate exceeds the statutory maximum, then it is
necessary to make an adjustment to avoid the FCU'a "receiving" an excessive
rate.
In order to avoid the possibility of an FCU being subjected to a
successful usury suit, NCUA has been constrained to require by regulation that a
recomputation (and, where necessary, a refund) be made everytime a mortgage loan
is prepaid in full.
Recommended change:
Amend Section 501 of P.L. 96-221 to Include Federal credit
unions.
5.
Second mortgage loans - maturity limits.
At present, FCU's may grant second mortgage loans with maturities up to 15
years if the loan is for home improvements.
subject to a 12 year maturity limit.
Other second mortgage loans are
This distinction has led to problems in
determining the proper treatment of second mortgage loans the proceeds of which
are used primarily but not entirely for home improvements.
The distinction has
also in some instances led to problems in defining precisely what constitutes a
home improvement (e.g., does the purchase of an adjacent lot qualify?).
In the
interest of simplicity and deregulation, we recommend that the maximum maturity
for all second mortgage loans be increased to 15 years.
100
Recommended change:
Amend Section 107(5)(A)(ii) by replacing the phrase "or for
the repair, alteration or improvement of a residential dwelling which is the
residence of the member" with the phrase "a second mortgage loan secured by a
residential dwelling which is the residence of a credit union member."
6.
Sale of real estate and home improvement loans in the secondary market -
prompt crediting.
Section 107(5)(A)(viii) of the FCU Act states that "a borrower may repay
his loan, prior to maturity in whole or in part on any business day without
penalty."
This may require that a payment be credited immediately upon receipt
in order to avoid the imposition of a penalty in the amount of interest that
accrues from the date the payment is received until the date the payment is
credited.
If in fact prompt crediting is required, then there is a conflict
between the procedures dictated by the FCU Act and those used in the secondary
mortgage market.
Institutional investors, such as FNMA and FHLMC, typically
require a seller-servicer of loans sold to them to credit payments only on the
due dates called for in the loan notes.
This is necessary to simplify the
accounting and computing for the vast number of loans handled by those
purchasers.
Uniformity is also necessitated because such institutional
purchasers themselves sell securities backed by the mortgages they purchase on
the bond markets, where this uniformity is expected.
While this problem may be
resolved by interpretation of Section 107(5)(A)(viii), any interpretation of
that Section will also be applicable to loans other than mortgage loans, which
may be contrary to Congressional intent.
Recommended change:
Amend Section 107(5)(A)(viii) by adding the following at
101
the end:
"except that on first or second mortgage loans a Federal credit union may
require that any partial prepayments (i) be made on the date monthly
installments are due, and (ii) be in the amount of that part of one or more
monthly installments which would be applicable to principal."
7.
Sale of_ real estate and home improvement loans - insurability of custodial
accounts.
In P.L. 95-22, Congress granted FCU's the power to sell their loans in
whole or in part to third parties.
This power was granted to permit FCU's to
take advantage of secondary mortgage market facilities.
Cong., 1st Sess. 12 (1977)).
(House Rep. 23, 95th
A financial institution's profit in the granting
and sale of mortgage loans generally comes from loan servicing, and specifically
from holding the custodial accounts.
It appears the Congress did intend for FCU's to service loans sold on the
secondary mortgage market.
However, this has caused a problem in
interpretation, since the institutional investors typically require that the
custodial accounts be insured by the Federal government, and NCUA insurance only
applies to "member accounts."
Recommended change:
Amend Section 101(5) by inserting the phrase "and such
terms mean custodial accounts established for loans sold in whole or in part
pursuant to Section 107(13) of this Act" between the phrase " . . . section 207
of Chifl Act" and ": Provided,
..."
102
8.
FCD authority to Issue GNMA Mortgage-Backed Securities.
At this tine FCU's are not expressly authorized to issue mortgage-backed
securities and, it is unclear whether the FCU Act provides a legal basis for
such activity.
An argument can be made that SlO7(7)(E) (invest funds) or a
combination of SS107(9) (borrowing) and 107(13) (pledge of eligible obligations)
provide the legal bases for such activity.
available.
Other arguments may also be
A clear statutory expression, however, would avoid the possibility
of strained Interpretations of the provisions of the FCU Act.
It would also
place FCU's on a parity with Federal savings and loan associations, which were
expressly granted this authority by P.L. 95-630.
Recommended change:
Amend §107(7) by adding after "Student Loan Marketing
Association," and before the semicolon:
"or in obligations, participations, securities, or other
instruments of, or issued by, or fully guaranteed as to
principal and interest by any other agency of the United States
and a Federal credit union may issue and sell securities which
are guaranteed pursuant to Section 306(g) of the National
Housing Act."
9*
Interest rate - "most favored lender" status.
In Title V of P.L. 96-221 Congress granted "most favored lender" status to
all federally chartered or federally insured financial institutions, with the
exception of Federal credit unions.
on a parity with national banks.
This placed all institutions except FCU's
This discrepancy stems from the fact that
103
FCU's are subject to a Federal Interest rate ceiling rather than to state
interest rate ceilings, whereas Title V was keyed to state laws.
Recommended changes:
Amend Section 523 of P.L. 96-221 by inserting in paragraph
(1) the phrase "or any provision of this Act" between the phrase "State constitution
or statute" and the phrase "which is hereby preempted."
The first paragraph
would then read:
"If the applicable rate prescribed in this subsection exceeds
the rate an insured credit union would be permitted to charge in
the absence of this subsection, such credit union may,
notwithstanding any State constitution or statute or any provision
of this Act which is hereby preempted . .
Also amend Section 523 of P.L. 96-221 by deleting in paragraph (2) the word
"State" from the phrase "such State fixed rate."
The second paragraph would
then read.
"If the rate prescribed in paragraph (1) exceeds the rate such
credit union would be permitted to charge in the absence of this
subsection, and such fixed rate is thereby preempted
10.
..."
Termination £f Inactive Members
Section 106.
Section 118 of the Federal Credit Union Act (12 U.S.C. 1764)
is amended to read as follows:
"(a) Except for those circumstances set out in subsection (b) of this
Section, a member may be expelled b> a two-thirds vote of the members of a
Federal credit union present at a special meeting called for the purpose, but
only after opportunity has been given him to be heard."
(8)
104
"(b) The board of directors of a Federal credit union may, by Majority vote
of a quorum of directors, adopt a policy to expel from membership any member of
a Federal credit union who (1) falls to vote in an annual credit union election
for three consecutive years or (2) fails to purchase shares from, obtain a loan
from, or lend to the Federal credit union for three consecutive years."
"(c) Withdrawal or expulsion of a member pursuant to either subsection (a)
or (b) or this Section shall not operate to relieve him from liability to the
Federal credit union."
The CHAIRMAN. Gentlemen, let us focus a little bit here. Last fall
and winter I met with the two of you, Mr. Connell and Mr.
Sprague, and your predecessor, Mr. Pratt, who at the time was
John Dalton, as well as with the Federal Reserve Board. The
reason for those meetings was that thrift industry leaders were
telling me, and it was agreed by all who participated, that the
savings and loans and the mutuals were in dire straits, that an
emergency existed. You went to work and came up with emergency
legislation, the regulators' bill. The administration vetoed it.
We have listened to your statements and you have sort of tiptoed
a little bit. Now let us ask the question directly. Has anything
changed since last fall and winter when everyone agreed that the
situation was bleak and the action was necessary? Have the circumstances changed in any way?
I note this morning the presence of quite a few members of the
committee and I think that is an indication of the concern that the
committee has. I want to know, are we wrong? Is there or isn't
there a problem out there as far as the mutuals, the savings and
loans, and the credit unions are concerned? I will start with you,
Mr. Connell.
Mr. CONNELL. Mr. Chairman, the circumstances have not gotten
better since we met earlier this year. As the high interest rates
persist, the equity of the institutions who are affected by the mismatch in assets continues to deteriorate.
The CHAIRMAN. Mr. Sprague?
Mr. SPRAGUE. Mr. Chairman, the need is more intense today
than when we last talked to you.
The CHAIRMAN. Mr. Pratt?
Mr. PRATT. Yes, sir. There has been a tremendous change in the
situation. The response which could have dealt with the situation
then is simply not sufficient at this time.
The CHAIRMAN. YOU think the situation is worse than it was last
fall?
Mr. PRATT. Substantially.
The CHAIRMAN. NOW, to each of you again, the Monetary Control
Act of 1980 contained a provision requiring the Federal Reserve
Board to provide access to the discount window for savings and
loans, mutual savings banks, and credit unions, and in so doing, to
take into account the special nature of these institutions and their
assets and liabilities. Do savings and loans, mutual savings banks,
105
and credit unions indeed have actual access to the window? Let us
start from this side this time.
Mr. PRATT. Mr. Chairman, about 10 days ago I wrote a letter to
Chairman Volcker indicating that the Federal Home Loan Bank
Board, upon consideration, had changed a previously existing
policy and that we were actively requesting the Federal Reserve
Board to develop programs to lend directly to savings and loan
associations both for overnight adjustment credit and on a longer
basis. We were further requesting that the Federal Reserve work
with us in developing a line of credit to the Federal Home Loan
banks. We were very well received with that letter and we have an
active program going with the Federal Reserve at this time to, in
fact, assure that those loans take place and that they become
available in the immediate future.
The CHAIRMAN. Mr. Sprague?
Mr. SPRAGUE. TO this point I am not aware of any extension of
credit by the Federal Reserve to any of the savings banks which I
supervise. There have been developments of the last 10 days. Chairman Volcker has called me on several occasions, and we have
active discussions underway which I believe will be fruitful.
The CHAIRMAN. Would you keep the committee informed as to
the results of those discussions?
Mr. SPRAGUE. Yes, sir. Chairman Volcker will be here next week.
The CHAIRMAN. I am sure that we will inquire of him, as well.
Mr. Connell?
Mr. CONNELL. Mr. Chairman, there have been at least two occasions where credit unions have borrowed overnight from the Federal Reserve. We do not, at this point, see the need because the
general liquidity situation is such that they have 32-percent liquidity and our central liquidity facility can meet their demands, so
they have not needed to draw on the resources of the Federal
Reserve System.
The CHAIRMAN. Mr. Pratt, you say that the current withdrawal
penalties are not sufficient to keep depositors from withdrawing
funds when interest rates vary by only 150 basis points or more.
You are becoming known in town as a man who wants to further
deregulate an industry to allow market forces to determine how
savings and loans will operate.
Is not the withdrawal penalty an item that should be deregulated, too? Shouldn't the market determine whether a penalty will be
imposed?
Mr. PRATT. Well, sir, I think this must be taken in the context of
what the Congress itself said in the Deregulation Act of last year.
If I remember correctly, the act clearly spoke in terms of an
orderly phaseout of controls.
Let us consider what happens if we have a 4-year account that is
totally deregulated as to rate, but has no withdrawal penalty. In
that case, an individual, of course, really has a 1-day account, and
you have gone in a single step to total deregulation of the liability
side as to interest rate and other factors. It is only through the
operation of something which truly keeps it a 4-year term that you
can have deregulation which is phased out over time.
The CHAIRMAN. By the same token, does this not make more
attractive that ogre that the savings and loans are yelling about,
106
and the mutuals as well as the commercials, to wit: the money
market fund? People may put money in a money market fund and
indeed withdraw the next day.
Don't you further disable, so to speak, the thrifts in competing
with these money market funds if you increase that withdrawal
penalty?
Mr. PRATT. The thrifts are caught between a rock and a hard
place. There are two problems which exist: an earnings problem
and a liquidity problem.
Deregulation of the liability side assists in the liquidity problem
in the sense that it allows these institutions to compete openly and
freely for funds and therefore to retain, defend, and perhaps even
increase their deposit base. At the same time, the deregulation
carries with it an instantaneous increase in the cost of their funds,
at a time when they are experiencing substantial losses, and which
earnings levels are threatening the industry itself.
It is a very tough question to call.
The CHAIRMAN. Thank you.
Mr. Sprague, one short question: As the regulator who has the
authority over the mutual savings banks, are you aware of any
administration plan directly geared to their problems?
Mr. SPRAGUE. Yes. Chairman Volcker is the principal architect of
this plan, and strongly supports it—the plan that I suggested to
you today.
The CHAIRMAN. I am asking you not about the regulators; I am
asking you about the administration: Does the administration have
a plan? I do not think that Chairman Volcker, since he is independent of the executive and the Congress, can be looked on as the
administration.
Mr. SPRAGUE. I was not sure how you classified him. Mr. Chairman, I believe that the Secretary of the Treasury has written to
you endorsing, or at least not opposing, one of the major elements
of our bill.
The CHAIRMAN. The merger section?
Mr. SPRAGUE. The interstate section. So we are halfway there.
With respect to the other, no, I am not aware of an administration
plan.
I can tell you that some lower level people in OMB and Treasury
approached Mr. Pratt and myself with an idea of exchanging paper
instead of money to in some way provide capital to institutions. I
do not believe that is an administration plan that has been staffed
by the Cabinet Committee or adopted by anyone. If there is any
backup paper for it, I have not seen it.
We are looking at it. I told them that we would. We have not
discarded it, because I am looking for more options, not less.
We are looking at such questions as what would this do to the
earnings of the thrift if you just exchanged paper. We doubt that it
would do anything. We are looking at how the accounting profession would look at the proposal: Would they require full faith and
credit of the U.S. Government? If that were true, I guess we would
have to amend our law to have an unlimited draw on the Treasury
for the FDIC fund. We are looking at whether people would really
believe this would help the market psychology. Would it be believable. We just don't know. But in the final analysis, we would have
107
to have a bill, in any event, because we have that essentiality
hurdle that we have very great difficulty in crossing.
Paul Nelson told me to keep my answers short, so I guess my
answer to your question is, "No." [Laughter.]
The CHAIRMAN. Mr. Stanton?
Mr. STANTON. Thank you, Mr. Chairman. I would simply add,
Mr. Chairman, in that regard, we do anticipate hearing from someone at the Treasury.
The CHAIRMAN. Yes. We will have someone from Treasury here
next week.
Mr. STANTON. SO we will ask them what their contingency plans
really are.
Gentlemen, I am a little bit surprised and quite disappointed in
reading over your statements last night, and the one this morning,
that all of your statements come accompanied with additional legislation. It just seems to me—and I think the chairman would
agree—that this is a step backward.
We came so close to a solution, at least on the regulatory powers,
that we worked on for 1V2 years. Now it seems unfortunate for the
committee to go back and consider additional powers. There was a
great advantage to a uniform approach. I believe it was interpreted
by us through Chairman Volcker when he presented it that it was
a united effort at that time. I do not have the time, but I wish that
you would get for me a little memo of how your new legislation as
far as the request for additional tools differs from what we had
talked about as a regulator's bill.
Is the regulator's bill still in effect? We understand the objections from the administration for additional funds for the FSLIC,
requests for additional funds which they objected strongly to. But
other than that, are the tools that you all requested, still wanted?
That, of course, was a question that the chairman asked: Are
these new powers appropriate? So I wish you would, for the benefit
of the committee, outline either in writing, if you will, how your
bills differ? How do your bills differ, in each particular case, as far
as the additional tools are concerned?
Do you want to give a short answer?
Mr. SPRAGUE. Our positions are identical, Mr. Chairman. We
would be delighted if you would move the clock back 90 days and
pass the bill we gave you then.
Mr. STANTON. Even with the additional
Mr. SPRAGUE. We have not even changed a comma in our sections.
Mr. CONNELL. I could certainly live with what Mr. Sprague proposes. We looked at these hearings as an opportunity to present a
number of other issues as well as those that are probably not of as
high priority as the regulators' bill originally was, but to describe
to the committee a broad range of things that are eventually
needed.
Mr. STANTON. In that regard, let me be fair. We do appreciate
that. What we have to do is to try to separate what are emergency
powers from additional tools, tools to carry out your prime responsibility under seminormal—certainly not emergency conditions.
We are disappointed we didn't do it a year ago. With a little
leadership, we would have hoped to have done that.
108
Mr. Pratt?
Mr. PRATT. Mr. Stanton, let me say first that I think one important element is that a tremendous proportion of the problem exists
in the savings and loan associations. Certainly in terms of the
problem relative to the regulatory agencies, I think the overriding
problems exist at the Bank Board. Mutual savings banks obviously
have their problems, but the FDIC's membership is composed in
such a manner that that is a relatively small percentage of their
membership.
With respect to our bill, I think the circumstances which we saw
last fall were several orders of magnitude different than what we
see today, and accordingly, our bill is substantially different. In
reviewing the regulators' bill, as time passed, and as economic
circumstances changed, we just found that it was totally inadequate, in our opinion, to deal with the short-term problem. Our
bill has a number of aspects which are vitally related to the immediate problem of making these institutions more viable, in that it
makes private capital much more willing to participate in the
immediate solution.
[In response to the above colloquy, the following response was
furnished for inclusion in the record by Mr. Pratt:]
109
RESPONSE TO QUESTION FROM REPRESENTATIVE STANTON
Q.
What are the differences between the provisions the Bank
Board proposed in the most recent version of the "Regulators'
Bill" and the FSLIC-related provisions contained in Title
IV of the Bank Board's June 30, 1981, draft legislative
package entitled the "Thrift Institutions Restructuring Act
of 1981?"
A. The differences between the sections the Bank Beard incorporated into the May 18, 1981, draft of the Regulators' Bill and
our Thrift Institutions Restructuring Act of 1981 (TIRA) Title
IV provisions are relatively minor, and are as follows:
1.
Emergency Mergers and Acquisitions;
TIRA; Section 8 of Regulator's Bill
Sections 401 and 402 of
(a)
Joint FSLIC-FRB approval of bank holding company acquisitions of thrifts. In section 401 of Title IV of TIRA,
we have dropped language from section 8 of the Regulators' Bill
designed to make emergency-context acquisitions by bank holding
companies of FSLIC-insured institutions subject to prior FSLIC
and Federal Reserve approval. This provision was eliminated
because the Bank Board decided that it would be anomalous to put
a more rigorous approval standard on takeovers of financially
troubled savings and loan associations by bank holding companies
than exists with respect to acquisitions of healthy associations.
It should be noted that nothing in Title IV would affect existing
law respecting the authority of a bank holding company to acquire
a thrift institution.
(b) Sunset requirement. In addition, the Bank Board has
stricken language appearing in section 8(d) of the Regulators'
Bill that would have "sunset" that section five years frore
enactment. This action was taken in the belief that the authority contained in section 401 would represent a valuable
standby tool for the FSLIC that should be available on a
permanent basis.
(c) Emergency waiver of Justice Department notification
requirement. A final provision appearing in Title IV that does
not appear in section 8 but that relates to the same subject
matter is section 402(b). The provision would provide an exception, in emergency supervisory cases, from the current requirement
that the Justice Department must be given thirty days to comment
on certain proposed acquisitions falling under the Savings and
Loan Holding Company Act before FSLIC approval of such acquisitions
can be granted. We believe the delays resulting from the requirement of awaiting Justice Department comment in failing institution
cases — the only ones to which the waiver would apply —• could
have undesirable cost consequences for the FSLIC, given the
premium on expeditious action existing with respect to institutions
in danger of default.
110
- 2 2.
Emergency Conversions;
Regulator's Bill
Section 403 of TIRA; Section 6 of
(a) Eguitability requirement in conversions. In section 403
of Title IV of TIRA, the Bank Board has eliminated language
specifying that conversions of mutual institutions to the stock
form must be on an "equitable" basis. This requirement was
regarded as ambiguous, and as adding nothing to the underlying
constitutional guarantees that would require the fair treatment
of mutual shareholders of a converting association.
(b) Grandfathered activities for converting savings banks.
Additionally, the Bank Board has stricken language that would
authorize mutual savings banks that receive federal charters
under section 403 to continue to engage in certain activities
permitted under state law. Because of the greatly expanded
investment powers available to federally-chartered savings banks
under Titles I and II of our TIRA proposal, the Bank Board
determined that there was no justification for extending special
grandfathering privileges to converting savings banks
particularly since no provision is made for providing similar
rights to converting savings and loan associations.
3.
FSLIC Conservatorship and Receivership Powers;
of TIRA; Section 7(b) of Regulator's Bill.
Section 405
Title IV of TIRA, in section 405(c), (d), (e), (f), and (g),
would provide the FSLIC with conservatorship/receivership powers
over State-chartered insured institutions approximately equal
to those which it now has with respect to Federal associations.
This proposed new authority was not included in the Regulators'
Bill. Under these new provisions, while the FSLIC still could
accept an appointment as receiver or conservator from a State
authority, and operate according to its regulation, the Bank
Board would be able to appoint the FSLIC as sole conservator or
receiver of a State-charted insured institution, superseding and
preempting any state appointment, upon a determination that the
institution was in an unsafe or unsound condition to transact
business, had substantially dissipated its assets, or had assets
less than its obligations. Current law provides that such preemptive power exists only where an institution actually has
been closed or a State receiver has been appointed for at least
15 days, where grounds exist identical to those required to
appoint a receiver or conservator for a Federal association, and
an account-holder has been unable to obtain a full withdrawal of
his account.
Section 405(b) of TIRA would clarify the fact that when the
FSLIC acts in its capacity as a receiver of a Federal association,
it pays the credit obligations of that institution only in its
capacity as receiver. The present statutory language raises
the possibility that the FSLIC's insurance fund might be held
liable for all the debts of a defaulted Federal association.
Ill
Additionally, the amendment would allow the FSLIC, as receiver of
a defaulted institution, to make such disposition of the defaulted
institution as it determines to be in the best interests of the
association, its savers and the Corporation itself. Currently,
an anomalous situation exists whereby the ability of the FSLIC
to make "such other disposition" of a defaulted S&L as is in
the best interests of its insured members applies only to statechartered insured institutions, and not to Federal associations.
Section 405(b) is identical to section 7(b) of the Regulators'
Bill.
4.
Borrowing Authority of FSLIC; Sections 407 and 408 of TIRA?
Section 10 of Regulators' Bill
(a) Line of credit with the Treasury. Unlike the Regulators'
Bill, which in section 10(b)(l) provides for an increase to $3
billion from $750 million in the Bank Board's line of credit to
the Treasury, the TIRA would leave the existing credit line undisturbed. This omission stems from the fact that the Administration has made it clear that an increase in our line of credit
would not be favorably regarded at this time.
(b) Federal Home Loan Bank lending authority. While TIRA
and the Regulators' Bill contain identical authorization for
the FSLIC to borrow from the FHLBanks, no power is given the
FHLBanks in the Regulators' Bill to make loans to the FSLIC.
This defect is remedied in section 408 of TIRA.
112
Mr. STANTON. One last question. I noticed, in reading your statement, that you assured the committee of your support for the all
savers bill.
The question among some of the members is if it is such a good
solution to a particular problem, why wouldn't it be fair to offer
the so-called all savers bill?
Mr. PRATT. AS I understand it, the original all savers bill does
incorporate all depository institutions within it.
Mr. STANTON. YOU have no objections?
Mr. PRATT. An old professor of mine once told me that something
beats nothing all to hell. The all savers bill is something. Our
estimates are that it would provide a substantial amount of benefit,
it would relieve the earnings problems to a substantial extent, and
would make our lives, as far as being able administratively and
financially to cope with the situation, substantially easier. It would
certainly help.
Mr. STANTON, YOU are in favor of the Senate version rather than
the House version?
Mr. PRATT. I have heard a great number of versions. I would
really prefer not to
Mr. STANTON. That is fair enough.
The CHAIRMAN. Mr. Gonzalez?
Mr. GONZALEZ. Thank you, Mr. Chairman. I wish to thank the
three members of the panel. At the very outset, I want to compliment Mr. Sprague and Mr. Connell, with whom I have had a
chance to correspond over the years and to say that they have done
a very good job, especially Mr. Sprague. And Mr. Pratt being
brandnew, I have not had much of an experience with him.
You have had for the first time since the Depression a bailout by
the Board. I think it was in Chicago, that a savings and loan went
completely under. There was no time, or, I guess, opportunity for
merger, and through the years—and I don't want anybody to interpret this as being partisan, because beginning with the regime of
President Johnson, who was not only a neighbor, but a great man
and a great President, I had correspondence and personal visits
that in fact upset him, because the handwriting has been on the
wall.
In fact, some of you may not have been officials at the time the
Hunt Commission was organized and reported. What you are
asking for is really in driblets what the Hunt Commission had been
envisioning on a more comprehensive scale. It ended up, like many
other commissions, a lot of noise for awhile. Nothing was done.
But today, for instance, Mr. Pratt, we have the administration
coming in on the one hand, absolutely with a program of blight, for
example, with respect to housing. Absolutely nothing. The only
thing the—it admits that there is a crisis. We have a housing crisis.
But it says, "We are appointing a commission to study the housing
situation and see what we can do about it," and in the meantime,
savings and loans either remain or are due for extinction as the
traditional source of home construction funds, mortgages, and the
like.
So in effect, what we are being asked to do here, in the guise of
emergency—because in your statement you say that we must have
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expeditious action, quick action, if we are going to save from—
something, you don't spell it out—but something awesome.
No matter what we do under the circumstances, we are apt to do
what we end up doing when we are pressured, and that is ending
up with inadequate legislation or faulty legislation, and still failing
to address ourselves to the basic question. The basic question, as
envisioned by the Hunt Commission, was that we had reached a
stage where the divisions of the traditional financial markets and
institutions of our country, savings and loans, banks, commercial
banks, mutuals and savings, and the other institutions, credit
unions, had faded and that there was a need to approach—and in
fact, they recommended a unitary regulation and the like.
The Congress did not respond, and it has not. It has not risen to
the occasion, but neither has the executive branch. In the meanwhile, we see a failure on the part of such vast enterprises as the
Federal Reserve to maintain the banking system as it was intended
by the Congress for it to function; that is, with a prime public
interest feature. Instead, the tremendous overwhelming financial
resources of the nations are being used by the behemoths. Look at
the current struggle between these troglodytes, and what are they
using? They are using banking resources.
The H. L. Hunt—Chairman Volcker, I believe, is quite eligible
for impeachment just in the role that he demonstrated in the H. L.
Hunt escapade in which there were available huge banking resources for what public purpose and necessity? That is what a bank
is chartered for. Everybody has forgotten that. I believe that unless
we address ourselves to that first, interest rates, everyone here and
everybody in leadership since 1969 treats interest rates as if it is
an act of God. Nobody can do anything about it, nobody should, is
what Secretary Kennedy told us in June of 1969.
I believe it is useless for us. We are not going to stop the
inevitable. The inevitable is a collapse, as I see it, and I hate to
think of it and I hope I am dead wrong; but I do not see how these
recommendations you have here can stem the tide.
Director Stockman used a phrase that he was urging the President to utilize and invoke the equivalent of Franklin Roosevelt's
moratorium, the first 100 years' emergency in 1932, and I am old
enough to remember. He said it was economic Dunkirk. I think
what we have here is an economic Waterloo, not a Dunkirk. I wish
it could be a Dunkirk, and I do not know what the regulatory
agencies, as they are presently set up, can gain to control this
situation in time, short term or long term, through this legislation
that is being requested at this point to stem this tide.
Unless we really invoke an emergency and the executive branch
is really willing to come in and invoke an emergency and really
consider these forces as controllable by the sovereign government, I
do not see how this will do any good, gentlemen.
I appreciate what you are trying to do, and I feel that actually
there is no alternative. What else? But it is just like trying to plug
a leak in the dike that is already bursting. But I want to thank you
anyway, gentlemen. [Laughter.]
The CHAIRMAN. I am impressed by my colleague's gratitude.
Mr. Paul?
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Mr. PAUL. Thank you, Mr. Chairman. I want to direct my first
question to the entire panel.
Last year we passed the Monetary Control Act and brought the
FDIC and the FSLIC more liabilities. We added approximately
10,000 institutions that qualified to borrow money at the discount
window. I would like to get an idea how many of the new institutions have made use of this discount window in the past year and
what the trend is for nonmember use.
Mr. PRATT. I would be happy to start. At the time, it was the
position of the Federal Home Loan Bank Board that, given its
system of regional banks, member institutions should first essentially exhaust the credit available to them through that system of
banks. As a result of that I think that there was no Federal
Reserve bank lending. There may have been one institution that
received a loan from the Fed somewhat by accident. I would have
to investigate, just to see if money actually changed hands in that
particular circumstance.
However, we feel the times have substantially changed. Access to
the Federal Reserve is important on a regular basis in order to
provide the benefits of Fed lending, and it is important on an
emergency basis because the Fed is the ultimate source of liquidity.
We have, therefore, in the last week directly and forcefully
changed our position and petitioned the Fed to begin making these
loans, and I suspect that they will respond fovorably. The initial
reaction has been positive and I should think, should I return in 90
days, that I would report that a number of institutions would have
borrowed by that time.
Mr. PAUL. Are you saying that none of the institutions that were
brought in in the last year have made use of the discount window?
Mr. PRATT. The institutions, for the most part, which are regulated by the Federal Home Loan Bank Board would not have made
use of the window. Some of our mutual savings bank members who
previously may have had some access may have continued to do so;
but in any case, it would have been virtually nonexistent.
Mr. PAUL. HOW about our credit unions?
Mr. CONNELL. The credit unions have not had to use the discount
window. First of all, they have had very ample liquidity the past
year. There have been two occasions where credit unions have used
overnight money, as I understand from the discount window. But
overall, they have had an excess of liquidity in the past year.
Furthermore, we have a central liquidity facility which some 50
percent of the credit unions belong to in the country, and that has
provided liquidity to them as needed. But overall, they have not
had to use it. They have been using the Federal Reserve facilities
acting as passthrough agents and have benefited from that portion
of the bill over the past year.
Mr. SPRAGUE. Most of the institutions that were added by your
law are the smaller commercial banks in the country that we
supervise. The use has been minimal. As Mr. Connell points out,
the funds are for liquidity and we have set up a mechanism with
the Federal Reserve and decentralized it within the regions to
expedite it. But should an institution make an application, we can
provide a telephonic response within a few hours on whether or not
the institution essentially qualifies.
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The use has been very, very small. I would have to provide the
numbers for you in the record.
Mr. PAUL. I have made inquiries along this line and have seen
reports that showed several hundreds of institutions that had not
qualified before the Monetary Control Act; that have actually made
use of the discount window. Your information and my information
contradict each other.
Mr. SPRAGUE. Mr. Paul, with 9,000 institutions, if the 200 figure
were true, that is minimal in relationship.
Mr. PAUL. There were several hundreds.
Mr. SPRAGUE. I will provide the answer for the record.
[In response to the request of Congressman Paul, the following
information was submitted for the record by Mr. Sprague:]
In reference to your inquiry concerning credit extended to insured state nonmember banks at the Federal Reserve discount window, during the 46-week period
from September 3, 1980 through July 16, 1981, 336 such banks borrowed a total of
1,833 times. The number includes 332 commercial banks and four mutual savings
banks. Commercial banks account for all but a few of the borrowing transactions.
Weekly transactions by insured state nonmember banks during the 46-week period
ranged from one to 108, the high figure being recorded the week ending July 1. The
trend in borrowing at the discount window, by insured state nonmember banks, has
been upward since September 3, 1980.
Mr. PAUL. Mr. Sprague, I want you to comment a little bit
further on the need for capital infusion. First, I would like to
challenge you a little bit on the word capital. I have the notion
that true capital comes only from savings, and when Government
creates credit and provides it for certain banks, it is not accurately
defined as capital. In present day terminology I understand we use
the word as such, but economically it does not act that way. What
kind of dollars are you talking about? What is this going to mean
in the budget? What kind of additional funds do you need here?
Mr. SPRAGUE. One of the reasons we support the bill is that we
are terribly concerned about the budget problems of the Government as a whole, and some 15 years or so ago the law was changed
to incorporate our budget in the general Federal budget, even
though we are completely an independent agency. I cannot tell you
the rationale, but I guess it is probably because we had a large
surplus and it helped the budget look better.
If we proceed under our present authorities and if we have to
pay out a large institution or if we have to dispose of it under any
of those seven options that I have included in my statement, it will
have extraordinary budget impact. It will mean that for those who
are supporting military spending, less for that. For those who are
concerned about social spending, possibly more cuts there. For
those who are concerned about balancing the budget, additional
problems.
That is one of the major reasons we want this legislation. The
present facilities we have are very, very costly. Loaning money to
an institution in relatively small amounts would, we think, prevent
some failures at minimal cost.
Mr. PAUL. DO you have an estimate on the dollar amounts? What
would you use if you had had this power in the past year?
Mr. SPRAGUE. We would not have used it in the past year, Mr.
Paul. When we first started drafting this legislation in the winter
of 1979, under the leadership of the Treasury Department—Under
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Secretary Carswell was the principal architect—we had a session
every Monday night over at the Treasury, just the principals and
an attorney, to draft the bill, and we had projections which I guess
were indefinite, but enough to make us feel that there would be a
problem in Dick Pratt's industry in 1981 and that there would be
problems in the savings banks in 1982. The legislation was designed to help us both in a timely manner. So, if we had all of the
powers I asked for now, I doubt that we would use them this year. I
feel certain we would next year.
Mr. PAUL. I still don't know how many dollars you need, but my
time has expired.
The CHAIRMAN. Mr. Minish?
Mr. MINISH, Thank you, Mr. Chairman.
Mr. Connell, on page 11 you propose permitting the Board, under
certain emergency situations, to merge credit unions with dissimilar common bonds. What does "dissimilar common bonds" mean?
Mr. CONNELL. The common bond is the limitation of the membership of a credit union. You can only do business with a credit union
if you are within that group. It could be an occupational group, it
could be an associational group such as a union, or it could be
people living within a clearly defined community, neighborhood, or
rural district. The common bond is like the McFadden Act problem. If we have a steel company credit union closing and we don't
have any steel company credit unions nearby to merge it, we
cannot merge it with a hospital credit union or a teacher's credit
union. We have to liquidate the institution.
In fact, this happened in Chicago this past year, where a credit
union of about $8 million that had been around since 1934 and was
very well run, the members woke up one morning and found out
that their plant was closed and we had no choice but to liquidate
the credit union. It is to prevent that type of liquidation that we
are dealing with this. It would be similar to interindustry, or
interstate mergers for banks.
Mr. MINISH. When you are aiding the thrifts through the discount window—how would the Fed keep the money supply under
control?
They have about $90 to $100 billion to work with.
Mr. PRATT. I am sorry. I missed the first part of the question, sir.
Mr. MINISH. If the Fed were to aid the thrifts with discount
window loans, how would they keep the money supply under control?
I don't know that you are concerned whether the Fed controls
the money supply or not, but I thought I would ask you.
Mr. PRATT. I have great confidence in their ability to handle
that. I suppose the way they would do so would be to offset thrift
access with open market operations in another sector of the economy. This, of course, is an allocation of resources.
Mr. MINISH. Your concern is, of course, that the thrifts get it?
You are not concerned about what happens with the banks, are
you?
Mr. PRATT. The banks are capable of defending their own interests.
Mr. MINISH. I agree with you.
That's all, Mr. Chairman.
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The CHAIRMAN. Mr. Leach?
Mr. LEACH. Thank you, Mr. Chairman.
I would like to address a question to Mr. Pratt. I must begin it
with a brief preface. As you know, we are in a financial Armageddon between the financially regulated institutions and the financially deregulated. It is obvious that the only fair competitive
answer is either equal regulation or equal deregulation. In this
sense, along with several others, I have proposed an equal regulation approach that implies putting reserve requirements on money
market mutual funds.
But I think most of us, and I as well, would prefer an equal
deregulation approach. It strikes me that a package that involves,
as you have suggested, more powers to the Federal Home Loan
Bank Board, more powers to individual savings and loans, coupled
with a tax-exempt savings certificate, coupled, as well with an
accelerated phaseout of regulation Q, so that regulated institutions
can compete more equitably for deposits in given areas, is probably
a better approach than the equal regulation approach.
Speaking personally, I think it is a better approach. Speaking
politically, I think it is the most savings and loans can get, and
probably the best they can get.
The question I would pose to you is: Is that enough to keep your
industry afloat?
Do you think that that will be sufficient, to allow the savings
and loan industry to survive in a very competitive way, in the near
future?
Mr. PRATT. Well, looking into the future is always difficult. It
depends entirely on what the economy holds for us over the coming
months and years. It is also a matter of degree.
Clearly, there are thrift institutions that will be competitive, and
especially so if given the powers we are suggesting, regardless of
what the economy may do. There is another group of thrift institutions which are well run, and which have served their communities, but which are quite vulnerable to economic circumstances.
Based on what we can see now, the program that you have
outlined, which would preclude some immediate financial amelioration through tax-exempt savings or some other approach, shows a
willingness to face the problem, and a particular willingness to face
the fact that you cannot deregulate deposit interest rates without
providing deregulation of the ability to use the money. We think
the combination of those actions and the other things we have
asked for would see the industry through.
But if we are going to have a tough time. The next few months
are going to be months of great pressure. However, the immediate
financial effects of congressional action would be to encourage
capital to flow to the institutions, and the statement of confidence
by Congress that these institutions will be made competitive and
given the fair ability to compete with others, would inspire public
confidence in their ability to compete and survive.
Mr. LEACH. Thank you.
I would only like to comment that the whole idea of a tax-exempt
savings certificate, in terms of congressional viability, is really only
1 month old. I think it is the most imaginative approach that this
Congress can take at this time, and it is frankly a preferable
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approach to putting reserve requirements on money market
mutual funds. If we go in that direction, it should be clear from a
congressional point of view that it will be considered a tradeoff
against the placement of reserve requirements on money market
funds and that this approach will have to be abandoned at this
time.
Thank you.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
I want to make a few comments. I really have no questions to
ask. I want to express my appreciation for the heads of the various
departments; the regulators that are here this morning. They have
my complete sympathies, as they know. In the last conference on
deregulation, I did not sign the report; I did not vote for the
legislation. There was nothing in that legislation that would protect the thrift institutions and the mutual savings banks.
To me, to have a Board composed of the Federal Reserve and the
various regulators, and then to expect the Federal Home Loan
Bank Board to come out on top—Mr. Pratt, you only got one vote,
and that is all you will ever have. You have been doing a good job.
I voted for the term of the Chairman of the Federal Reserve in
this committee and in the House, to run coterminous with the
President. President Reagan has my complete sympathies for inheriting Mr. Volcker. Had our bill passed in the Senate, as it
should have passed—but we just don't do anything right around
here, when it comes to the vast masses of the American people. We
kid ourselves into believing that the Fed is an independent agency.
Now, if you believe that hogwash
You know, independence—independent people who do not belong
to something—an organization—have destroyed every institution
that they have ever touched. I have almost seen my own party
destroyed by independents, because they do not know if they are
Democrats or if they are Independents, or some other title, you
know, that they place on themselves. So independency is a luxury
we cannot afford in America.
We are a great country because we developed a great two-party
system. You know, we like to criticize the European parliaments as
compared to our own representative government here in America.
Well, we have seen our representative government become a coalition government, just like any European government. We have
seen that demonstrated twice on the floor of the House.
I want to say to the regulators that you had a bill, known as the
regulators' bill. That bill was vetoed by the administration. So
what is going on is really not your fault, but it is a long history of
not passing legislation as far as the Fed. The last deregulation bill
was a farce.
Now we are told that one of the reasons that your legislation, the
regulators' bill, was vetoed is that Mr. Stockman and the Secretary
of the Treasury, Mr. Regan, did not want any draws on the Treasury which would upset the phony numbers in the Gramm-Latta II
reconciliation bill. I am not an economist, so I am not going to
argue about the $35 billion in cuts, because anything can happen.
I know that when the President comes to the Congress in October, for $1 trillion debt ceiling bill, I know the Republicans might
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run. But I have been here 17 years, and I never voted against the
debt ceiling; and if it is $1.5 trillion, I am going to vote for it. We
made the bills, and they are going to have to be paid. So the
President will have the honor of being the first President to ask for
a $1 trillion debt ceiling bill.
I would also like to point out that I want to wish Mr. Stockman a
lot of good luck. I do not agree with his economics. I think that the
deficit in the end, when we get through with this $1.3 trillion bill
that we have been discussing, in the Department of Defense they
are going to have a deficit of at least $60 billion, $70 billion, to $80
billion.
But this situation is a lot more serious than we try to imagine. I
want to know, in my own city of Chicago, that the thrift institutions, like everywhere else, the mutuals, are in very serious trouble. When the blow comes, these people who are trying, you know,
to protect a theory—I think it is some professor of economics'
curve, the Laffer curve—they want it to come out at the expense of
the American people.
You are going to see—and I hope I am wrong—Dave Stockman's
$35 billion so-called cuts go down the drain, if you have 200 or 300
or 400 of these institutions close, Mr. Pratt and Mr. Sprague. You
know the small banks are in trouble, and everybody is going to
save everybody else by opening up, crossing State lines, and create
bigger and bigger banks.
Well, we had a Great Depression. It was known as the Hoover
Depression. When these institutions start folding up, I do not think
that this legislation is going to do it. We have not prepared ourselves to do it. I agree with Mr. Gonzalez, you are going to have
David Herbert Hoover Stockman of 1981. This is what is going to
happen.
I yield back the balance of my time. [Laughter.]
The CHAIRMAN. Certainly the members of the panel want to
comment. [Laughter.]
Mr. Shumway?
Mr. SHUMWAY. Thank you, Mr. Chairman.
Mr. Sprague, if I might address my first question to you. You
have asked us to consider a couple of provisions which would
extend the ability of your agency to come to the rescue of thrifts.
Dr. Paul asked some questions about the dollar impact of those
provisions, and I don't think that you were able to fully answer his
questions.
My question deals with a related matter. I get in my mail, from
time to time, a string of letters commenting on the ability or lack
of ability, as it really is, of the FDIC to really provide the kind of
insurance that America's depositors and savings institutions are
led to believe is there. Now, whether that is in fact true or not—I
am just wondering if, in the event there were a massive failure of
these financial institutions in America, and the FDIC were called
upon to bail out all of the individual depositors; and assuming
further that it would have a difficult time in doing so; how can we
now realistically talk about expanding those programs, expanding
the potential dollar liability of the FDIC by these two provisions
which you have described to the committee here this morning?
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It seems to me that if indeed you are going to be hardpressed to
back up, in terms of insurance, the deposits that you are now
obligated to protect, aren't you putting your neck even more into
the noose by going into new and more expensive programs that
would call upon your Agency to come forward with even more
dollars?
Mr. SPRAGUE. Mr. Shumway, I think I can answer both of you at
once, with this response:
Our fund now is approximately $11.5 billion. It is fully adequate,
as far as we can tell, for any eventuality. It has grown rapidly.
Under the normal course of events, the fund would be $25 billion
by 1985.
Now, you talk about expanding our authorities. Very rough numbers—please do not hold me to them; they are ballpark. You have a
$2 billion institution that we must pay off. We write a check on
day 1 for $2 billion. You have that same $2 billion institution, but
we work out a merger, assuming a 30-percent depreciation in the
portfolio. We put up perhaps $600 million on day 1. You have a $2
billion institution that we can keep alive by providing $200 million
of capital.
We are not asking for more authority to spend more money. We
are asking for authority to save money and hold down the deficit.
The numbers are dramatic.
Mr. SHUMWAY. Right now, the fund stands at $11 billion—$11.5
billion—and you expect it to expand to $25 billion by 1985?
Mr. SPRAGUE. Well, if we get this bill, yes.
Mr. SHUMWAY. Mr. Pratt, if I might address this question to you.
You have outlined to us some of the proposals that we have had
before, but which we know would be—they would have as their
effect the overriding of certain State prerogatives. Many of us in
Congress have really gone to bat in terms of trying to preserve
what is left in America of home rule, and honoring the role of
States.
It seems to me, at this particular point in time, States are just as
aware and just as concerned, and just as anxious to search for
solutions for the problems of savings and loans, and banks, and
thrift institutions, and the problems of disintermediation, as is this
committee, as well as the entire Congress.
I am not satisfied, as one member here, that there has been a
sufficient case made that we should be overriding those State prerogatives; that we somehow have a better solution at hand.
Now certainly, if you are suggesting that we confine our efforts
to interstate matters—things that States themselves, by their own
actions, cannot attend to—certainly I would understand that. But if
we are going to invade the prerogatives of States, and say that
"Washington wants it this way," in an effort to save the thrift
institutions—I would just like to know: Do you believe that a
sufficient case has been made to proceed in that direction?
Mr. PRATT. Let me give a couple of quick examples. One, where
we have experience already, is the override of State usury laws
affecting first mortgage loans. In my opinion, that was socially
very beneficial and was strongly supportive of the public interest.
A second issue concerns the "due-on-sale" clause. A portion of
our legislation would provide for Federal preemption of State laws
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forbidding excercise of the due-on-sale clause. The due-on-sale
clause, of course, states that at the time the borrower sells the
security property, which in the case of a mortgage loan is his
home, the lender may call that loan.
Our preemption proposal would not disturb his secure tenure
and fixed payment while he is in the house, but does not necessarily allow him to capitalize on the value of a low-yielding loan for
resale and add that to the profits from his house—unless his contract permits such a result.
The Federal Home Loan Bank Board believes that it is very
much in the public interest, in that it makes more mortgage credit
available and lowers the cost of mortgage credit if "due-on-sale"
clauses are allowed to operate. Please remember that these clauses
are part of private contracts between borrower and lender.
As you know, a number of States has struck down these clauses,
saying that they cannot be enforced. What this does, of course, is
transfer wealth from future borrowers to past borrowers. It creates
substantial windfall gains. But why is it a Federal problem?
Well, one example of why it is is that the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association have said that they will require the exercise of due-on-sale
clauses in all States in which it is legal.
What this, of course, has provoked is a substantial number of
States passing legislation to make the clauses illegal. It was a
beggar-thy-neighbor policy in two regards: One, across State lines;
and two, the people who have received loans essentially taxing
those not receiving them, as well as those who provide capital to
thrift institutions.
We think in that regard, a major piece of the problems which
thrift institutions face is because of the persistence of inflation,
which they could not possibly have anticipated. It is a very tough
question, but I think there are instances where Federal preemption
serves the public interest even though it is is distasteful in some
respects. There it is advantageous in that it will save the use of
Federal money directly, and in any event it is essentially equitable.
Mr. SHUMWAY. Thank you, gentlemen.
My time has expired.
Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Blanchard.
Mr. BLANCHARD. Thank you, Mr. Chairman.
I want to commend you on holding these hearings. As you know,
a good number of the members of the Banking Committee have
been deeply concerned for some time about potential widespread
failures of financial institutions and what that might do to the
public competence.
In our system of money and credit, I have talked to a number of
financial analysts who are not in charge of regulating institutions
and do not perhaps run them. All of them concur; as one of them
said, the situation with regard to savings and loans at least, and
mutuals, is a ticking time bomb, that if left unaddressed will be a
matter of grave concern for our economic system.
Now, I am having a hard time understanding what all of you are
really saying, other than it seems like you are kind of poking at
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the margin here of something that is far more serious that you
would really rather discuss publicly.
As I understand it, Federal spending will continue to go up,
despite the eloquent speeches of the President and Members of
Congress. There is very little else therefore being done to fight
inflation. There is no incomes policy.
Essentially, everyone I have talked to—and that means conservatives and the liberals, economists and businessmen, but bankers
and the like, concur that inflation is being fought almost exclusively with monetary policy. We are borrowing a tax cut to sprinkle
around which does not due much to ease the pressure and interest
rates either. It would appear we are going to have continued high
interest rates, albeit hopefully slightly lower than they are at this
point.
So, with what I see, no relief in sight, all of us, including you and
members of the administration, have a responsibility to prevent
the condition you describe from getting any worse.
Now, I am concerned because the psychology, as discussed earlier, created when an institution is permitted to fail or perhaps
allowed to be liquidated can be very serious. In my home State,
there are several institutions in which there is a run going on on
them, because certificates that people hold in excess of $100,000 are
not insured. I think the panic can increase if they see the FSLIC
allowing liquidations to occur, rather than some other method of
rescue.
I do not think it would take too many failures in too many States
for the average person to lose faith in the integrity of our financial
institutions and cause a problem far greater than the one exists
now.
Now, having said all that, I am curious as to whether you concur
in my analysis? Also, given your range of powers, how many institutions under your jurisdiction are in serious trouble?
Mr. Pratt?
Mr. PRATT. Well, your analysis was wide ranging. In looking at
the situation of the thrifts and the savings and loan associations
under our jurisdiction, clearly there exists a substantial earnings
pinch. This has a number of implications to it, particularly for a
number of institutions which very likely are not viable unless
economic conditions change rather substantially.
We do see a tremendous ability on the part of management to
solve its own problems and to take effective steps to get through
this very difficult time. We are seeing a tremendous number of
voluntary mergers, and generally a tremendous creativity on the
part of management in dealing with their own problems. We
should not underestimate their ability to do so.
Beyond that, we have a wide variety of powers with which to
deal with those institutions which ultimately become the concern
of the FSLIC. The caseload of the FSLIC, however, is very, very
large as compared with any other historical period
I believe the last number that we reported in this regard was
something over 200 institutions, 263 I believe, which we feel have
special problems. How this situation will evolve is tremendously
dependent on what happens in the economy. It depends on whether
the all savers bill is passed, for that would represent money to the
123
bottom line. It depends on the level of interest rates, and on how
rapidly they change. At this time, we think we have the ability to
deal with it.
Mr. BLANCHARD. What are your current resources with your
insurance fund, including any expected income that you have or
additional assessments or Treasury borrowing authority that you
could use to deal with this problem if the situation seriously worsens?
Mr. PRATT. The FSLIC has about $6 billion, and it has an income
of about $1 billion a year.
Mr. BLANCHARD. There are reserves from Treasury you could
use?
Mr. PRATT. We have a line with the Treasury of $750 million.
Mr. BLANCHARD. I am curious. As I understand it, you were
hoping to see the FSLIC have its borrowing authority increased,
even thought those reserves may seem quite ample; is that correct?
Mr. PRATT. Yes; we did. In the original regulators' bill there was
a provision asking that the line of credit be increased from $750
million to $3 billion. This would be consistent with the growth
which has occurred in the responsibilities of the FSLIC.
Mr. BLANCHARD. Isn't it also true you were concerned that available reserves were not sufficiently out. Given the nature of this
problem, that the possible savings and loan failures might, in
terms of numbers, exceed what was available to you?
Mr. PRATT. At this time, we think that we do have the resources
to deal with the failures which will occur.
Again, one cannot forecast the economy—at least I cannot—and
the absolute level of interest rates, the level of public confidence
and other factors. But our best analysis at this time indicates that,
in fact, we can deal with the problems as they arise.
We also think enactment of the legislation we are proposing
would aid tremendously in dealing with the problems that might
exist, and would cause a number of them to be taken care of on a
rapid basis.
Mr. BLANCHARD. One concluding question here: Your recent legislation on savings and loan powers did not contain any such
insurance fund strengthening provisions. Is that essentially because the White House and Treasury asked that you not include
them? Or was there a change in your judgment?
Mr. PRATT. There are really two things: First, we were not led to
believe that such a suggestion would be well received. Second, we
believe that the bill, as we have now structured it, which is substantially different than that which existed previously, will greatly
increase the likelihood of bringing private capital into an industry
which to them would then appear to have reasonable prospects of
profit and liability and that the private markets, which we basically rely on, would become a much larger portion of the solution.
Mr. BLANCHARD. I hope you are able to deal with this before it is
too late.
Thank you.
The CHAIRMAN. Mr. Weber.
Mr. WEBER. Thank you, Mr. Chairman.
I have a number of questions. I will try to be as rapid as possible
so we can squeeze them all in.
124
First of all, the all savers bill, Chairman Pratt supports it very
strongly.
Mr. Connell and Mr. Sprague, what are your feelings on that
act?
Mr. CONNELL. Mr. Weber, first of all, the all savers bill appears
to be a very expensive approach to the issue. It is a rather crude
tool to deal with the particular problems.
I think the thing that concerns us mostly is that provisions that
limit it to institutions that have a high proportion of their assets in
housing, savings and loan associations essentionally, if that were
passed in that form, we think it would be very disruptive.
Mr. WEBER. Assuming we had an all savers bill that did not have
that type of credit allocation, which is, I believe, what the Senate
bill provides?
Mr. CONNELL. Yes; then it would be beneficial to credit unions, as
it would encourage greater savings to flow from other types of
nondepository instruments.
Mr. WEBER. Thank you.
Mr. Sprague?
Mr. SPRAGUE. I believe the Treasury projections are that this
would be an enormously costly legislation, $4 billion, $6 billion—I
don't know what the cost would be—and that the benefits would
essentially go to those in the upper income brackets.
I think the breakoff figure is 34 percent, marginal income tax
bracket. Further, there is some dispute about how much new savings it would bring in and whether the effect would be just to
provide benefits to those who are already saving. I discount that. I
think that it inevitably would bring in some additional savings. I
also think that probably the big commercial banks will scoop up
most of the gravy. On balance, I would oppose the bill.
Mr. WEBER. Thank you very much.
Now, a point of information—I am a little bit confused by the
testimony of Mr. Pratt and the testimony of Mr. Sprague.
On page 10 of your testimony, Chairman Pratt, you are complaining that State laws now prohibit the interstate merger of
failing saving and loan institutions. There is a prohibition in the
Saving and Loan Holding Company Act against the saving and
loan holding companies acquiring control of insured institutions in
more than one State.
On page 6 of Mr. Sprague's testimony, there is the statement
that the FSLIC may assist the merger of a failing insured savings
and loan with an out-of-State savings and loan.
Can the two of you clear up my misunderstanding?
Mr. PRATT. The savings and loan business, as is true with commercial banks, is chartered under dual chartering systems, with
some State charters and some Federal charters.
With federally chartered institutions, we have relatively complete control. And we can allow them to merge across State lines.
If institutions are State chartered, then it would depend upon
the laws of the State. And as a matter of fact, of course, there are
savings and loan associations, quite a number of them, that operate
on an interstate basis in the United States at this time under State
law.
125
The Holding Company Act is a specific issue that is of importance to us. I do not think there is a conflict. I think it is just
working through the labyrinth of various regulations and laws.
Mr. WEBER. Your statement on page 10, what is the change in
legislation that you are seeking to expand the interstate acquisition?
Mr. PRATT. There are two or three items that deal with this. One
would be the authorization of holding companies to hold institutions in more than one State.
The second type of problem that we are seeking to deal with is
represented by the situation that exists, for instance, in the State
of New York at this time, where we have problems converting a
mutual to a stock association. Such a conversion facilitates our
dealing with the problem, enabling us to sell someone who might
have cash for such an investment.
So, the legislation gives us power to allow various forms of organization which will best meet the needs for injections of private
capital by allowing merger on a basis which will solve the problem.
Mr. WEBER. Are you seeking a law that permits State-chartered
savings and loans to merge across State boundaries?
Mr. PRATT. We would be seeking increased authority for supervisory cases only in this regard.
Mr. WEBER. I don't understand what that means.
Mr. PRATT. It would only apply to institutions which are essentially failing institutions.
Mr. WEBER. Mr. Sprague while we are proceeding on the interstate question, on page 8 of your testimony you state under your
interstate change of law, a winning out-of-State bidder may reopen
a State bank only as a subsidiary, so that no interstate branching
will result.
You will have to explain to me the difference between interstate
branching and operating as an interstate subsidiary.
Mr. SPRAGUE. Yes; very briefly to respond to your first question,
our request is somewhat similar, but somewhat different from Mr.
Pratt's authority. We have a very limited entree under our proposed bill. Only the 107 largest institutions would be eligible for
across-State mergers. None of them would be eligible until they
had been closed, dead and gone. It has nothing to do with viable
interstate branching. Very, very limited provision that we are seeking.
The difference, as proposed in our bill, is to preserve the prerogatives of State law. The way our bill is designed, the winning bidder
would have to operate as a subsidiary and be totally controlled by
the laws of whatever State he goes into. As contrasted by having
them just extend their branch network of their existing institution.
It is a major States rights provision.
The CHAIRMAN. Mr. Mattox?
Mr. MATTOX. Thank you, Mr. Chairman. Let me start off by
stating my preexisting prejudice, and that is against the crossing of
State lines by institutions. We have had it in Texas. We had a
situation where there was a grandfather provision where, I think,
Imperial Savings & Loan of California already had some interest in
Gibraltar Savings, which bought four of them in Texas, and they
merged across State lines through a grandfather provision.
126
But in your testimony, you cite on page 6 the provisions that the
FSLIC right now may approve a merger of a troubled savings and
loan with an out-of-State savings and loan institution, at the very
bottom of the page, page 6.
Mr. SPRAGUE. Yes.
Mr. MATTOX. It is my
understanding that even though they have
got that power, that they have never used that power, or the power
has not been actually given by legislation, but there is nothing to
prohibit the FSLIC from granting that—or taking that action; is
that your understanding of the situation?
Mr. SPRAGUE. Mr. Pratt would have to respond. That is my
understanding. But they came right to the verge in the last month
of using the power.
Mr. PRATT. I would believe we have certainly approved a number
of institutions' operating on an interstate basis. Savings and loan
associations have historically in certain parts of the United States
had extensive interstate operations. States of Washington, Oregon,
Utah, Montana, Hawaii, and many others already operate on a
regular daily basis with healthy institutions across State lines. I
would have to research what approvals we have—may have made,
of mergers.
I believe that we did approve an interstate merger, and perhaps
more than one.
Mr. MATTOX. Of a troubled institution?
Mr. PRATT. Yes, sir.
Mr. MATTOX. The question I am really trying to get to, if this
piece of legislation that basically you have divided into three parts
and brought back to us is so important, is it important because you
think that there is going to be an immediate need to approve an
assortment of these across-State-line types of mergers with savings
and loans? Mr. Pratt, I would ask you.
Mr. PRATT. I think at this time we do not have pending any such
backlog of cases. Again, what the future will bring, I do not know
at this time.
It is important to note that we do have some geographical problems. There are some instances where, because of the economic
conditions within a certain State or the status of its State laws for
a period of time—let us say with respect to usury—that we have
concentrations of problems. We do not have a such a good mixture
of, let us say, strong and weak institutions, which make solving the
problem within a State or within a small area more difficult than
under other circumstances.
Mr. MATTOX. What you are telling the committee is that at the
present time, there is no critical need for mergers across State
lines of troubled with healthy institutions, at the present time.
Mr. PRATT. At this moment, I don't know of any cases. I am not
saying that that could not arise in 1 week, or 2 weeks, or 5 weeks.
Various things trigger a need for us to act, and there are tremendous numbers of institutions which are working out their own
problems. We may not see their suggested solutions until they are
asking approval for it.
Mr. MATTOX. I have not had a chance to study your legislation
carefully, but it is my impression that what you are asking for is to
allow the Home Loan Bank Board, FSLIC, basically, to approve,
127
perhaps, the merger of a bank with a savings and loan or a bank
holding company to purchase savings and loan inside of the State,
or to allow the purchase by a bank holding company of a savings
and loan across State lines.
Would you comment on whether that is a correct interpretation
of what
Mr. PRATT. This would obviously be very helpful to us. We recognize it is an important public policy question, however, and our
FSLIC-related provisions would make no changes in existing law in
this regard.
As a general matter, we intend to seek the guidance of Congress
even in some areas where we believe we have legal authority to
act, but that involve matters of substantial public policy. We would
like to hear the Congress voice on such issues. We will implement
whatever that voice would be.
The CHAIRMAN. Under the Bank Holding Company Act, the Federal Reserve right now has the power to authorize bank holding
company acquisitions of savings and loans, doesn't it?
Mr. PRATT. That is my understanding.
Mr. MATTOX. They have not done so. I guess they have ruled the
opposite: They have ruled that they will not approve that kind of
action.
Mr. PRATT. I think that they are reexamining that. They have
that issue out for comment. I believe they turned down such an
acquisition recently, without prejudice. But those would be questions, obviously, that would be better asked of the Fed.
Mr. MATTOX. Let me move into another area. I know that there
are several savings and loans that have approached you about the
possibility of making major loans to the institutions, and in effect,
taking back the security for those loans, the low-yielding mortgages
that they hold in their portfolios, with the agreement that possibly
at a later time they may come back in and reacquire those mortgages over a 5- to 7-year period, in effect to allow them to phase
themselves out of some of the problems.
Now, with the legislation that you are talking about, would it
permit you to have additional capital to bring about those solutions?
Mr. PRATT. NO, sir.
Mr. MATTOX. YOU are
not providing any kind of additional means
for that?
Mr. PRATT. It improves our ability to perform such operations,
but it does not include any funding within it.
Mr. MATTOX. I don't mean direct funding; I mean such as allowing
Mr. PRATT. It does expand the flexibility with which we can
operate. It does increase the flexibility we have to provide various
solutions, including those which would involve the injection of
capital for a period of time.
Mr. MATTOX. It does not allow a direct draw on the Treasury for
additional money.
Mr. PRATT. That's correct.
Mr. STANTON. Would the gentleman yield? I am curious about
that.
128
Would you need additional legislative authority to do what the
gentleman from Texas is talking about, buying old loans?
Mr. PRATT. I don't know that we have examined the exact question of buying old loans. We have staff working on developing
capital instruments which we feel we could legally purchase under
present law. There are, again, some Federal and State law questions that sometimes make these cumbersome, and those questions
are dealt with in our legislation.
Mr. MATTOX. If I could ask one more question, would you tell me
the extent of the moneys you would need to deal with the existing
troubled savings and loans to implement a plan that would allow
you to in effect go in and purchase the low-yielding instruments
with the agreement that the savings and loans would come back
and buy those instruments back over a 5- to 7-year period, with not
only paying the principal, but also the subsidy interest? Do you
have that kind of a figure?
Mr. PRATT. I can't give you that figure. I would be more than
happy to supply that to you in written form. I think we could come
up with some pretty good estimates for you.
Mr. MATTOX. YOU understand the question I am asking?
Mr. PRATT. Yes, sir; and we can clarify it.
Mr. MATTOX. I would appreciate it.
[In response to the request of Congressman Mattox, the following
additional information was submitted for inclusion in the record by
Mr. Pratt:]
129
MATERIAL REQUESTED BY REPRESENTATIVE MATTOX
Federal Cost of Five-Year Warehousing Program
Table 1 shows estimates of the outstanding principal balances of
below current market coupon mortgages held by savings and loan associations
as of December 31, 1980. As can be seen from this table, the bulk of the
below current coupon mortgages are in the 9 to 10 percent range. Accordingly,
the estimates provided of the federal cost for a five-year warehousing
program are based on purchase of mortgages bearing coupons below 10 percent.
The table below shows the estimated cost to the federal government
if it were to purchase at par all mortgages carrying interest rates below
10% for a five-year period, subsequently selling the mortgages back to the
original selling institution, also a par. Shown below are both the initial
outlay (a portion of which would be recouped when associations repurchased
the mortgages) and the cost, termed the warehousing cost, to the government
of carrying these mortgages for the five-year period. The warehousing cost
is the difference between what the government would earn on the mortgages
and what it would have to pay to finance the purchase. This cost is based
on current costs of intermediate-term government debt. 1/
Initial Outlay $305.2 billion
Warehousing Cost $94.9 billion
A few caveats are in order. First, the cost estimates are based on
an assumption of no mortgage prepayments. A prepayment would lessen the
cost since the government could retire the financing debt when the mortgage
prepaid. Second, the costs are understated since no attempt was made to
estimate the increase in Treasury's borrowing costs caused by the increased
demand placed on the credit markets as a result of the additional borrowing.
Third, no estimates of transactions costs are included. Fourth, no estimate
of a lower cost resulting from additional tax revenues as associations invest
the proceeds from the sale of mortgages to the government in higher-yielding
assets is included.
1/ Yield on 5-year Treasury Security.
the yield was 15.24 percent.
As of week ending July 24, 1981,
Table 1
Residential Mortgage Holdings by
Coupon Rate at Saving rind
Loan Associations
Less
than
6.00-6.99*
9 .00-9.99*
1.26
3.37
9-52
22.89
29.67
5,765
15,420
43,560
104,735
135,757
Percent outstanding
mortgages, 9/80 1/
Residential mortgages,
12/80 (million $)
7.00-7.9'J* 8.00-8.99*
10.00-10.99*
14.30
65., 431
11.00-11.99*
9.32
42,644
12*
and
over
9.65
TOTAL
99.93
44,154 457,466
Assumptions:
Coupon
Original maturity £•/
(years)
Average age (years)
Remaining Life (years)
5.5C*
6.5*
22
24
24
25
26
27
27
27
17
5
13
8
16
5
11
20
2
24
1
26
1
26
1
26
7.5*
8.50*
9.50*
}J Based on a survey taken by the U.S. Savings League in September, 1980.
2/ Based on when these coupon rates were prevalent.
10.50*
11.50*
12.505*
9.55
131
The CHAIRMAN. Mr. McCollum?
Mr. MCCOLLUM. I would like to clarify something, Mr. Pratt. Is
my understanding correct that you would favor the purchase or
merger between bank holding companies, commercial banks, and
savings and loan institutions?
Mr. PRATT. I don't know if it is a question of what I would favor.
It is a question of our having a problem and what are the possible
solutions. That is clearly a solution which exists and which might
provide substantial infusions of capital into ailing thrifts and
which would not require the use of public funds.
Obviously, there is a public policy question which has been
stated as to the appropriateness of the financial structure of the
United States, and obviously that is the question you have to deal
with. It would help us. It would allow us to deal more effectively
with our problems.
Mr. MCCOLLUM. Would the use of that merger action within the
intrastate idea avoid the necessity of interstate merging?
Mr. PRATT. I think the two of them go together in many respects.
Each of them provides a portion of the solution. Obviously, the
most total solution is provided by a combination. Institution eager
to go interstate will find this opportunity the most attractive. They
are going to be willing to put up the most capital. They are going
to be willing to go the furthest in solving the problems which we
may be facing. Therefore, the broader geographical net you can
cast, the better that solution will be.
Mr. MCCOLLUM. Mr. Sprague, your testimony on pages 10 and 11
indicates some similar thinking with regard to the merger potentialities between commercial banking establishments and savings
and loans.
Do you agree with what Mr. Pratt has said with respect to this?
Or do you think that your position is different in some respect on
that issue?
Mr. SPRAGUE. I am in complete agreement. What we need is
more options.
Mr. MCCOLLUM. Mr. Pratt, from an equity standpoint, there is
probably no serious question that—and this is what you said—the
banking industry ought to allow savings and loans to have demand
deposits. But you have indicated in your testimony that you do not
think there is any serious question.
I presume that means there is no serious question in your mind.
But is there a serious question in the banking industry's mind? Do
you know what their thinking is about that?
Mr. PRATT. I would not see them rushing to support this legislation. They clearly should represent their own self interest. I am not
sure that seeing competitive equity in this regard is necessarily
something which they see as of substantial benefit.
Mr. MCCOLLUM. Am I correct that the basic proposals you have
in the long term section of your statement would just simply break
down most of the barriers between commercial banking and savings and loan institutions?
Mr. PRATT. Yes, sir. It is my belief, that given the mandate of
Congress that institutions must bid for funds in an open, free, and
competitive market, that the only structure which makes any sense
and which will allow survival and competition and serving the
132
public interest, is to allow institutions to sell funds in a competitive
market. To the extent we have major legislative constraints, that
clearly does not exist.
Mr. MCCOLLUM. In light of the long-term goal, and even though I
am aware of the short-term problems that savings and loans have
right now, do you think that returning the differential at this time
would be really that beneficial to savings and loans in terms of
their drawing of capital away from other markets that seem to be
broadening and more available? Would it not in fact damage the
long-term prospect?
Mr. PRATT. I may be a little bit like the person who loved
humanity but hated people. I do not wish to talk out of both sides
of my mouth here, but as I did mention earlier: There is a shortrun problem; an immediate earnings problem; as well as a structural problem.
This earnings problem has been caused by the configuration of
these institutions over time, and the losses have already occurred.
It is a question of how to ameliorate these losses. How do we deal
with them? Imposition of the differential is clearly a short-term
move away from competitive equality, in one sense, and in another
sense, to the extent that these institutions do not have the other
powers, it may be an establishment of better equality, which then
should be removed as the powers are given.
Mr. MCCOLLUM. What I am getting at is with money market
funds, with the availability of such different types of borrowing
and investment opportunities today for the consumer, would the
return of the differential be significant at all in the short term for
the savings and loans in the current financial environment?
Mr. PRATT. If we look at the 6-month money market certificates
prior to removal of the differential, savings and loans held about $2
for each $1 that commercial banks held. At the present time, that
is almost totally reversed.
Further, if we look at the ability of these institutions to capture
household savings, where we would think savings and loans would
be strongest—this is really their area, dealing with households—in
the last 3 years their market share of these households savings
flows has decreased tremendously.
Money market mutual funds have increased in size, but very
interestingly, commercial banks have essentially held their own. So
what you have had is, in my opinion, a very dramatic shift from
savings and loan associations to commercial banks as a result of
the removal of that differential.
Now, given that savings and loans do not have competitive asset
powers, it seems to me that was not an orderly phasein of deregulation.
Mr. MCCOLLUM. I yield back the balance of my time. Thank you.
The CHAIRMAN. Mr. Vento?
Mr. VENTO. Thank you, Mr. Chairman.
Gentlemen, I appreciate your being here today. You know I paid
special attention to the comments, especially with regard to the
Tax Code, for financial institutions to acquire help through that
particular means.
Is it your judgment, Mr. Sprague, that that is the only game in
town? Is it the most efficient one, or do you think more efficient
133
changes to help financial institutions would be through a regulatory method or through Congress dealing with special programs?
Mr. SPRAGUE. AS I said, Treasury apparently is searching diligently for an alternative to what is not too attractive a solution. I
do not know if they will come up with one or not.
Over the long term, I think proposals like Mr. Pratt has made
about improving the ability of the institutions to do their job
should be looked at.
Over the short term, like now, I think we have to have some
legislation to let us handle things that may well happen before the
impact of all of these other changes comes about.
Mr. VENTO. YOU do not believe that trying to provide the regulatory relief or trying to provide some remedy for problems that exist
through a tax code is very efficient?
Mr. SPRAGUE. We don't know. It may postpone some of the
problems a few months or years. I don't look to it as any ultimate
solution.
Mr. VENTO. That seems to be the only thing that is moving
around here and frankly the only place where we can offer help. I
am not enamored with that as a solution. As long as we are going
to pass the tax bill, some of us say we should try to make it
noninflationary, provide savings incentives in it. Maybe it will
help, and maybe it won't with regard to specific problems, but we
do not find it efficient. It helps both the healthy and the unhealthy. It does not target the money generally, and when you do
try to target it, such as the housing targeting in supposedly the All
Savers Act, you get the response that is the evidenced at the
witness table this morning.
Let me address one other problem that is apparent to me. One of
the things so far in the discussion that we have talked about is the
viability of financial institutions and the proposed modifications to
keep them solvent within current and future economic circumstances.
My question is, What about the purpose for which they are
created? Are you extending credit, providing capital growth with
regard to special functions, or have these activities been markedly
affected by the movement to different arenas—money market certificates, bonds, and so forth? Will the modifications that you have
proposed address the totality of maintaining the roles that you
actually have. That really is the question.
It seems to me this morning we are talking about a holding
action until the economic storm blows over. The question is whether the assets will ever come home. I am interested in that particular question.
Are we going to be able to do the job, or are we just talking
about saving some institutions that have a bad portfolio of paper
versus doing the job in terms of what you are supposed to do?
I do not know what types of studies or what type of testimony
you can give to that particular question.
Mr. SPRAGUE, Our mandate from the Congress clearly is to protect the insured depositors of America. It does not say anything
about saving banks or savings and loans or building housing or
doing any of those other things. We have a very narrow perspective
from our corporation—insurance corporation, and that is to handle
134
our business in such a way that no insured depositor will ever lose
a nickel. I can assure you, it just cannot happen—any scenario that
the chairman may draw—no insured depositor is going to lose
anything.
Now others have different charters, but that is our charter—to
protect the insured depositors.
Mr. VENTO. But what about the institutions that engage the use
of that insurance? Are they going to end up healthy as a consequence of this? Will they be able, under the existing circumstances
or future circumstance—to engage in the commercial activities
successfully?
In other words, will we see a return, for instance, with these
changes themselves that will not cause a change in terms of the
level of activity right now that we see centered around savings and
loans or commercial banks or credit unions?
In other words, they are designed to protect the insurance fund,
to protect the depositors, more than they are to really deal with
what might be characterized as a type of disintermediation.
Mr. SPRAGUE. We do not attempt to address the structural problem. The structural problems—Mr. Gonzalez talked about the Hunt
Commission report of a dozen years ago. There have been a
number of other reports along the way. Mr. Pratt has a proposal
today. There is room for an extraordinary amount of turf fighting
over this problem.
All I am trying to suggest today is, can't we please not solve
everything at once? Let us just zero in and take care of today what
we need today.
Mr. VENTO. But shouldn't we be concerned about some sort of a
formal analysis of such problems in terms of where the institutions
are going? At least we ought to know for the integrity of the
insurance fund, shouldn't we?
Mr. SPRAGUE. Certainly.
Mr. VENTO. And you are saying that we cannot address that. I
think Mr. Gonzalez, in terms of talking about the Hunt report,
probably identified a legitimate benchmark—myself.
Maybe, Mr. Pratt, you have been talking about the health of the
savings and loans. Maybe you would like to try to address that
question yourself.
Mr. PRATT. Yes, sir; I think you have hit it directly. That is
really the issue of the efficient functioning of these financial markets.
We believe that our legislation and our proposals go directly to
the ability of thrift institutions to serve the marketplace and to
provide financial services. We are suggesting that a major part of
the steps which we have been talking about today are designed, in
fact, to improve the competitiveness with which the consumer is
served and to allow him a broader range of choice as to where he
gets his financial services, and to make sure that institutions
which have ability and expertise in various types of financing,
including residential real estate finance, are there to provide funds
to the consumer.
Mr. VENTO. YOU are asking for a redefinition of your functions.
In a sense, you point out that 20 percent, in terms of commercial
credit, was not adequate. You are asking for that.
135
The fact is, does that mean a desertion of the former functions
that thrifts and savings and loans have performed?
Mr. PRATT. NO, sir; I don't think it does. I think we will see some
institutions move in different directions. I think it is very much a
question of giving housing a good-sized slice of a growing and
viable pie or giving housing, maybe, a bigger piece of a pie that is
disappearing; 100 percent of nothing is substantially less than 70
percent of something large.
Mr. VENTO. Very good. I appreciate your response. Thank you
very much.
The CHAIRMAN. Mr. Wylie?
Mr. WYLIE. Thank you, Mr. Chairman, and distinguished gentlemen of the panel.
I think you put your finger on one of the problems that we have
as far as the committee is concerned, Mr. Sprague, when you said a
little while ago that there is a considerable amount of turf fighting.
Do you endorse Mr. Pratt's approach that he has submitted to us
here this morning?
Mr. SPRAGUE. I am not even going to have time to address his
proposal. I am going to spend my full time trying to get the
emergency bill. When we have that, I will sit down and really work
with Mr. Pratt on his.
Mr. WYLIE. YOU have not analyzed his proposal?
Mr. SPRAGUE. NO, it is too long.
Mr. WYLIE. NOW you have one. Do you endorse Mr. Sprague's
proposal, Mr. Pratt?
Mr. PRATT. I have no problem whatsoever with the FDIC getting
the legislation they need to deal with their problems. I invite the
FDIC to help us get the legislation we need to deal with our
problems.
Mr. WYLIE. Did you hear the comment, Mr. Connell? You see the
thrust?
Mr. CONNELL. Certainly, Mr. Wylie. I agree with Mr. Sprague in
terms of the regulators' bill, that it should be passed, and we are in
full support of that.
I am also in support of what Mr. Pratt proposes in terms of
broadening the operating powers of savings and loan associations.
We have a system that was designed in the thirties to meet a
Depression-era market situation. We are in an entirely different
situation today.
It is just not possible evidently for thrift institutions to operate
as long-term lenders, as they have in the past. The missing ingredient which will take a longer time, I think, to analyze and evolve is
how one develops an incentive system for housing finance, as we
have developed since 1934. That will take a great deal more
thought.
But it is a missing ingredient, and the structure that we have
developed, that was developed in the thirties, does not suit the
eighties, and so I think we have to reanalyze that entire structure
of the Federal Home Loan Bank System, the entire regulatory
structure.
Mr. WYLIE. I agree with you, and I think that that is very
perceptive. For that reason, I cosponsored the All Savers Act. I
136
think it is important to get money flowing into the savings and
loans and commercial banks.
You have suggested, Mr. Sprague, that you do not like the All
Savers Act because it would benefit higher income people a little
more. In attempting to analyze this situation, before the first of the
year, I introduced a bill which would exclude up to $10,000 in
interest—in taxes on income from savings—interest on savings
accounts. The United States is the only country in the world that
penalizes savings. That is my opinion.
I think something like that, as I say, which would exclude up to
$10,000 from taxes on savings deposits might very well encourage
business and give a nice boost to the depressed housing industry at
the same time.
What would you think of that approach? I know that is not
necessarily in your field, but you do have some expertise. I am not
getting very far with my bill, and I have not asked anybody on this
panel about it yet. I am taking the opportunity I have now.
Mr. SPRAGUE. YOU just stole my answer. You said that was not
my field. It really is not; I am not an expert in that area.
People in Treasury tell me that it could result in a lot of shifting
of savings, but not necessarily new savings, and people who already
are saving will just get this benefit. I don't know.
As long as it is so extraordinarily expensive and those kinds of
questions are not answered, I think you ought to go slow. Now you
are going to have Treasury people in front of you a week from
today, and I would suggest
Mr. WYLIE. I have already put the question to Secretary Regan.
He thinks it would be too much of a tax loss. I do not know how
you sort it out as to whether there would be more of a tax loss on
this kind of a bill or a 10-10-10 in all savers or whatever.
Mr. SPRAGUE. I don't know.
Mr. WYLIE. The savings and loans allege, and I think the commercial banks too, that in many cases money market mutual funds
are taking money from all over the country and investing that
money into a few large financial institutions in some of the large
banking communities, as you know.
Is there a national problem developing there? I have put this
question to some people in the money market mutual fund industry, and they suggest that an attempt now is being made within
the money market mutual funds to reinvest the money which they
take from the community back into that community. Have you
seen any movement in that regard?
Mr. SPRAGUE. NO. We identified the problem that you suggested
earlier of funneling the money from the little communities of
America essentially into the large, central city banks.
I am not aware of any solution to the problem. I will certainly
check with my regional directors. I will be meeting with them next
month.
Mr. WYLIE. DO you have any expertise on that?
Mr. PRATT. NO, sir. I don't have any figures on it. I would think
that money market mutual funds operating efficiently, as they do,
with very small margins for the most part are certainly going to
look for generally wholesale outlets for their funds which require
little or no management. Therefore I would certainly not expect
137
them to be involved in directly serving credit needs of small communities. Perhaps by limited investment in savings and loans and
commercial banks of those communities they might, in fact,
achieve some of that.
Mr. CONNELL. I have seen reports in the paper about attempts to
recycle the money through smaller banks. But I think overall, it is
more cosmetic than substantive at this point.
Mr. WYLIE. I want to get into some of the substance of the bill,
but I know my time is about to expire—it has, he says.
I will finish my questk>ff, and then I would like to submit some
questions for the record if I may, Mr. Chairman.
The CHAIRMAN. Without objection.
Mr. WYLIE. What impact would the extension of demand deposit
powers to Federal associations have on the Federal Reserve's implementation of monetary policy and control of the money supply?
On page 15 of your bill, Mr. Pratt, you say:
As a first step, we urge that the Home Loaner's Act be amended to allow all
Federal associations to offer demand deposits to any customers.
Mr. PRATT. Yes, sir. First, I guess it does seem extremely surprising to me, given the great support for deregulation which I have
found among certain elements of the banking community and elsewhere, that they would have any objection to letting others have
the same accounts that they have.
Second, I see no difficulty whatsoever with regard to the monetary role of the Federal Reserve. As a result of the legislation last
year, thrift institutions, for monetary purposes, were brought
under Federal Reserve control. They could continue to exercise
their reserve controls over these institutions—and in my opinion,
without difficulty. You might want to ask the Fed.
Mr. WYLIE. Thank you.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. Thank you, Mr. Chairman.
Mr. Pratt, there are 10 new deregulatory elements that you
included in your bill. Are these new powers essential to the longterm survival of the thrifts?
Mr. PRATT. Yes, sir. In my opinion, and given the mandate of
Congress for competition in the purchase of funds, they are essential.
Mr. BARNARD. Are these powers as broad, or are they broader,
than those granted to national banks?
Mr. PRATT. I have not studied the national banking laws. I would
think, for the most part, that they would be similar. There are a
couple of areas where, in fact, they might be broader; and that
would perhaps be in the direct investment in real estate, which a
number of State-chartered institutions presently have, and which
many of them in fact are using to solve their problems at this time.
The States of California and Florida have direct real estate investment powers.
I am also not entirely familiar with national banks' authority to
have what we call service corporations, which allow the development of ancillary activities. So, it would, for the most part, bring
effective equality, we think. I am sure there are some differences.
Mr. BARNARD. If you study it carefully, you will have broader
powers than the national banking system.
138
Are not these new powers that you are asking for, Mr. Pratt, all
addressing the asset side of the ledger?
Mr. PRATT. Not all of them. One important power—and I don't
understand why thrifts don't already have it—is the ability to take
checking accounts from all customers. It does seem amazing to me
that we tell 'a major financial institution that it will not be allowed
to service a certain set of customers.
Mr. BARNARD. But primarily, they are affecting the asset side of
the ledger?
Mr. PRATT. Yes, sir. The Congress has dealt effectively—and
some people think too effectively—with the liability side, through
the deregulation act of last year, which mandates the broadening
and deregulation of powers on the liability side.
Mr. BARNARD. If they have, then why has the liability side for
savings and loans, mutual savings banks, thrifts, credit unions, and
banks been so eroded?
Don't you think that the impact of certain funds—namely money
market mutual funds, to the tune of $135 billion—is somewhat of a
problem?
Mr. PRATT. Yes, sir.
Mr. BARNARD. HOW is that addressed in your bill?
Mr. PRATT. It is addressed by giving thrifts the
ability to earn
sufficient returns on assets so that total deregulation on the liability side could take place and, so that rates, comptitive with those
offered by nonregulated or nondepository institutions could be offered.
Mr. BARNARD. Aren't you dodging the issue, if you do not have
the liabilities to service the assets?
You cannot make leasing loans, consumer loans, consumer loans
if you don't have the funds to do that.
Mr. PRATT. Of course, the two sides of the balance sheet are
connected. You must have sufficient earnings in order to go out
and compete with those funds. If your point is, would we support
deregulation of the liability side in order to compete with money
market mutual funds, we would support it totally, if the Congress
sees fit to give our institutions the right to earn from their assets.
Mr. BARNARD. It looks to me like we are dealing with a very,
very narrow spectrum, in trying to correct the problem. The problem is a much broader picture, as I see it, than has been brought
out this morning.
I think we are somewhat myopic if we believe that we can
change a few asset laws and a few other liability structures, and
we will solve the problem. The problem is money market mutual
funds, and the need for small savers to earn market rate interest.
Do you have the power to permit savings and loans to commingle
funds?
Mr. PRATT. For what purpose? For a money market mutual fund?
Mr. BARNARD. Right.
Mr. PRATT. I would like to doublecheck this with my general
counsel. But, subject to check, I believe we have the authority to
authorize service corporations to run money market mutual funds.
Mr. BARNARD. Why hasn't the Federal Home Loan Bank Board
done this?
139
Mr. PRATT. It is a very complex issue, in my opinion. As you
know, the spreads on the money market mutual funds tend to be
very thin—I think in the neighborhood of 50 basis points, something of that nature. For small and regionalized savings institutions to offer such funds, one of the big problems is that they would
be primarily competing with their own deposits.
Assume you have First Federal money market funds: If it pulls
money out of its own institution, which funds then must be arbitraged into U.S. Government securities and other things; and the
savings and loan consequently has to go to the Federal Home Loan
Bank and borrow money at 21 percent, then would have substantially harmed themselves.
It is an intricate question. It is one that is presently under
consideration, and we have not come to a final conclusion as to
whether it would be helpful to the institutions and to the public.
But we are studying it.
Mr. BARNARD. With all that we see in the news today—the
expansion of American Express and the insurance industry into
the investment business, and even into the banking business—
when we see so many of the other securities dealers getting into
the banking business in so many regards, do you see that there is a
need to address the Glass-Steagall Act?
Mr. PRATT. Yes; we need to look at the total set of financial
services and the conditions under which they are being offered in
this country. We really need a very basic public policy examination
of the direction in which we are heading, and whether we wish to
continue going that way.
Mr. BARNARD. Mr. Sprague, can you answer that same question?
Mr. SPRAGUE. I believe that you are probably going to do that—
reexamine everything. The world is moving so fast. Reexamination
would be useful, and I hope you address it promptly, after you pass
our bill.
Mr. BARNARD. Mr. Connell?
Mr. CONNELL. I would be for a quick repeal. The act is unnecessary. The securities laws that have developed from 1933 on address
the issues that really were the core problems that caused the
Glass-Steagall Act to be enacted.
Mr. BARNARD. Every one of you gentleman express urgency, that
something be done.
Do you feel that we need to do something as far as GlassSteagall, as soon as possible?
Mr. PRATT. Are you addressing me?
Mr. BARNARD. Yes.
Mr. PRATT. I don't
have the expertise to know with what degree
of urgency Glass-Steagall should be examined.
Mr. BARNARD. YOU would agree that the money market mutual
funds' erosion of thrift deposits is one of the biggest problems we
have got?
Mr. PRATT. It certainly is. I would certainly agree with you to
that extent.
Mr. BARNARD. Mr. Sprague?
Mr. SPRAGUE. It should be addressed in the context of the total
package. If you are going to reexamine the missions and roles of all
of the institutions, Glass-Steagall comes into that category.
140
Mr. BARNARD. While we are talking with broad subjects, let us
talk about the McFadden-Douglas restrictions.
Mr. Sprague, how do you feel about any changes in those particular laws, in light of what is going on today, with the competition
among financial and nonfinancial institutions, and all that it is
doing to depository institutions?
Do you feel that this question, likewise, should be addressed?
Mr. SPRAGUE. We think it should be addressed, but we have no
preconceptions of the resolution. As you are aware, we are forced
by necessity to request a minor change in Douglas right now.
Mr. BARNARD. YOU would agree that banks particularly, as well
as savings and loans, are being discriminated against today, because of the prohibitions of McFadden-Douglas, as far as nonfinancial institutions?
Merrill Lynch, American Express, Bache—you name it, they already have interstate operations, but banks are limited to operations in one State.
Mr. SPRAGUS. There is no question about that.
Mr. BARNARD. Thank you, sir.
The CHAIRMAN, The Chair would like the indulgence of the members. Something has just come to his attention. I would like to ask
one question of Mr. Pratt.
Mr. CARMAN. Fine.
The CHAIRMAN. Mr. Pratt, I am reading from the July 13, 1981,
Washington Financial Reports, and I want to make sure that it is
accurate. I am sure you do, as well:
Pratt also briefed the panel on the current state of the S. & L. industry, which he
acknowledged is experiencing a substantial period of difficulty. As of the end of
April, he said the bottom 10 percent of the industry, 395 associations, had a net
worth of assets ratio of 1.68 percent, with an industry average of 5 percent, and a
negative return on assets of about 350 basis points. About 80 percent of all savings
and loans are now experiencing operating losses, he said. Without any intervening
factors, Pratt said an average of one S. & L. per day would hit zero net worth.
Overall, he said about one-third of the industry, worth about $200 billion in assets,
is not viable under today's conditions.
Under a downslide estimate, but not a wildly radical, pessimistic estimate, Pratt
said the failure of those institutions could produce losses of about 30 percent, or $60
billion. Those losses would be possibly offset by $10 billion in book net worth of the
associations, and $5 billion in Federal Savings and Loan Insurance Corporation
funds, leaving a $45 billion gap.
And then you go on to speak about mergers, to close the gap.
The full text of this article will apear in the record at this point.
[The material referred to by Chairman St Germain is from
Washington Financial Reports and follows:]
141
(From Washington Financial Reports, July 13, 1981)
"SWEEPING LEGISLATIVE CHANGES"
URGED BY FHLBB CHIEF TO AID S&Ls
Chairman Richard T. Pratt of the Federal Home Loan Bank Board June 9 said he will
soon propose "sweeping legislative changes" to help the financially ailing thrift institutions.
Pratt^ in a briefing for members of the President's Commission on Housing, said the
bank board's proposals will "virtually amount to rewriting the 1933 Home Owners* Loan Act
to allow institutions statutorily to choose the line of business they will be in. The board believes that the de facto direction in the deregulation of the purchase of funds must have logical
sequence in the sale of funds. "
The board's approach as a regulatory agency, he said, "is to do everything within our
power to give management the right to solve its own problems, invest funds in a competitive
market and let the market work. "
Pratt said a bill to carry out the board's proposal for the "sweeping changes " has been sent
to the White and the Treasury Department for review. The FHLBB chief said he hopes to discuss the proposed measure when he testifies July 14 at the opening of hearings by the House
Banking Committee on the impact of the government's policy on the S&Ls and other financial
institutions (Report No. 130, A-l).
The legislation also would allow S&Ls to have demand-deposit accounts, or checking
acounts, for businesses, and Pratt acknowledged that if the bill is enacted, an S&L "would
really be able to be a commercial bank if it chose to be one. "
The chairman argued, however, that the deregulation of deposit rates, which has
raised the cost of funds, means thrift institutions must have expanded asset powers in order
to remain viable. Any attempt to force institutions to remain specialized housing lenders
while they have to pay market rates for funds could lead to the disappearance of the thrift
industry, Pratt warned. He added, however, that he expects thrifts to continue to specialize
in residential and household finance because of their expertise in those areas.
Pratt also contended that housing will be better off with a healthy, growing thrift industry, even if the percentage of thrifts' funds going into housing declines.
To improve S&L earnings and investment flexibility, Pratt said the bank board intends
to propose regulations July 22 authorizing full balloon-payment loans. He said he expects
final regulations to be in place by September 1.
In a balloon-payment loan, the amortization schedule is based pn a loan which extends
beyond the actual loan term, leaving a large unpaid balance when the loan matures. This
balance must then be paid off or refinanced at current interest rates. This plan is widely
used in home mortgages in Canada.
Pratt also briefed the committee on the current state of the S&L industry, which he
acknowledged is experiencing a "substantial period of difficulty. "
As of the end of April, Pratt said, the bottom 10 percent of the industry (395 associations) had a net worth to assets ratio of 1.68 percent -- the industry average was about 5 percent -- and a negative return on assets of about 350 basis points per year. About 80 percent
of all savings and loans are now experiencing operating losses, he said.
142
Without any intervening factors, Pratt said, an average of one S&L per day would hit
zero net worth. Overall, he said, about one-third of the industry, with about $200 billion in
assets, isn't viable under today's conditions.
Under a "downside estimate, " but not a 'wildly, radically pessimistic estimate, "
Pratt said the failure of those institutions could produce losses of about 30 percent, or $60 billion. Those losses would be partially offset by $10 billion in book net worth of the associations
and $5 billion in Federal Savings and Loan Insurance Corporation funds, leaving a $45 billion
gap.
Mergers: One way to close the gap, or avoid the losses, Pratt said, is through mergers
but he said those are getting harder to arrange under current law.
The bank board's draft legislation would alleviate the problem, Pratt said, by allowing
the board to arrange interindustry and interstate supervisory mergers and acquisitions. In
other words, an ailing S&L in one state could be merged with an S&L in another state or
with a commercial bank.
In addition, Pratt said, the bill would allow supervisory conversions of associations
from mutual to stock form, which should make it easier for them to raise new capital. The
bill also would provide increased flexibility in chartering,
including new federal charters
for mutual savings banks and conversions between S&Ls1 and savings banks' charters.
Eventually, Pratt said, this could lead to the amalgamation of the S&L and savings bank
industries.
Pratt said the bank board will also seek a federal preemption of state laws restricting
the enforcement of mortgage due-on-sale clauses. As much as 10 percent of S&L losses
may be attributable to state legislation and court decisions preventing associations from
calling a loan or raising the interest rate when a property is transferred, Pratt said.
On the liability side, Pratt said high interest rates and competition from other institutions,"^ucTraTm^reymarket funds, have driven S&Ls out of the retail savings market,
forcing them to rely for funds on "jumbo" certificates of deposits, Wall Street, and Federal
Home Loan Bank advances.
Pratt expects a "record increase" in FHLB advances during the second half of 1981,
which could be a "testing of the bank system's ability to expand." As of the end of May,
S&Ls had $50.9 billion in advances outstanding, up about $4 billion from the end of 1980.
Asked about the possibility of subsidized advances to reduce the S&Lsf cost of
borrowing, Pratt said he would support such a plan only if the money to cover the subsidy
comes from the Treasury, rather than from the Federal Home Loan Banks.
143
The CHAIRMAN. IS that an accurate report of a statement by you?
Mr. PRATT. A portion of those numbers come off some very
preliminary monthly indications that we receive. And therefore,
they have some margin of error in them. But the report would be
generally reflective of what was discussed, as far as the second half
of the statement goes. This was a briefing to a professional group, a
housing commission—the finance subset of it. And the second half
of it represents essentially a hypothetical circumstance, but one
that perhaps could be envisioned.
The CHAIRMAN. IS that an accurate report?
Mr. PRATT. Yes. An accurate report of my discussion.
The CHAIRMAN. Thank you, Mr. Pratt.
I thank the members.
Mr. Carman?
Mr. CARMAN. Thank you, Mr. Chairman.
I would like to express my thanks as well, for the presentations
that each one of you gentlemen have made. I would like to follow
up immediately on what the chairman has raised.
I understood you to say, Mr. Sprague, that under no circumstances would depositors lose any funds in this country, whether
through the FDIC or the FSLIC. I suspect that is true.
I am very, very concerned—as I think many members of this
Banking Committee are concerned—with what has been discussed,
which Chairman St Germain just alluded to. I feel that we are
presaging an economic hurricane. The winds have been blowing,
and I think that by October, they are going to be extremely strong;
and by January or February of next year, it is going to be a very,
very difficult problem.
I do not see, Mr. Pratt, specifically how you are suggesting that
we are going to meet the short-term liquidity problems that are
going to have to be met by the industry, specifically the thrift
industry, if we are to insure that we are not going to have wholesale problems which will affect not only the thrift industry, but the
entire financial community, as well.
Perhaps you perceive the all savers legislation as being that
answer? I do not know, but I am concerned about it and I wonder if
you might tell us how that is going to be solved or what you are
projecting.
Mr. PRATT. In looking at the liquidity, there are several levels of
defense. The first of these is really the liquidity of the individual
associations, which is relatively high at this point in time; substantially higher than the regulatory level which we have required,
and which I think represents a defensive
Mr. CARMAN. Let me interject this. We have, in general terms,
about $800 billion worth of assets in the thrift industry nationwide.
They have between $31 and $35 billion overall in reserves.
What the gentleman from Rhode Island just spoke to a few
moments ago was the hypothetical situation where we could be
down as much as $45 billion. The hypothetical situation obviously
has to contemplate that we are going to have interest rates as high
as they are now. These institutions are holding on to portfolios that
are like cement blocks around their necks in a race.
I just don't see how in the world, from what has been proposed
thus far, how we are not going to be into "negative reserves." I
144
have heard people talk about infusions of capital, but—my specific
questions to you are: First, do you believe that the Federal Home
Loan Bank Board, at the present time, has sufficient authority to
meet the short-term liquidity problems we may face in the very
immediate future? Second, do you need additional materials in
addition to what you have asked for here?
It looks like it is a very difficult problem to avoid. I think we
have a problem, now. The question is: How do you meet it?
Mr. PRATT. We believe we have the ability to meet liquidity
needs, and the legislation of last year giving the Federal Reserve
the ability to lend to thrift institutions, is particularly promising.
There are administrative and mechanical factors which are involved, and we believe we can deal with them. If times change, you
will be assured that we will be back with proposals that we think
are necessary under those circumstances.
Mr. CARMAN. My specific concern, then, following that up, would
be the time we have to act. A dialog has been going on between the
regulatory agencies and members of this committee for some time.
The industry as a whole is wondering how long people can hold
their breath, so to speak, in an economic sense. Last year was
certainly a bad year. This year is bad. You certainly have testified
that 1982 could be worse. No one seems to know what 1983 can
bring. Notwithstanding all of the prognostications that the economic situation will change—inflation will go away, interest rates will
drop, and so forth. There do not appear to be any solutions being
proposed to deal with the immediate problem. How quickly do you
anticipate you will be coming before us? Shouldn't you be coming
before us now to ask for the kinds of relief you believe are needed
or necessary? Or don't you think you need relief?
Mr. PRATT. I think there are two options you have, when you
talk about this multiyear period. One is an option of being ready to
provide public funds on a continuing basis. The second is to be
willing to face the issues which associations and institutions have,
and make them viable in an unpredictable economy. We have
addressed that issue very strongly. As the economy changes in the
short run, it is clear that financial needs could occur. At this time,
we think we can meet what we see, but if we cannot, we will be
back.
Mr. CARMAN. In your testimony, Mr. Pratt, you discuss the need
to give broader powers to the savings and loan associations, and
indeed the entire thrift industry.
Mr. Connell, you allude to the fact that you think there is a need
to give broader authority to the institutions. Indeed including allowing stock to be issued by various mutuals which would take
away the public ownership that we now have, generally speaking,
with Federal savings and loan associations.
It would appear to me that at the present time that housing is
not being considered a major priority. Do you anticipate that we
will continue to make housing a major priority if we are moving
toward an integrated banking system?
Mr. PRATT. I think the question of the level of priority to be
assigned to housing has never really been addressed by the Congress. If "priority" means expenditure of Federal funds to subsidize
145
housing, then that is clearly something that ought to be addressed
very explicitly.
I think that if one means having a housing priority which in
some sense attempts to tax a certain category of financial institutions, the thrifts, it is clear they simply do not have the funds to
pay the tax, and that strategy will fail. If this Congress wishes to
have housing subsidies or to set housing priorities, it should go
about it directly, and these institutions will clearly be there to
provide the finance.
Mr. CARMAN. Thank you very much.
Mr. LAFALCE. Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman. My questions are primarily to Mr. Pratt and Mr. Sprague, but maybe also to Mr.
Connell later on.
It has been said that $1 in money market mutual funds is worth
$2 in the bank. Does that apply also to savings and loans, with the
current interest rates, Mr. Pratt?
Mr. PRATT. The numbers I have seen recently for money market
mutual funds would indicate the yields are in the range of 17
percent at the current time, whereas a money market certificate,
depending when it was purchased, would be in the range of 14 V2
percent. There are, of course, other advantages to the depository
institutions, but the high rates of the money market mutual funds
have obviously been quite persuasive to a number of people.
Mr. PATMAN. With those figures, it is actually worth $3 in the
bank or $3 in the savings and loan.
Mr. PRATT. NO; on $100 in a money market mutual fund, you
would earn $17 a year, roughly speaking, whereas from a money
market certificate, $14.50. It is more like $1.25 something like that.
Mr. PATMAN. What about passbook savings accounts?
Mr. PRATT. Passbooks pay slightly over 5 percent. There would
be about 3-to-l in terms of return.
Mr. PATMAN. AS to the protection now provided to your depositors and those in banks, what is the ratio of the amount we have—
Mr. Sprague, you mentioned $11V2 billion—to the total deposits
that are insured by that amount?
Mr. SPRAGUE. The ratio of our fund to deposits, approximately
1.15. It has been in that range for a number of years.
You recall that in the last legislation that this committee addressed the possible problem of the ratio dropping, and changed the
assessment refund from 66% to 60 percent, and also provided a
bottom and top. It is roughly 1.15.
Mr. PATMAN. Percentagewise 1.15; right? Is that what you say?
Mr. SPRAGUE. Right.
Mr. PATMAN. What about the ratio of the protection to the net
worth of the institutions you have deposits in which you are providing protection?
Mr. SPRAGUE. I don't have that figure. I will have to get it for the
record.
Mr. PATMAN. What about you, Mr. Pratt? Do you have that?
Mr. PRATT. The insurance fund relative to deposits would be
slightly over 1 percent. These figures are subject to check. It is
about $6 billion against something in the neighborhood of $500
billion. In terms of the insurance resources relative to the net
146
worth of institutions, it would be about one-fifth. The net worth of
institutions is approximately $30 billion. The insurance funds are
approximately $6 billion.
Mr. PATMAN. DO you give the percentage of the protection fund
to the deposits?
Mr. PRATT. Approximately IV2 percent. We will be happy to
provide you the exact figure.
[In response to the request of Congressman Patman, the following additional information was submitted for inclusion in the
record by Mr. Pratt:]
RESPONSE RECEIVED FROM MR. PRATT
As of June 30, 1981, the ratio of the book value of the FSLIC's insurance fund to:
(a) total insured deposits was 1.4 percent; and (b) total industry net worth was 21.7
percent.
Mr. PATMAN. If interest rates stay at the present level, Mr.
Pratt, how long will it be until savings and loans, all of the savings
and loans in the United States, are in serious trouble?
Mr. PRATT. Well, we don't think that all of the savings and loans
in the United States would be in serious trouble, even at this level
of interest rates. There are certain institutions which can continue
to be profitable at this level. They would go through a period of
decreased earnings, perhaps zero earnings for a period of time, but
would come out viable at the conclusion.
Mr. PATMAN. Even if the present rates at their present levels
stay that way for an indefinite period of time?
Mr. PRATT. Yes, sir. At some point in time, of course, circumstances begin to turn around for an institution that has the ability
to survive. While the transition is very slow, at some point, the
assets begin to be replaced with the higher yielding assets which
return the institution to viability.
That is not to say that a very substantial portion of the business
does not have substantial problems, and that a continuation of
rates at this level would present a very difficult circumstance.
Mr. PATMAN. The higher levels of interest rates or yields that
you are looking forward to, those are represented by higher rates
of interest that the prospective homeowner pays. Is that true in
loans, by and large?
Mr. PRATT. Yes. The present rate on mortgages is substantially
above the level of the portfolios, of course, and may even be forced
somewhat higher than might have occurred otherwise, because of
the earnings problem and structural problem which these institutions have.
Mr. LAFALCE. The time of the gentleman has expired.
Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman. I direct my question to
each of the three of you. You can give me just a brief answer.
The first question, Do you have a gravity schedule of troubled
institutions? If so, do you categorize them by those that are in
trouble by virtue of market forces or those that just have plain
poor management?
Mr. CONNELL. Mr. Wortley, we do have a schedule of credit
unions that are troubled, and we do not categorize them according
to market forces and management, necessarily. They are the prob-
147
lem cases that we have to deal with. The method we take to deal
with the problem differs when it is market forces versus management.
Mr. SPRAGUE. My answer is essentially the same as Mr. Connell.
The basic list is not differentiated. But those kinds of questions
clearly are considered when we decide what to do.
Mr. WORTLEY. May I follow up and ask you, about how many
institutions do you have on your list at this time?
Mr. SPRAGUE. I dislike getting to the question of a problem list,
because as I say, we don't work with lists, we work with banks. The
lists are so outdated. They are useful for our annual report that we
will print a year from now, for example.
What we really work on are problem institutions. For example,
Mr. Thompson, head of my division of bank supervision, meets with
me every Friday and we go over in some detail problems that
might arise over the next 60 or 90 days.
I guess we have a list floating around someplace that says there
are about 200 institutions on it.
Mr. WORTLEY. Thank you.
Mr. Pratt?
Mr. PRATT. My answer would be similar. Again, we maintain a
list of institutions that bear watching, and the list is not categorized as to the source of the problem.
Mr. WORTLEY. What do you do with the funds that you receive
from the respective financial institutions in terms of premiums? Do
you invest those funds? If you do, who determines how they are
invested? What sort of return do you get? Do the funds go into the
U.S. Treasury, or do they remain in your so-called trust accounts?
I know that is several questions in one. But, starting with Mr.
Connell, would each of you respond?
Mr. CONNELL. We invest them in U.S. Government securities,
mostly short term. I cannot give you the return right now, but I
would be happy to give you the most current return. It changes
because so much of it is in short-term securities. About $100 million in short term, about $70 million in longer term.
Mr. WORTLEY. Does that income accrue to your own trust account, or does it go to the Treasury?
Mr. CONNELL. That accrues to the trust fund, and is used for
liquidation expenses only. It does not accrue to the general revenues of the Treasury.
Mr. WORTLEY. It is not included in the general revenue.
Mr. CONNELL. NO, it stays in the insurance fund.
Mr. WORTLEY. HOW much does that amount to in the course of a
year?
Mr. CONNELL. We have a small fund, probably in the area of $25
million this year.
Mr. WORTLEY. Mr. Sprague?
Mr. SPRAGUE. All of our money is in U.S. Treasuries. We try to
keep $200 or $300 million on 1-day money for an emergency. The
rest on the short range, I will have to give you the exact figure of
what we are earning now. Last year it was about half of our $1.3
million increase in the fund, something like $600 million, and it all
goes in the fund. That is one of the reasons that I feel so good
about our ability to take care of the depositors
148
Mr. WORTLEY. You don't invest in money market funds?
Mr. SPRAGUE. NO, sir. The United States of America.
Mr. PRATT. Our investments are in Treasury securities. We earn
more than $600 million per year, which is entirely available for the
FSLIC.
Mr. WORTLEY. Who determines how it is invested?
Mr. PRATT. It all goes into U.S. Treasury securities, and it would
be, I suppose, a matter of negotiation between ourselves and the
Treasury as to the maturities that might be chosen.
Mr. WORTLEY. Does the amount of income returned on those
investments—would that almost pay for the operations of your
agency?
Mr. PRATT. Historically, it has been far in excess of our needs,
and has allowed substantial growth of the insurance fund.
Mr. WORTLEY. Thank you, Mr. Chairman. I yield back the balance of my time.
The CHAIRMAN. Mr. LaFalce?
Mr. LAFALCE. Thank you, Mr. Chairman. I am having lunch
shortly with a professor of economics from Stanford University,
and he is reputed to have said with respect to the problems of the
thrift industry they are having some earnings problems. So what?
All companies have earnings problems. Why should we come in
and bail them out?
How would you answer that professor of economics? Some people
would compare the "So what?" statement to the statement of Mr.
Ford, President Ford, saying to New York City, "Drop dead."
But how would you answer it?
Mr. SPRAGUE. I would get another luncheon partner, for starts.
[Laughter.]
Mr. LAFALCE. Are you suggesting we get a new Secretary of the
Treasury, Mr. Sprague?
Mr. SPRAGUE. YOU are extending my remark beyond the limits of
prudence.
The CHAIRMAN. Don't have lunch with him.
Mr. SPRAGUE. I am not a member of the "so what" school. It may
well be that we should at some point in time just have one kind of
a financial institution, amalgamate them all along the lines the
Hunt Commission that Mr. Gonzalez talked about and what Mr.
Pratt and Mr. Connell are talking about today.
But in the interim, thrifts, in my judgment, have provided an
extraordinary service to the country. I would like to give them one
more chance.
Mr. LAFALCE. Let me go on. I want to make the pointMr. SPRAGUE. YOU did.
Mr. LAFALCE. I can't quite
understand how the administration
could so strongly oppose the regulators' bill—at least that portion
of it which would permit the infusion of capital into the thrifts.
Apparently they have plead nolo contendere regarding the merger
provisions, or they have taken a position of neutrality in any event.
They can oppose a loan to be paid back and yet apparently be
neutral, or at least acquiesce in silence, with the all savers bill,
which will call for a direct—an indirect expenditure of Federal
dollars, not on a loan basis, but in grant form of perhaps $4 billion.
149
Now, I want to understand a little bit better the position of the
three regulators.
Now, Mr. Connell, as I read your statements—and tell me if I am
right or wrong—you think it is a bad concept, the all savers bill,
you think it is inefficient, you think it is expensive; you think if it
passes, favoring those institutions which have a certain percentage
of their moneys in housing, it could be extremely destructive to the
credit unions.
But despite all of this, you hold your nose if the credit unions
would be included within its embrace and it would not favor institutions that go along with housing. Is that basically correct?
Mr. CONNELL. I essentially stated that I thought that the proposal was expensive—a rather crude instrument—and if it was geared
just toward housing, would be disruptive.
In my responsibility for the stability of the credit union system, I
have to address that issue in terms of tax incentive programs, I
personally favor the IRA approach toward savings incentives and
expanding that area, because it is more directly targeted.
Mr. LAFALCE. What if we were to make the approach—at least
prospectively—a credit approach, as opposed to a deduction?
Wouldn't that even make it more attractive, especially to your
clientele?
Mr. CONNELL. The credit—of course, a tax credit is always more
appealing to a taxpayer than a tax deduction.
Mr. LAFALCE. We would have to change the dollar amounts. We
would not permit the same credit that you get for the deduction.
Mr. CONNELL. What I particularly liked about the IRA-type of
savings approach—and that would include modification for withdrawals for home purchase and that type of thing—it encourages
regular savings.
Mr. LAFALCE. And long-term savings.
Mr. CONNELL. Yes. It gets the American public back into the
concept of savings.
Mr. LAFALCE. It would also counteract the problem we are
having with social security.
Mr. Sprague, you not only hold your nose at the all savers bill,
but you actually say no to it; correct? You said you opposed it.
Mr. SPRAGUE. Yes, that is true.
Mr. LAFALCE. Good enough.
Thank you. Just wanted to clarify.
Mr. SPRAGUE. All right.
Mr. LAFALCE. I cosponsored the all savers bill with the thought
in mind that if the administration realized that we want to do
something about the problems of the institutions, they surely
would not go along with the all savers bill, but they would perhaps
go along with something like the regulators' bill.
Now I find we are going to have the exact opposite situation.
They are not going to retract on the regulators' bill, but they are
going to permit the all savers bill to go into effect.
I have now gotten reservations about what we have wrought. I
just cannot believe the administration is going to go ahead with
this. I am all for tax incentives for savings, but not all tax incentives are made alike. This one certainly is not made alike.
150
Now, Mr. Pratt, as I read your statement, you certainly do
support it, I understand. But it was a brief, very small—one paragraph, about one or two sentences.
Let me just ask you this question: Which would you prefer, the
regulators' bill or the all savers bill?
Mr. PRATT. The all savers bill would be much more helpful, of
course, than the regulators' bill. I am not referring to the totality
of our legislative proposal, however.
Mr. LAFALCE. YOU already have the problems—you already have
the powers that Mr. Sprague does not have.
Mr. PRATT. Pretty much; yes, sir.
Mr. LAFALCE. If you were Chairman of the FDIC, which do you
think you would favor?
Mr. PRATT. I would go to lunch with the professor from Stanford.
I would like to have the financial position that the Chairman of
the FDIC has. I do not know how I would respond under those
circumstances.
Mr. LAFALCE. If the all savers bill is passed, are the savings and
loans going to invest those newly found moneys in housing? Or
might those savings and loans, because the all savers bill is just a
1-year bill, might they turn to some alternative forms of investment other than the housing market, that which could maximize
their gain within a 1-year period?
Mr. PRATT. I think it would be most helpful if they would use
those funds to reduce the cost of operations, and they reduce the
probability of other public funds having to be applied to the problem. That is, of course, what we would encourage. It would seem to
be of questionable prudence to divert those funds to long-term
loans at fixed rates, given the short-term nature of the bill.
Mr. LAFALCE. YOU are saying that we cannot expect a particular
bonanza for the housing market through the passage of the all
savers legislation?
Mr. PRATT. The bonanza comes through maintaining the health
and viability of the principal mortgage lenders.
Mr. LAFALCE. What about the complaints of the municipalities—
my time is up?
The CHAIRMAN. Mr. Coyne.
Mr. J. COYNE. Thank you, Mr. Chairman.
I am concerned that Congress or many of our regulators are
really ignoring the very fundamental change in our financial institutions that is occurring in this decade and perhaps in the last
decade, and analogous to going from the horse-and-buggy era to the
automobile. I am afraid that many people are calling for us to
subsize or support the buggy maker and make sure that he is
restricted from going into the automobile business, for example,
when, in fact, the marketplace and the consumer are making
changes and forcing changes upon the industry.
Of course, the most fundamental element of this is the shift from
savings institutions to money market funds for many of our savers.
I would like to first address the question to Mr. Sprague.
When Commissioner Shad was before us, he affirmed that those
people investing in money market funds are not savers, but rather
investors. Of course, he said that the FDIC should look after savers
and the SEC should look after investors.
151
Do you agree that depositors using the money market funds are
somehow different? Are they investors, and not savers, as are your
depositors, the people you oversee? Should there be a difference
between the two, and should we have two different regulatory
agencies overseeing these two different types of institutions?
Mr. SPRAGUE. Clearly, money is flowing from banks and savings
and loans into the money market funds. It is the same money.
Mr. J. COYNE. YOU would declare that the money market fund
participants are savers just as in your institutions?
Mr. SPRAGUE. TO a large extent, I would think so.
Mr. J. COYNE. That brings a question of why we should have two
different agencies reviewing or regulating two different elements of
the savings institution marketplace?
Mr. SPRAGUE. YOU are suggesting that the FDIC, rather than the
SEC, would regulate mutual funds; is that the thrust?
Mr. J. COYNE. Perhaps the first step might be to bring the Fed,
as has been mentioned earlier, some of the oversight for the monetary funds, of money market funds.
Mr. SPRAGUE. The long-term answer is get to a free market and
have less regulation, rather than more.
Mr. J. COYNE. But you said earlier your responsibility was to look
after the interest of the American saver.
Mr. SPRAGUE. The insured depositor.
Mr. J. COYNE. If those depositors, for some short-term gain, or
whatever, decide to remove all of their assets from your insured
institutions and move them into uninsured institutions at the rate
of $3 billion a week, you don't consider that a problem?
Mr. SPRAGUE. Once they leave, they are not our responsibility.
They also are not insured.
Mr. J. COYNE. YOU feel they are not the Government's responsibility? If the Government has a responsibility for them when they
are part of your institution, do we abdicate a responsibility when
they mover over under the SEC?
Mr. SPRAGUE. Of course not. The Government
Mr. J. COYNE. It seems that we are turning our back on the
American saver to a substantial measure.
I would like to turn over, if I may, to Mr. Pratt, very briefly.
The savings bank, savings and loans, it seems to me, engage in
very, widely varying businesses. One, of course, is the origination of
savings, the development of savings.
Another one, of course, is loan origination, especially for the
homebuilding industry.
The third might be considered cash management services for
local people who want to maintain checks or business accounts.
Can you say that the savings institutions are dealing with each
of these different businesses equally? Or are we perhaps seeing a
phenomenon in which the savings origination portion of the business is shifting to the money market fund. Perhaps the savings and
loans will become more proportionately a loan-origination type of
business, perhaps a cash management business, to the extent that
they want to provide that service to their communities. What was
principally the savings, retail, and wholesale element of their business, may shift to the money market funds, because apparently the
152
money market funds have been able to provide their service more
competitively?
Mr. PRATT. NO, I don't see that happening. In fact, I think that
that would be managerially unfortunate. It seems to me the great
expertise the savings and loans have and the great thing going for
them is that they are well located relative to the homeowner. They
are identifiable. They are part of the community. They have a
history of dealing with people. They need to stay strongly in the
acquisition of savings; this is one of their fortes.
What they need, of course, is the financial strength to be able to
compete. That is what they don't have at this time. That is what
has caused the tremendous shift to money market mutual funds.
I would expect that under an equilibrium situation they would
be heavily engaged in the solicitation of retail savings and should
be encouraged in that direction.
Mr. J. COYNE. DO you have any data to suggest that the marketing of this service is holding its own?
My a priori data would suggest that in the 20- to 35-year age
bracket people virtually are not using savings and loan for savings
depositories anymore.
Mr. PRATT. I think the savings and loans have been almost
totally forced out of the retail savings market at this time. That is
a very bad development.
Mr. J. COYNE. People have used the "forced" terminology a lot. I
am curious as to whether it really is a situation of forced, or
whether it is, in fact, marketplace taking advantage of the 20th
century, and perhaps even some of the 21st century technology,
involving increased productivity, if you will, in developing institutions for accumulating savings, and pulling that, and then refunneling it back into the society?
I was not here the past 10 years and did not get an opportunity
to listen to representatives of the savings and loans with regard to
their quest for protection in regulation. But many who were here
tell me that they were not forced into this, that rather the choice
between borrowing short and lending long was a choice that they
made on their own and that they, in fact, fought for that right, to
borrow short at protected rates and lend long.
Now we have a marketplace where, obviously, that strategy has
not been wise. In fact, they were not forced at all to choose a
market path or a marketing strategy that has led to this very, very
serious problem.
Mr. PRATT. What is forced and what is not is probably a difficult
thing to develop. I think there is certainly a very strong element of
correctness in what you say. The interpretation I would place upon
it, of course, is that those institutions perceive at that time that it
was the intention of Congress to maintain a sheltered housing
finance sector.
Mr. J. COYNE. NOW you are talking about the other business,
loan originentation in terms of providing loans for housing.
Mr. PRATT. It was sheltered on both sides. To the extent that you
had regulation Q, it was sheltered regarding the acquisition of
funds. To the extent that this caused funds to be provided at lower
rates, it was sheltered on the other side. The market or the Congress, or both, then changed dramatically and said, "We are not
153
going to hold down rates paid to savers. They should have the right
to earn a competitive rate." It was that abrupt transition from a
sheltered housing finance sector to an unsheltered one which has
generated the present conditions.
Mr. J. COYNE. Thank you.
Ms. OAKAR. Let me ask Mr. Connell a few questions first of all. It
was in this room, I think, that former Chairman Patman, my good
colleague's father, said that next to the church, credit unions were
the most important institutions. I am wondering about the Bankruptcy Act that we passed a couple of years ago. How has that
impacted on your members?
Mr. CONNELL. We are in the process of completing a study on
that very subject and our preliminary indications are that of
course first of all, very obviously, bankruptcies have gone up and
losses to bankruptcies have increased since the act was passed.
Ms. OAKAR. I think there were 350,000 filings in 1980.
Mr. CONNELL. They have been up considerably. About 53 percent
of that I think we can attribute to the changes in the act, and the
remainder, quite frankly, is attributable, to a certain extent, to
more liberal lending practices. The act has had an adverse effect,
but not nearly all of the losses are due to the Bankruptcy Act
itself.
Ms. OAKAR. Let me ask, since so many Federal employees turn to
the credit union because of convenience, let me ask if you have
done any analysis on the impact of the reduction of Federal employees. As you know, the Reagan Administration proposes to
reduce Federal employees by 100,000. There are $4.2 billion of
reductions in Federal employees' compensation and benefits. Is
that going to have an impact on the credit union movement, particularly those Federal credit unions that serve Federal employees?
Mr. CONNELL. Yes; credit unions are going through a structural
change. I alluded to it in my statement specifically with respect to
the automobile industry, but the same phenomena exists with
public employees. Of the $40 billion in Federal credit union assets,
about $16 billion represents savings of Government employees.
Now, that would include State, county, and municipal as well as
Federal and educational employees.
We expect that, as propositions 13 and 2Vfc and the programs to
reduce Government employees at the State and Federal level occur,
they will affect the credit unions and for that reason we see them
evolving into community-type credit unions and community banks
over a longer period of time.
Ms. OAKAR. Let me ask Mr. Pratt one quick question. From what
I recall, we have saved about 50 percent less since 1975, compared
to what we save today. If you look at our competitors in West
Germany and Japan, they save, I believe, about 14 percent to more
than 20 percent of their salaries. How do you account for their
thrust in savings versus our rapid decline beyond, citing money
market mutual funds and unfair competition, and so forth. They
have inflationary problems also.
Mr. PRATT. I simply have not studied that. I have seen the
numbers but I have made no definitive study of the incentives that
might be provided for savings in those nations. There are so very
154
many variables: The effect of cultural patterns, the relative
strength of inflation, and so on.
Ms. OAKAR. Don't you think that would be a good subject to
study, if they are on the upswing and we are on the decline? They
might be doing some things right that we are not. Our industries
are now taking a look at what they are doing perhaps more competitively than we are, in terms of the various industrial outputs
that we have. It seems to me, and I don't mean to be openly so
critical, but it seems to me that there ought to be more kinds of
avenues that you would have researched that would—-as my colleague Congressman Barnard indicated—make some recommendations that were a little more creative than some of the things that
we have before us.
Mr. PRATT. One must keep in mind the scope of responsibility
which we have as regulators. Moreover, when one looks at the
Japanese experience, for instance, it is my understanding that
their economic system is substantially different from ours. The
integration of monetary and fiscal policy is particularly different. I
have had experience in working as a consultant in Korea, which
used the Japanese economic system as a model. Those are things
that I have taken substantial note of and I could go into some
explanations.
Ms. OAKAR. YOU don't think the economy, because of the various
differences, really merits any kind of study, then?
Mr. PRATT. I think such a study would be more properly performed at the congressional level, as a basis for broad action on the
economy. In my fairly extensive work in foreign countries, I have
not seen institutional or regulatory factors that would be an explanation of the things you are talking about.
Ms. OAKAR. Could I just cite one other thing, and that is that
some of us were somewhat disappointed that there is a possibility
that the Ways and Means Committee may eliminate the $200 to
$400 tax-free interest area, and that the tradeoff is the $1,000
savings certificate business. I am wondering how you feel about the
tradeoff?
Mr. PRATT. If you are asking me as a regulator, I feel it would be
a very helpful tradeoff. If we are going to expend some public
funds, which is what tax manipulations actually do, we should at
least be oriented toward some solution of the problem.
Ms. OAKAR. Wouldn't it hurt the small saver? Aren't we discouraging people who are of moderate- to middle-income means, then,
from getting a little break by saving?
Mr. PRATT. AS I understand, there are alternatives such as tax
credits which are being discussed. It seems to me that a bill could
do both, if Congress wishes.
Ms. OAKAR. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Barnard, for a brief question.
Mr. BARNARD. Mr. Pratt, during our previous questioning we
discussed briefly the similarity that would develop with these additional powers between thrifts and national banks. If we found that
such a similarity did exist, we would be achieving parity between
institutions as far as services are concerned. Why shouldn't a question about repealing the Home Loan Bank Act and have a unified
financial structure where all institutions can operate under the
155
same law and have the ability to specialize in home mortgages if
they choose to get the tax advantage, be seriously examined at the
same time?
Mr. PRATT. We feel it would be an approach which would not be
fruitful for us to pursue at this time. But in the longer run, It
would seem a worthy area for congressional scrutiny.
Mr. BARNARD. One further short question. Your draft legislation
includes a provision raising the deposit insurance levels on IRA
and Keogh accounts to $500,000, providing insurance at that level
for new types of retirement accounts. Given the concerns over the
current coverage of the insurance funds, the number of problem
institutions and the questions that many have over the usefulness
of insurance or attracting deposits, how can you justify this increase and this expansion in potential liabilities for the fund?
Mr. PRATT. First, concerning attractiveness, we find at this time
that some individuals may well have retirement plans which on an
individual basis exceed the insurance amount. We think that it
does not serve the public interest for people to have to worry about
this and consider splitting their fund between two or three institutions.
In terms of increasing the exposure of the insurance fund, we
feel that the ability to attract and hold these funds would more
than offset any particular increased exposure that might occur.
Mr. BARNARD. YOU would apply this increase across the board?
Mr. PRATT. Yes, sir.
Mr. BARNARD. For all financial institutions?
Mr. PRATT. Absolutely.
The CHAIRMAN. The Chair, without objection,
would state that
all members will have the opportunity to submit written questions
for the record.
The Chair would at this time announce that Chairman Volcker
will appear before this committee on July 21, and on July 22 the
Deputy Secretary of the Treasury, Mr. McNamar and very probably Mr. Mehle. In addition, the Under Secretary for Monetary
Policy, Beryl Sprinkel, will appear to discuss the matters of monetary policy, as well as the matters we have been discussing this
morning. As a result of your fantastic presentations this morning,
you have given us a great number of questions and topics to discuss
with both Chairman Volcker and the representatives of the Department of the Treasury.
The Chair would also like to express his deep appreciation to the
panel and congratulate them. As you see, you have attracted quite
a number of members of the full committee, which is most unusual. You should be very pleased with the concern and interest that
the members of the committee have for the problems that you
gentlemen are encountering.
The committee will be in recess, subject to the call of the Chair.
[Whereupon, at 12:47 p.m., the hearing was adjourned, subject to
the call of the Chair.]
[The following written questions were submitted by committee
members to Mr. Pratt, and a response to the questions may be
found commencing with page 493:]
156
QUESTIONS SUBMITTED BY CONGRESSMAN WYLIE
Question 1. In communities which have a single bank and a competing Federal S.
& L. association, could the sharing of demand deposit balances threaten the profitability of the bank?
Question 2. If we followed your suggestion, could it be said that Congress would be
simply recreating the national banking system at significant cost and without
provisions requiring home financing?
Question 3. Will the restrictions on overdrafts and insider activities contained in
FIRA and applicable to banks be applied to S. & L.'s under these provisions?
Question 4- Will restrictions placed on national banks in their lending and investment activities apply to S. & L.'s (e.g., single borrower limits)?
Question 5. If service corporations are to be truly that, shouldn't they be limited
to doing what S. & L.'s can do for themselves, as with bank service corporations?
Question 6. Does section 212 mean that investments in state-chartered, nonFederally insured institutions would count toward liquidity requirements?
QUESTIONS SUBMITTED BY CONGRESSMAN LOWERY
Question 1. Under section 210 of your proposed legislation, you suggest that
federal institutions be allowed to invest up to 10 percent of their assets directly in
real estate. Do you feel enactment would hinder traditional residential mortgage
lending activities?
Question 2. If, in the near future, the distinctions between different depository
institutions become blurred to the point of non-recognition, what proposals would
you make to change the regulatory structure into a system more in touch with the
state of modern financial intermediation?
Question 3. You suggested that removal of the rate differential on money market
certificates in May 1980 was premature. Could you describe these circumstances
under which the elimination of the differential would be appropriate?
Question 4- On page 10, you state "we believe that the FSLIC, when adverse
financial conditions exist such as those we currently are experiencing, should be
empowered to authorize any FSLIC-insured institution in danger of default to merge
with any other FSLIC-insured thrift, or to be acquired by such an institution, or by
any savings and loan holding company."
On page 11, you state "by giving us this authority, Congress would vastly increase
the universe of institutions potentially able to acquire a troubled thrift, . . . it
would avoid the development of a pattern of liquidations occasioned as a result, not
of selection of the least costly of alternative approaches. . . . "
In view of the trend toward the homogenization of depository institutions, why
should merger prospects be limited to FSLIC-insured institutions?
CONDUCT OF MONETARY POLICY
TUESDAY, JULY 21, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met, pursuant to call, at 10 a.m., in room 2128,
Rayburn House Office Building; Hon. Fernand J. St Germain
(chairman of the committee) presiding.
Present: Representatives St Germain, Reuss, Gonzalez, Annunzio,
Fauntroy, Neal, Blanchard, Hubbard, D'Amours, Lundine, Vento,
Barnard, Frank, Patman, W. Coyne, Stanton, Wylie, McKinney,
Hansen, Leach, Paul, Parris, Weber, McCollum, Wortley, Roukema,
Lowery, and Bereuter.
The CHAIRMAN. The committee will come to order.
This morning the committee resumes its semiannual hearings on
monetary policy. Too often these hearings become bogged down in
esoteric discussions of the "M's" with no attempt to determine that
the real world impact of money supply targets might be. The focus
has been on aggregate numbers and the total economy rather than
looking at the experience of small business, individuals, and regions of the country to see what these numbers really mean.
Last week we began a series of hearings designed to provide that
analysis. The committee heard from the three depository institution insuring agencies. All three agencies provided the committee
with data which reveals the severe impact that monetary policy
and high interest rates have on the financial industry. The number
of institutions on the problem list is rising quickly,
Those institutions which have limited asset flexibility are especially hard hit. Savings and loans, mutual savings banks, and
credit unions find it increasingly difficult to continue operating as
interest rates push up their cost of funds. Liquidity is decreasing at
thrifts. Earnings have been devastated by the negative marings on
income and expenses. Net worth ratios continue to decline and the
number of institutions with unsatisfactory net worth levels grows
monthly.
When these institutions face the problems they do, then other
segments of the economy suffer as well. Credit availability is reduced since the depository institutions either do not have lendable
funds or they shift to investment strategies emphasizing shortrun
profits and arbitrage.
Credit for mortgages, automobiles, and other consumer purchases
fall in aggregate terms. People cannot find, let alone pay, for loans
to finance transportation and housing. Mortgage loan commitments
by thrifts have steadily fallen to $5 billion from $10 billion per
month over the last half of 1980 and 1981. Housing starts are at
(157)
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their lowest annualized level since the recession in 1974. Automobile sales continue to sag because people cannot afford to pay
the high costs of the cars and the financing charges as well.
The high levels of interest rates coupled with extreme violatility
in rates and the continuance of an inverted yield curve play havoc
with the credit markets. The bond market is virtually closed as a
result of inflation and the interest rate structure. The ratio of
current liabilities to current assets of nonfinancial corporations
continues to decline as firms load up on short-term liabilities because they do not want to lock in high-cost, long-term financing.
The Congress is continuing to wrestle with fiscal policy which is
impacted by monetary policy. The conference on the reconciliation
bill is hopefully nearing an end. The result will be a major slowdown and reduction in governmental programs which provide assistance to those people in our economy who cannot afford current
high interest rates, cannot find decent sanitary housing, and often
cannot find a decent meal. Programs within the jurisdiction of this
committee take particularly stiff cuts.
This process is part of the administration's purported four-point
plan to improve the economy. It wants to cut Government expenditures, cut taxes, control the money supply, and simpify the regulatory process. The recommended budget cuts, I believe, fall with a
heavy hand on the lest fortunate in our society. The administration's tax recommendations benefit the wealth and, given the magnitude of the proposed reductions, raise questions about the level of
the Government's deficit and the ability of the monetary system to
cope with the increased flow of funds without further increases in
interest rates.
Monetary policy, with its emphasis on the monetary base and its
devil may care attitude about interest rates also impacts the most
on the least fortunate and the small firms which cannot afford
such costs but have to rely on credit. The papers are filled with
daily stories about huge credit lines going to companies engaged in
bidding wars and takeovers. DuPont, Conoco, Marathon Oil,
Texaco, Mobil, Pennzoil—these companies have no problems securing all the credit that they need for any purpose. The charts
supplied by the Federal Reserve in its mandated report clearly
point out this discrepancy. Household and State and local government borrowing continue to fall rapidly, yet nonfinancial corporations continue to borrow and to borrow large amounts.
This committee needs to know why the impact of monetary
policy falls so unevenly on the population. Why is it that takeover
loans totaling almost $35 billion yesterday, $40 billion today, can
be made on short notice, yet those who need loans for automobile
purchases, for home mortgages, cannot find money? Or, if people
can find money, the interest rate risk is transferred to the borrower through instruments like the adjustable mortgage instrument?
Is our Government becoming a Government run by and for big
business? Are corporations taking over the government and the
economy at the same time? The corporate mergers mentioned earlier are raising the issue of economic concentration once again. And
these mergers are being fueled by credit—credit that, if available
to small businesses at all, is at prohibitively high rates that fore-
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close inventory financing and recapitalization, and, what is more
tragic, has a devastating effect on unemployment.
Are our credit markets becoming the province of the rich and
the powerful? Will the average man or woman be able to find
credit and other financial services at any price? I do not know the
answers to many of these questions, but I intend to elicit the
response of the Chairman of the Federal Reserve on many of these
issues.
Mr. Volcker, I want to personally welcome you. Prior to my
recognizing you, I know that Mr. Stanton would like to make an
opening statement, and I understand Mr. Fauntroy would also.
I will recognize Mr. Stanton.
Mr. STANTON. Thank you very much, Mr. Chairman.
Mr. Volcker, we welcome you back once again to what is this
committee's sixth hearing on the conduct of monetary policy pursuant to the Full Employment Balanced Growth Act of 1978, better
known as the Humphrey-Hawkins Act.
I think you would agree with me that economic history teaches
us that probably the No. 1 opponent to reaching the fundamental
goals of the Humphrey-Hawkins Act is inflation or perhaps more
importantly, the psychology of inflation. In this regard, I would
hope that your report today, together with recent and future actions of the Congress and the Reagan administration, will help to
reduce the inflationary pressures in the months and immediate
years ahead.
Yet, just as our inflationary problems were not created overnight, I am aware that there are no easy short-term solutions. In
fact, there are very real and sometimes very painful costs associated with any program to reduce inflation and promote economic
stability.
The scenario that our chairman most painfully had to remind us
of at this time is obvious to all of us.
In going back to basics, I think, Mr. Chairman, though, there is
an element of encouragement, however, slight, in the immediate
future. The pace of inflation seems to be slowing considerably in
the first half of this year. It has receded from double-digit figures
for the first time in 2 years. The Consumer Price Index as noted on
page 29 of your report is decelerating from a 12V2-percent pace in
1980 to an annual rate of about 8V2 percent through May of this
year.
So, Mr. Chairman, it is with pleasure that I join our Chairman
and members of our committee in looking forward to your testimony. Thank you very much, Mr. Chairman.
The CHAIRMAN. The Chair recognizes Mr. Fauntroy.
Mr. FAUNTROY. Thank you, Mr. Chairman.
Mr. Volcker, it is a privilege for me, likewise, to welcome you.
Once again, we meet to take testimony on the conduct of monetary
policy pursuant to the requirements set forth in the HumphreyHawkins Full Employment and Balanced Growth Act. Once again
we find little with which we can take any comfort at all. While
inflation as measured by the CPI, has moderated in recent months,
the decline in areas such as energy and food, which are likely to
rise in the future, the basic rate of inflation, based on the rate of
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wage increases that represent two-thirds of all business costs,
remain at or close to 10 percent.
Meanwhile, the interest rates remain at near-record levels. These
high interest rates have kept unemployment at rates well in excess
of 7 percent. This unemployment rate, which is unconscionably
high, represents one of the longest sustained periods of high employment. Needless to say, for those who are black, the unemployment rate is more nearly double the national rate.
Much as I wish to see inflation brought under control, I cannot
support a program that relies solely on monetary policy to do so.
The costs of such a program in terms of economic stagnation and
high unemployment are far too severe. Monetary policy itself is too
imprecise to serve as the only weapon against inflation. There are
grave difficulties in discerning which elements of the money supply
should be focused upon, in translating long-term objectives into
intermediate targets given problems of float, seasonal shifts in
currency demands, and changes in velocity.
Controlling the money supply as part of an anti-inflation program is clearly important. It is equally clear that increasing the
money supply simply to reduce interest rates is self-defeating. However, the Federal Reserve must pursue a pragmatic monetary
policy that recognizes the crudity and imprecision of its powers to
control the growth of money aggregates.
For similar reasons, the Federal Reserve must be cautious in its
actions to prevent interest rates from being unnecessarily high or
tightening credit so much that a severe depression and terribly
high unemployment results.
However, inflation, like cancer, is a complex disease. Treating it
only with monetary policy would be like treating cancer only with
surgery, or worse, only with laetrile. The treatment may, or may
not work, but the patient may die. Yet, I am afraid that the
administration, its protests notwithstanding, is doing exactly this.
Its fiscal policies and deregulatory efforts seem to have less to do
with prudent Government policy or inflation than with a purely
philosophical dislike for the Federal Government and what the
public sector has contributed to the well being of the poor and
middle class instead of the rich and powerful.
Nothing is done to help bring down the rate of pay increases that
are propelling inflation along, nothing is done to reduce the economic concentration that keeps prices high when demand drops,
and nothing is done to prevent the diversion of scarce credit into
speculative and unproductive activities like mergers and acquisitions of large companies. Without a prudent fiscal policy, and
without a credit policy, the administration seems to leave the
control of inflation to the Federal Reserve, at the cost of recession
and continuing, high unemployment.
While an effective anti-inflation program must include monetary
policies which counsel restraint, it must not be the only program.
We simply cannot have an economic policy which prods the Fed to
tighten the money supply more and more until a recession or
depression finally brings prices, wages, and the whole economy to a
screeching halt.
Our policies, whether from the Fed or other places, must be
measured. The burdens they impose must be shared by all and not
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merely by the poor, the elderly, and those who have modest credit
needs that support housing, automobiles, education and health
care.
Mr. Chairman, under your guidance, these hearings mark the
turning point which will show the American people the foolishness
of this administration's policies and the consequences of relying
upon one institution to do the work that a whole Government must
be committed to doing. In creating this opportunity today and
tomorrow, you have again done yeoman's work for this country,
and I commend you for this.
Thank you.
Mr. HANSEN. Mr. Chairman, as ranking member of the subcommittee, may I respond also, as Mr. Fauntroy?
The CHAIRMAN. The gentleman is recognized. I think we are
going to put a 5 minute limit on these, however.
Mr. HANSEN. I have never been known to speak over 5 minutes,
Mr. Chairman.
Mr. Chairman, I, too, want to welcome the Chairman of the
Federal Reserve here.
I appreciate very much your being here, Mr. Volcker. These are
serious times. That is the reason I have asked to speak out, because
I feel that somehow the voice of the small guy, the small businessman and middle America is just not being heard, Mr. Chairman.
I would just like to read an excerpt of a letter, to give you an
idea of what we are getting here in Congress:
I wish to express my concern regarding the high price interest rate and detrimental effect it is having on Idaho based small business. As you may know, First Idaho
Corporation is a Boise-based public financial services company. We are currently
paying 22 ¥2 percent interest on $3.4 million. Since January 1, 1981, First Idaho
Corporation's losses have been in excess of $275,000.
During the past 24 months, we have cut our staff more than 20 percent. We have
sold assets, taken other steps to survive the conditions created and encouraged by
the Federal Reserve.
I received another letter. They talk, of course—before I go on—
about a number of their clients who also have been having similar
problems, and many of them have gone into bankruptcy as a direct
result of the high cost of money. Then they talk about the senior
vice president of a mortgage company who says, "The capital formation cannot occur with short-term rates at 20 V2 percent plus.
That means the Reagan economics is doomed to failure. Paul
Volcker must be forced to look at the other side of his restrictive
monetary policies/'
Mr. Chairman, my concern is that over the past 2 or 3 years—
and this is something that perhaps there is good explanation for—
but we have had an erratic monetary supply management policy
which has seen us not going on some kind of a direct line toward
realizing our targets, but we have been on a roller coaster, up and
down and all over the deck,
Twenty percent. Then during the political campaign, for whatever reason, coming down from 20-percent to businessmen being in
the IFA needle of the storm, seemed to take some kind of heart.
They reinvest, get themselves committed again on huge flooring
situations or whatever. Then all at once they are hit with an
extended 20 percent roller coaster again. This is the kind of thing
we are finding. We are forcing these people out of business.
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Now, I sent a couple of years ago, Mr. Chairman, a couple of
staff members from the Banking Committee and my staff to New
York to the Fed there to try and see what was going on, if there
was some kind of preoccupation with foreign lending or something
else that maybe was not allowing the Fed to get the real feeling of
what is going on within America down at the small business level.
I found that there was a preoccupation all day long with this type
of thing.
Finally, at the end of the day they admitted they were getting
complaints from upstate New York and other areas. The point I
am trying to make is I am just not sure the Federal Reserve has
been getting the message, even way into the time when some of
these small businesses were having their problems, Mr. Chairman,
and I mean we are dead in the water, we had statements issued
from the Feds, yourself and others stating I think the message is
finally getting to the countryside.
I would like to ask when the message is going to get to Washington, because the thing that is happening here is that we find
Government overspending for years has created a problem which
we are trying to deal with now in the Federal Reserve, and some
credit to you—has been trying to help us alleviate the problem by
this. But in doing so, it seems we are always penalizing the private
sector and making them sacrifice.
I hear some of the large corporations say they are making unprecedented profits and doing very well. But this is not true out in
the countryside. I am afraid if we continue the money policies we
have now, trying to preoccupy ourselves, as the gentleman from
the District of Columbia said, with inflation alone and with the
interest rates, we are getting to the point where there is not going
to be anything left to save in the countryside and we are going to
have a European-type economic situation where you have a few
people own it all and the rest working for them, Mr. Chairman.
It seems to me when you look at the credit situation as envisioned by the takeover of Conoco by certain large corporations, you
see the differences in the way interest rates are treated between
the large corporations and others.
I would like to leave this little bit of counsel. I think what is
happening is we are destroying the small businessman, we are
destroying middle America and the American dream, the ability to
own a car and home. We are feeding inflation more than we are
actually defeating it, because anytime you have the Federal Government paying 20 percent or 18 percent or whatever for the
money it is borrowing, you actually are heaping it on the Federal
debt and creating larger deficits than we had before.
And, Mr. Chairman, I think it is time we got away from catering
to the big banks, big corporations, big income people, and catering
to a type of capitalism in this country it was never designed to
have, and see if we can't have something for middle-America. I
encourage you to take a look at this in the testimony and the
answers you are giving today.
The CHAIRMAN. The Chair will instruct staff to find a seat on
this side of the dais for the gentleman from Idaho, after hearing
that statement. [Laughter.] Mr. Volcker, I think your time has
come. [Laughter.]
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STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN, FEDERAL
RESERVE BOARD
Mr. VOLCKER. Perhaps the most constructive thing I can do at
this point, Mr. Chairman, is read the statement I have prepared
which deals with some of these questions.
I am pleased to be here this morning to review the conduct of
monetary policy and to report on the Federal Reserve's objectives
for the growth of money and credit for this year as well as tentative targets for 1982. You have already received our formal report,
but I would like to briefly summarize some points and amplify
others.
I do not need to belabor the point that the current economic
situation is far from satisfactory. That has already been done fairly
satisfactorily here. We do see some encouraging signs that we are
beginning to make progress against inflation. I realize the evidence
in the recent price data is not, by itself, conclusive. However, I
strongly believe that we now have the clear opportunity and responsibility to achieve and sustain further progress on the price
front. That progess, in turn, will be an essential ingredient in
laying the base for a much healthier economy in the years ahead.
The process inevitably requires time and patience. It would obviously be much more pleasant for me to appear before you today
were both unemployment and interest rates lower. High interest
rates undeniably place a heavy burden on housing, the auto industry, small business, and other sectors especially dependent on
credit. The thrift industry, in particular, has come under heavy
stress as its costs of funds exceed returns on fixed rate assets
acquired when interest rates were much lower.
The high level of U.S. interest rates also has repercussions internationally, complicating already difficult economic policy decisions
of some of our major economic partners. The surprisingly strong
growth in national output last winter has given way to a much
more sluggish picture. With continuing sizable increases in the
labor force, unemployment has not declined from higher levels
reached last year. The trend of both productivity and savings remains low.
Amidst these difficulties, we must not lose sight of the fundamental point that so many of the accumulated distortions and
pressures in the economy can be traced to our high and stubborn
inflation. Moreover, turning back the inflationary tide, as we can
see, is not a simple, painless process, free from risks and strains of
its own. All that I would claim is that the risks of not carrying
through on the effort to restore price stability would be much
greater. Dealing with inflation is essential to our future well being
as a nation, and the Federal Reserve means to do its part.
As I noted, we have begun to see some tentative signs of a
realization of price pressures. To be sure, much of the recent improvement in various price indicators is accounted for by some
reversal of "special" factors that drive the inflation rate higher in
1979 and part of 1980. Instead of the huge increases of the last 2
years, energy prices have stabilized and some oil prices have even
declined in the fact of the recent production surpluses.
164
Retail food prices have risen at rates less than 1 percent this
year, partly reflecting improved crop conditions, in contrast to the
10 Vi percent pace in 1980.
Commodity prices generally have been weak, as speculative
forces have subsided under pressure of the high cost of finance and
more restrained price expectations. Despite sharply rising mortgage costs, the recorded overall cost of homeownership has been
rising less rapidly.
Some of these developments could prove temporary. Special factors and short term improvements in the prices most sensitive to
credit restraint alone cannot be counted upon to sustain progress
indefinitely. The deeply entrenched underlying rate of inflation is
sustained by the interaction of labor costs, productivity, and prices.
So far, there are only small and inconclusive signs of a moderation in wage pressures. Understandably, wages respond to higher
prices. But in the economy as a whole, labor accounts for the bulk
of all costs, and those rising costs in turn maintain the momentum
of the inflationary process.
Low productivity gains, high taxes, and unnecessary regulatory
burdens aggravate the situation. Moreoever, to the extent firms
and their workers are shielded form the competitive consequences
of poor productivity and aggressive price and wage policies, those
attitudes are encouraged.
These considerations help point to the wide range of policies
necessary to support a sustained and effective effort against inflation. Fortunately, recognition of the need is widespread, and progress is being made in a number of directions. But there can be no
escaping the fact that monetary policy has a particularly crucial
role to play and, in current circumstances, has a particualrly heavy
burden.
An effective program to restore price stability requries reducing
growth in money and credit over time to rates consistent with the
growth of output and employment at stable prices. That is the
basic premise of our policies, and I believe consistent with the
philosophy of the Humphrey-Hawkins Act mandating our report to
you today on our monetary growth ranges. The periodic decisions
we in the Federal Reserve reach about those monetary targets, and
the implementation of policy, are entirely within the broad policy
context; essentially, they are matters of how much, how fast, not
basic direction.
In approaching its midyear review of the monetary and credit
targets within this framework, the Federal Open Market Committee was faced with rather sharply divergent trends in the several
aggregates during the first half of the year.
These trends were significantly influenced by the rapidity of
market responses to regulatory or structural changes, including the
exceptionally rapid growth of NOW accounts nationwide and of
money market mutual funds.
The basic measures of transaction balances—"narrow money" or
Mi—have risen relatively slowly, after adjusting for the effects of
the one time shifts of funds into interest bearing NOW accounts;
those accounts were available for the first time nationwide, and
have been aggressively marketed by banks and thrift institutions.
To a degree that cannot be precisely measured, individuals and
165
businesses, spurred by high interest rates, appear to have intensified cash management practices designed to minimize the use of
traditional transactional balances, tending to speed up the velocity
relationship between Mi and GNP during early 1981.
For example, to some limited degree, needs for Mi transaction
accounts may have been reduced by the growing popularity of
money market funds—not included in the definition of Mi —which
can be used as a substitute for demand deposits or NOW accounts.
At the same time, as shown on table 1, the broader aggregates,
M2 and M3, which do include money market funds and some other
close money substitutes, have been rising at or above the upper end
of the target ranges. You may recall I suggested to the committee
in presenting the targets for 1981, that these broader aggregates
might well be expected to rise toward the upper part of their
ranges. This expectation is reinforced by the further liberalization
of interest ceilings of depository institutions by the Depository
Institutions Deregulation Committee, a continued growth of money
market funds, and potentially the availability of tax exempt socalled "All Savers Certificates" at depository institutions, all of
which could continue to result in some diversion of funds from
market outlets into M2 and M3.
In the light of this situation, the committee considered the possibility of making small adjustments in the 1981 ranges to account
for the impact of institutional change. However, it seems probably
that the strongest impact of the introduction of NOW accounts and
of adjustments of cash management practices to high interest rates
may be behind us. Therefore, the committee did not feel that
changes in the growth ranges for 1981 were justified. And I might
say these growth ranges are set forth in table 2.
However, given developments during the first half of year and
the need to avoid excessive growth in coming months, the committee agreed that growth in Mi-B near the lower end of its range for
the year as a whole—that range is SV2 to 6 percent, after adjusting
for NOW account shifts—would be acceptable and desirable, particularly should relatively strong growth in the other aggregates
continue.
As indicated at the start of the year, the committee does feel it
acceptable that growth in M2 and M3 be toward the upper part of
their ranges—6 to 9 percent and 6V2 to 9V2 percent respectively.
Growth of bank credit, while often fluctuating considerably from
month to month, is expected to remain within its specified range of
6 to 9 percent.
In its tentative consideration of the targets for 1982, the committee decided to plan for targeting and publishing a single Mi figure,
equivalent in coverage to the present Mi-B. Assuming that further
structural shifts into NOW accounts from nontransaction accounts
are by that time minimal, shift adjusted targets and data should
not be necessary. The tentative range for Mi in 1982 was set at 2V2
to 5Y2 percent, the midpoint of 4 percent is three-quarters of 1
percent below the midpoint of the closely comparable current
range for Mi-B shift adjusted.
The tentative ranges for the broader aggregates in 1982 were left
unchanged at 6 to 9 percent and 6V2 to 9% percent for M2 and M3,
respectively. However, we would anticipate actual growth closer to
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the midpoint in 1982, consistent with the desired reduction over
time.
Setting precise targets has inevitably involved us in consideration of the effects of technological and regulatory change on monetary measures. Those technical considerations should not obscure
the basic thrust of our intentions—that is, to lower progressively
effective money and credit growth to amounts consistent with price
stability. We believe the targets for both 1981 and 1982, and our
operations, are fully consistent with that objective.
I have often emphasized that money supply data—like many
other financial and economic data—have some inherent instability
in the short run. The trend over time is what counts, both as a
measure of monetary policy and in terms of economic effect. For
some months in the latter part of 1980, as you will recall, the rise
in Mi was relatively rapid. Against that background, the sluggish
growth during most of the first half of 1981 was welcomed as a
desirable offset by the committee, conforming the trend toward a
lower rate of growth over time.
At the same time, we have been conscious of the relative
strength of M2 and M3. Those measures include money market
funds, short-term repurchase agreements, and certain U.S.-held
Eurodollars, that to a greater or lesser degree can serve as substitutes for Mi balances. With those components growing relatively
rapidly, our experience this year, to my mind, reinforces the need
to take account of all available information in assessing the significance of short term movements in the monetary aggregates and
judging our policy posture.
More fundamentally, what recent experience also confirms is
that demands for money and credit growing out of an expanding
and inflating economy, pressing against a restrained supply, will be
reflected in strong pressures on interest rates and credit markets—
pressures that in turn restrain the growth in business activity.
Some important sectors of the economy are relatively impervious
for one reason or another to direct financial restraint—energy,
high technology, many services, and defense. Those sectors have
been strong sustaining forces in the economy generally, and particularly in some geographic areas.
The brunt of the restraint falls on other credit dependent sectors,
and as the dollar has sharply appreciated, increasingly on exporters faced with a less favorable competitive position. Should interest
rates decline in response to weakness in the economy, many of
those sectors would likely, and rather promptly rebound.
In a longer time frame, the outlook for interest rates will depend
importantly on confidence that inflation will be controlled, and on
actual progress toward greater price stability, as well as such factors as the Federal deficit. Differences of opinion about these matters help to account for the relatively wide range of forecasts now
characteristic for the period ahead, including those set forth by
members of the Federal Open Market Committee, which are attached to this statement.
I cannot fully resolve all these uncertainties in the outlook for
you this morning. What does seem clear to me is that progress on
inflation is a prerequisite for lasting improvement in financial
markets, and for sustained, balanced growth. I can also emphasize
167
the policies that seem to me necessary to speed the transition to
more equable financial markets and to a more prosperous, productive, economy generally.
First, as I have already indicated, curbing inflation will require
persistent restraint on the growth of money and credit. An attempt
to escape from high interest rates and strains on financial markets
and institutions by abandoning that restraint would be self-defeating. By encouraging expectations of more inflation, that approach
would soon stimulate even more borrowing, further reduce incentives to save, and ultimately result in still higher interest rates and
more economic difficulty.
You and I know that, after a decade and more of disappointment,
there is persisting skepticism and doubt about the ability of the
Nation to persevere in an anti-inflation program. I believe that
skepticism is unwarranted, but we must make that claim good by
our actions. Indeed, sustained monetary restraint, by encouraging
greater confidence in the price outlook, will in time help bring
interest rates lower.
Pressures on financial markets can also be relieved by actions
from other directions, entirely consistent with the anti-inflation
effort and the longer run needs of the economy. Specifically, today,
Government deficits and credit programs absorb today a large fraction of our available limited savings.
You are well aware that the administration and the Congress are
hard at work on both sides of that equation. It requires a difficult
balancing of priorities. Some forms of tax reduction are justified by
the need to improve incentives and to reduce costs. But if we are to
be convincing in our efforts to reduce the deficit at the same time,
Congress will need to maintain and even intensify the courageous
effort to reduce the upward trend in spending.
Monetary restraint does imply that the growth in the current
value of our output—the nominal GNP—will also be restrained. To
the extent that restraint falls on prices, the more room there will
be for the growth in real output we want. I have already suggested
that the recent improvement in the price performance has some
elements that we cannot count on continuing. But along with the
present slack in many labor and product markets, the more encouraging price data certainly does help create a more favorable setting
for changing the fundamentals of price policy and wage behavior in
ways that can be sustained.
A bulge in labor compensation early this year, and related continuing large increases in unit labor costs, have reflected in substantial part a catchup in wages after last year's large rise in the
consumer price index, as well as sizable increases in the minimum
wage and social security taxes. These sources of pressure should be
much diminished or absent in the period ahead. Intensified by the
appreciation of the dollar internationally, there are also strong
competitive incentives domestically and internationally, on important industries to control costs.
In these circumstances, there is a compelling logic, from an
overall economic view, in looking toward a sense of greater caution
and restraint in both wage and pricing behavior. What is at issue is
the extent to which that need will seem equally compelling, viewed
from the specific shop floor or the individual executive suite. Those
168
decisions are, of course, made continuously in the nonunion sector
of the economy, but a crucially important round of union wage
bargaining begins next January, potentially setting a pattern for
several years ahead.
That is one reason why we need to be clear and convincing in
specifying our monetary and fiscal policy intentions, and their
implications for the economic and inflation environment. Without
room for financing both high levels of inflation and strong growth,
inflationary behavior by individual firms can jeopardize markets,
jobs and profits.
The lesson already seems apparent in some key industries. Government can and should help directly by removing unnecessary
regulatory burdens, and by reviewing laws and practies that actually inhibit competitive pricing and add to costs. I believe it can
also help indirectly by making clear that industries suffering from
problems of their own making are not entitled to new governmental protection.
What this all adds up to is that we are at a critical point in the
fight on inflation.
We do see the first stirrings of progress in the most recent data.
With enormous effort, the administration and the Congress are
moving together to attain control on spending. We all know much
remains to be done for future years, but the unparalleled effort
bodes well for the future. With a full measure of success, the most
urgently needed tax reduction can be responsibly reconciled with
reduced deficits.
We in the Federal Reserve are committed to reducing growth in
money and credit. There is, I believe, a genuine urge to let the
competitive marketplace work, and to review Government practices
that unnecessarily add to costs or limit competition.
These policies can and will be effective. But if they are to work,
they must be sustained with conviction. Then, the apparent reluctance of many to bet on reduced inflation—in financial markets, in
wage bargaining, in pricing, and in other economic decisions—will
change. As they do, the unwinding of the inflationary process
should be much easier.
In a real sense, the hardest part of the job faces us now and in
the months immediately ahead. We must demonstrate our ability
to carry through on our good intentions, not just in monetary
policy, but in the fiscal and other areas as well.
I have talked at some length this morning about the technical
aspects of monetary policy and our numerical targets for the various monetary aggregates. I have reemphasized why the Federal
Reserve must be and is determined to avoid excessive growth in
money and credit. I have stressed the key role other policies, including budgetary restraint, must play if we are to make real
progress toward price stability and relieve pressures on financial
markets.
That may all seem abstract and even singleminded, given the
pressing problems of the real world.
For far too long, we have not had acceptable economic performance. The average worker has found his or her real income growing
slowly, if at all. The overall unemployment rate, high as it is, does
not reflect the intensity of the problem for some groups and areas,
169
and the burden too often falls on those least able to bear it.
Interest rates are at extraordinary levels.
We in the Federal Reserve are acutely aware of these problems.
We do not restrain money and credit for its own sake, or simply
because inflation is an evil in itself.
Financial discipline is a means to an end. It is an essential
part—if only a part—of strengthening our economy so that productivity and living standards can rise and worthwhile jobs can be
found, not just for a few months, but for the longer period ahead.
Thank you, Mr. Chairman.
[Mr. Volcker's prepared statement follows:]
170
Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Finance and Urban Affairs
House of Representatives
July 21, 1981
171
I am pleased to be here this morning to review the
conduct of monetary policy and to report on the Federal
Reserve's objectives for the growth of money and credit for
this year as well as tentative targets for 1982.
You have
already received our formal report, but I would like to
briefly summarize some points and amplify others.
I do not need to belabor the point that the current
economic situation is far from satisfactory.
But we see some
encouraging signs that we are beginning to make progress
against inflation.
I realize the evidence in the recent price
data is not, by itself, conclusive.
However, I strongly believe
that we now have the clear opportunity and responsibility to
achieve and sustain further progress on the price front.
That
progress, in turn, will be an essential ingredient in laying
the base for a much healthier economy in the years ahead.
The process inevitably requires time and patience.
It
would obviously be much more pleasant for me to appear before
you today were both unemployment and interest rates lower.
High interest rates undeniably place a heavy burden on housing,
the auto industry, small business, and other sectors especially
dependent upon credit.
The thrift industry, in particular, has
come under heavy stress as its costs of funds exceed returns on
fixed rate assets acquired when interest rates were much lower.
The high level of U.S. interest rates also has repercussions
internationally, complicating already difficult economic policy
decisions of some of our major economic partners.
The surprisingly
172
strong growth in national output last winter has given way to
a much more sluggish picture.
With continuing sizable increases
in the labor force, unemployment has not declined from higher
levels reached last year.
The trend of both productivity and
savings remains low.
Amidst these difficulties, we must not lose sight of
the fundamental point that so many of the accumulated distortions
and pressures in the economy can be traced to our high and stubborn
inflation.
Moreover, turning back the inflationary tide, as we
can see, is not a simple, painless process, free from risks and
strains of its own.
All that I would claim is that the risks of
not carrying through on the effort to restore price stability
would be much greater.
Dealing with inflation is essential to
our future well-being as a nation, and the Federal Reserve means
to do its part.
As I noted, we have begun to see some tentative signs of
a relaxation of price pressures.
To be sure, much of the recent
improvement in various price indicators is accounted for by some
reversal of "special" factors that drove the inflation rate
higher in 1979 and part of 1980.
Instead of the huge increases
of the last two years, energy prices have stabilized and some oil
prices have even declined in the face of the recent production
surpluses.
Retail food prices have risen at rates of less than
1 percent this year, partly reflecting improved crop conditions,
in contrast to the 10% percent pace in 1980.
Commodity prices
generally have been weak, as speculative forces have subsided
173
under the pressure of the high cost of finance and more
restrained price expectations.
Despite sharply rising mortgage
costs, the recorded overall cost of homeownership has been
rising less rapidly.
Some of these developments could prove temporary.
Special factors and short-term improvements in the prices most
sensitive to credit restraint alone cannot be counted upon to
sustain progress indefinitely.
The deeply entrenched underlying
rate of inflation is sustained by the interaction of labor costs,
productivity, and prices.
So far, there are only small and in-
conclusive signs of a moderation in wage pressures.
wages respond to higher prices.
Understandably,
But in the economy as a whole,
labor accounts for the bulk of all costs, and those rising costs
in turn maintain the momentum of the inflationary process. Low
productivity gains, high taxes, and unnecessary regulatory burdens
aggravate the situation.
Moreover, to the extent firms p.yid their
workers are shielded from the competitive consequences of poor
productivity and aggressive price and wage policies, those attitudes
are encouraged.
These considerations help point to the wide range of
policies necessary to support a sustained and effective effort
against inflation.
Fortunately, recognition of the need is
widespread, and progress is being made in a number of directions.
But there can be no escaping the fact that monetary policy has a
particularly crucial role to play and, in current circumstances,
has a particularly heavy burden.
174
An effective program to restore price stability requires
reducing growth in money and credit over time to rates consistent
with the growth of output and employment at stable prices.
That
is the basic premise of our policies, and I believe consistent
with the philosophy of the Humphrey-Hawkins Act mandating our
report to you today on our monetary growth ranges.
The periodic
decisions we in the Federal Reserve reach about those monetary
"targets," and the implementation of policy, are entirely within
that broad policy context; essentially, they are matters of how
much, how fast, not basic direction.
In approaching its mid-year review of the monetary and
credit targets within this framework, the Federal Open Market
Committee was faced with rather sharply divergent trends in
the several aggregates during the first half of the year.
These trends were significantly influenced by the rapidity of
market responses to regulatory or structural changes, including
the exceptionally rapid growth of NOW accounts nationwide and
of money market mutual funds.
The basic measures of transaction balances —
money" or Ml —
"narrow
have risen relatively slowly after adjusting
for the effects of the one-time shifts of funds into interestbearing NOW accounts; those accounts were available for the
first time nationwide, and have been aggressively marketed by
175
banks and thrift institutions.*
To a degree that cannot be
precisely measured, individuals and businesses, spurred by high
interest rates, appear to have intensified cash management practices
designed to minimize the use of traditional transaction balances,
tending to speed up the "velocity11 relationship between Ml and GNP
during early 1981.
For example, to some limited degree, needs for
"Ml" transaction accounts may have been reduced by the growing
popularity of money market funds —
of Ml —
not included in the definition
which can be used as a substitute for demand deposits or
NOW accounts.
At the same time, as shown on Table I, the broader aggregates,
M2 and M3 (which do include money market funds and some other close
money substitutes) have been rising at or above the upper end of
the target ranges.
You may recall I suggested to the Committee
in presenting the targets for 1981, that these broader aggregates
might well be expected to rise toward the upper part of their ranges.
This expectation is reinforced by the further liberalization of
interest ceilings of depository institutions by the Depository
Institutions Deregulation Committee, a continued growth of money
market funds, and potentially the availability of tax-exempt so-called
"All Savers Certificates" at depository institutions, all of which
could continue to result in some diversion of funds from market
outlets into M2 and M3.
•These shifts sharply depressed recorded (i.e., before "shift
adjustment") MIA early in the year because the bulk of the NOW
accounts reflected transfers from demand deposits which are included
in MIA. Recorded MlB, which includes NOW accounts, was "artificially"
increased to the extent funds were shifted into NOW accounts from savings
accounts or other assets not counted as transaction accounts, but continue in part to serve the economic function of savings. The Federal
Reserve publishes estimates monthly of "shift-adjusted" data based on
a variety of sources. As the transfers diminish, as appears to be
happening, the "adjusted" and "unadjusted" data will more closely
coincide.
176
In the light of this situation, the Committee considered
the possibility of making small adjustments in the 1981 ranges
to account for the impact of institutional change.
However, it
seems probable that the strongest impact of the introduction of
NOW accounts and of adjustments of cash management practices to
high interest races may be behind us.
Therefore, the Committee
did not feel that changes in the growth ranges for 1981 were
justified.
(All targets for 1981 and 1982 are shown in Table II.)
However, given developments during the first half of the
year and the need to avoid excessive growth in coming months, the
Committee agreed that growth in M1B near the lower end of its range
for the year as a whole (3*5-6 percent, after adjusting for NOW
account shifts) would be acceptable and desirable, particularly
should relatively strong growth in the other aggregates continue.
As indicated at the start of the year, the Committee does feel it
acceptable that growth in M2 and M3 be toward the upper part of
their ranges (5-9 percent and 6*5-9*5 percent, respectively) .
Growth
of bank credit, while often fluctuating considerably from month to
month, is expected to remain within its specified range of 6-9 percent.
In its tentative consideration of the targets for 1982,
the Committee decided to plan for targeting and publishing a
single Ml figure, equivalent in coverage to the present M1B.
Assuming that further "structural" shifts into NOW accounts from
non-transaction accounts are by that time minimal, "shift adjusted"
targets and data should not be necessary.
The tentative range for
177
Ml in 1982 was set at 2^-5^ percent, the midpoint of 4 percent
is three-quarters percent below the midpoint of the closely
comparable current range for M1B "shift adjusted."*
The tentative ranges for the broader aggregates in 1982
were left unchanged at 6-9 percent and 6H-9H percent for M2 and
M3, respectively.
However, we would anticipate actual growth
closer to the midpoint in 1982, consistent with the desired
reduction over time.
Setting precise targets has inevitably involved us in
consideration of the effects of technological and regulatory
change on monetary measures.
Those technical considerations
should not obscure the basic thrust of our intentions —
that
is, to lower progressively effective money and credit growth to
amounts consistent with price stability.
We believe the targets
for both 1981 and 1982, and our operations, are fully consistent
with that objective.
*The tentative range for Ml in 1982 is substantially below
the range of 6-8^ percent specified for recorded MlB growth
for 1981. Recorded MlB data for 1981 have been strongly affected,
particularly during the early months of the year, by the "one-tiMe"
shifts into NOW accounts of savings and other funds not included
in the Ml series. These shifts are diminishing, and the. new
tentative target for 1982 assumes they will be essentially completed
by the end of this year. The slightly wider range specified allows
for the possibility of some residual shifting. That assumption
will, of course, be reviewed at year end.
178
I have often emphasized that money supply data —
many other financial and economic data —
instability in the short run.
like
have some inherent
The trend over time is what
counts, both as a measure of monetary policy and in terms of
economic effect.
For some months in the latter part of 1980,
as you will recall, the rise in Ml was relatively rapid.
Against that background, the sluggish growth during most of
the first half of 1981 was welcomed as a desirable offset by
the FOMC, confirming the trend toward a lower rate of growth
over time.
At the same time, we have been conscious of the
relative strength of M2 and M3.
Those measures include money
market funds, short-term repurchase agreements, and certain U.S."
held Eurodollars, that to a greater or lesser degree can serve
as substitutes for Ml balances.
With those components growing
relatively rapidly, our experience this year, to my mind, reinforces the need to take account of all available information
in assessing the significance of short-term movements in the
monetary aggregates and judging our policy posture.
More fundamentally, what recent experience also confirms
is that demands for money and credit growing out of an expanding
and inflating economy, pressing against a restrained supply, will
be reflected in strong pressures on interest rates and credit
markets —
pressures that in turn restrain the growth in business
activity.
Some important sectors of the economy are relatively
impervious for one reason or another to direct financial restraint
179
energy, high technology, many services, and defense.
Those
sectors have been strong sustaining forces in the economy
generally, and particularly in some geographic areas.
The
brunt of the restraint falls on other credit-dependent sectors,
and, as the dollar has sharply appreciated, increasingly on
exporters faced with a less favorable competitive position.
Should interest rates decline in response to weakness in the
economy, many of those sectors would likely, and rather promptly,
rebound.
In a longer time frame, the outlook for interest rates
will depend importantly on confidence that inflation will be
controlled, and on actual progress toward greater price stability,
as well as such factors as the Federal deficit.
Differences of
opinion about these matters help to account for the relatively
wide range of forecasts now characteristic for the period ahead,
including those set forth by members of the FOMC.
(Table III
sets forth the range of those projections.)
I cannot fully resolve all those uncertainties in the
outlook for you this morning.
What does seem clear to me is
that progress on inflation is a prerequisite for lasting improvement in financial markets, and for sustained, balanced growth.
I can also emphasize the policies that seem to me necessary to
speed the transition to more equable financial markets and to a
more prosperous, productive economy generally.
First, as I have already indicated, curbing inflation
will require persistent restraint on the growth of money and
credit.
An attempt to escape from high interest rates and
180
strains on financial markets and institutions by abandoning
that restraint would be self-defeating.
By encouraging
expectations of more inflation, that approach would soon
stimulate even more borrowing, further reduce incentives to
save, and ultimately result in still higher interest rates and
more economic difficulty.
You and I know that, after a decade
and more of disappointment, there is persisting skepticism and
doubt about the ability of the nation to persevere in an antiinflaticn program.
I believe that skepticism is unwarranted,
but we must make that claim good by our actions.
Indeed,
sustained monetary restraint, by encouraging greater confidence
in the price outlook, will in time help bring interest rates
lower.
Pressures on financial markets can also be relieved by
actions from other directions, entirely consistent with the
anti-inflation effort and the longer-run needs of the economy.
Specifically, government deficits and credit programs absorb
a large fraction of our available limited savings.
You are
well aware that the Administration and the Congress are hard
at work on both sides of that question.
balancing of priorities.
It requires a difficult
Some forms of tax reduction are
justified by the need to improve incentives and to reduce costs.
But if we are to be convincing in our efforts to reduce the
deficit at the same time, Congress will need to maintain and
even intensify the courageous effort to reduce the upward trend
in spending.
181
Monetary restraint implies that the growth in the
current value of our output —
be restrained.
the nominal GNP —
will also
To the extent that restraint falls on prices,
the more room there will be for the growth in real output we
want.
I have already suggested that the recent improvement
in the price performance has some elements that we cannot
count on continuing.
But, along with the present slack in
many labor and product markets, the more encouraging price
data certainly helps create a more favorable setting for
changing the fundamentals of pricing policy and wage behavior
in ways that can be sustained.
A bulge in labor compensation early this year, and
continuing large increases in unit labor costs, have reflected
in substantial part a "catch up" in wages after last year's
large rise in the consumer price index, as well as sizable
increases in the minimum wage and social security taxes.
These sources of pressure should be much diminished or absent
in the period ahead.
Intensified by the appreciation of the
dollar, there are also strong competitive incentives domestically
and internationally, on important industries to control costs.
In these circumstances, there is a compelling logic, from
an overall economic view, in looking toward a sense of greater
caution and restraint in both wage and pricing behavior.
What
is at issue is the extent to which that need will seem equally
compelling, viewed from the specific shop floor or the individual
executive suite.
These decisions are, of course, made continuously
182
in the non-union sector of the economy, but a crucially
important round of union wage bargaining begins next January,
potentially setting a pattern for several years ahead.
That is one reason why we need to be clear and convincing
in specifying our monetary and fiscal policy intentions, and
their implications for the economic and inflation environment.
Without room for financing both high levels of inflation and
strong growth, inflationary behavior by individual firms can
jeopardize markets, jobs, and profits.
The lesson already seems apparent in some key industries.
Government can and should help directly by removing unnecessary
regulatory burdens, and by reviewing laws and practices that
actually inhibit competitive pricing and add to costs.
I
believe it can also help indirectly by making clear that
industries suffering from problems of their own making are
not entitled to new governmental protection.
What this all adds up to is that we are at a critical point
in the fight on inflation.
We see the first stirrings of progress in the recent
data.
With enormous effort, the Administration and the Congress
are moving together to attain control of spending.
We all know
much remains to be done for future years, but the unparalleled
effort bodes well for the future.
With a full measure of success,
the most urgently needed tax reduction can be responsibly reconciled with reduced deficits.
183
We in the Federal Reserve are committed to reducing
growth in money and credit.
There is, I believe, a genuine urge to let the competitive marketplace work, and to review government practices
that unnecessarily add to costs or limit competition.
These policies can and will be effective.
But if they
are to work, they must be sustained with conviction.
Then, the
apparent reluctance of many to bet on reduced inflation —
in
financial markets, in wage bargaining, in pricing, and in other
economic decisions —
will change.
As they do, the unwinding
of the inflationary process should be much easier.
In a real sense, the hardest part of the job faces us
now and in the months immediately ahead.
We must demonstrate
our ability to carry through on our good intentions —
not
just in monetary policy, but in the fiscal and other areas
as well.
I have talked at some length this morning about the
technical aspects of monetary policy and our numerical targets
for the various monetary aggregates.
I have reemphasized why
the Federal Reserve must be and is determined to avoid excessive
growth in money and credit.
I have stressed the key role other
policies, including budgetary restraint, must play if we are to
make real progress toward price stability and relieve pressures
on financial markets.
184
That may all seem abstract and even singleminded, given
the pressing problems of the real world.
For far too long, we have not had acceptable economic
performance.
The average worker has found his or her real
income growing slowly if at all.
The overall unemployment
rate, high as it is, does not reflect the intensity of the
problem for some groups and areas, and the burden too often
falls on those least able to bear it.
Interest rates are at
extraordinary levels.
We in the Federal Reserve are acutely aware of these
problems.
We do not restrain money and credit for its own
sake, or simply because inflation is an evil in itself.
Financial discipline is a means to an end.
essential part —
if only a part —
It is an
of strengthening our
economy so that productivity and living standards can rise
and worthwhile jobs can be found, not just for a few months,
but for the longer period ahead.
185
Table 1
GROWTH RANGES AND ACTUAL GROWTH IN MONEY AND CREDIT
(All data percent at annual rates)
Growth Ranges
1980Q4 - 1981 Q4
Actual
1980Q4 - Latest Data
1980Q4 - 1981 Q2
3-1/2 to 6
2.2
2.6 (July 8)
M2
6 to 9
9.5
8.7 (June)
M3
6-1/2 to 9-1/2
11.5
11.1 (June)
6 to 9
8.9
8.7 (June)
Ml-B*
Bank Credit
*Adjusted for shifts into NOW accounts. The range for recorded M1B associated
with the "shift-adjusted" MlB range at the start of the year was 6 to 8-1/2
percent. Actual growth in that measure from 1980Q4 to 1981Q2 was 6.8 percent
at an annual rate. With NOW account growth larger than anticipated at the
beginning of the year, the divergence between the recorded and shift-adjusted
data should be slightly greater than anticipated at the start of the year.
Table 2
GROWTH RANGES AND ACTUAL GROWTH OF MONETARY AND CREDIT AGGREGATES
(Percent changes, fourth quarter to fourth quarter)
Ml-A
Growth Range for 1980
Actual 1980
Growth Range for 1981
Growth Range for 1982
Ml-B
3-1/2 to 6
6-1/4*/
2
3 to 5-1/2 /
n.a.
M2
M3
Bank Credit
4 to 6-1/2
6 to 9
6-1/2 to 9-1/2
6 to 9
6-3/41/
9.6
2
3-1/2 to 6 /
3
2-1/2 to 5-1/2 /
10.2
8.0
6 to 9
6-1/2 to 9-1/2
6 to 9
6 to 9
6-1/2 to 9-1/2
6 to 9
1. Adjusted for unanticipated transfers into ATS and other similar accounts from other assets.
2. Adjusted for shifts into NOW accounts.
3. Assumes negligible impact of shifting into NOW accounts.
^
187
Table 3
FOMC
MEMBERS' ECONOMIC FORECASTS
Actual
1980
Projected
1981
1982
9.4
-.3
9.8
10 to 11-1/2
1 to 3-1/2
7-1/2 to 9
9-1/2 to 12-1/4
1 to 4
6-1/2 to 8-1/2
7.5
7-1/2 to 8-1/4
Change from fourth quarter to
fourth quarter, percent
Nominal GNP
Real GNP
Implicit GNP deflator
Average level in fourth quarter
Unemployment rate (percent)
7 to 8-1/2
The CHAIRMAN. Thank you.
Mr. Chairman, you recall I recently sent you a letter expressing
my dismay and my concern over the lines of credit that have been
obtained by various corporations to engage in the monopoly game
going on to purchase Conoco. At that time, we were looking at $35
billion worth in lines of credit. Since then, you testified before the
JEC and stated that, well, this is not too much concern, because
only one bidder will be successful.
However, subsequent to your testimony, we find that Gulf Oil
has obtained a $5 billion line of credit, and they ain't telling who
their target is. Rumor has it that their target is City Service.
Then lo and behold, Pennzoil has a $3 billion line of credit. And
they stated they really don't know who they want to take over, but
they figure they want to get into the act. They want to play the
game.
Now, as a matter of fact, Mr. Chairman, I think that the subsequent events, following your testimony before the JEC should give
rise to further real concern. No. 1, these funds aren't being put into
any productive capacity. During the period of time that these lines
of credit exist this denies credit to other people. We are talking
here about $35 billion last week, and now $40 billion tied up.
Money supply growth last Friday was $9 billion, and yesterday the
market dropped 18 points and the bottom fell out of the bond
market.
My guess is, subsequent to your testimony before the JEC, when
we look at what is happening in this game of monopoly and mergers, and the urge to merge, don't you feel, don't you think that this
is becoming a serious situation? And doesn't this have a dramatic
effect on the interest rates that the small businessman and the
potential home purchaser and the automobile purchaser are forced
to pay?
Mr. VOLCKER. I believe I expressed some concern about the
matter last week, Mr. Chairman. One has to wonder what accounts
for this great flurry of takeover bids or financing in preparation for
such bids. This month, all of a sudden, so many billions of dollars
are potententially involved, even though so much of these commitments potentially are duplicative. Why does this all go on now
188
when these didn't look like such good deals 1 month ago or 2
months ago or 3 months ago? This raises some concerns as to
ordinary banking practices: How much financing goes on how
quickly without, perhaps in all cases, knowing what purpose the
money is used for?
This activity does raise that kind of question. I think it is true
that a lot of these lines of credit may not be drawn on because they
may have the same company as target. I think it is also generally
true that in this kind of a situation the money does not leave the
market. If it is drawn upon, someone is buying a company from
somebody else who then has the money to put back in the market.
There is always the question of what is a justified and a productive
merger.
The CHAIRMAN. Isn't some of this money coming in from Europe?
That is my understanding. Doesn't that affect your attempts for
monetary control?
Mr. VOLCKER. Some of it can come from abroad potentially.
These international flows of funds are large, in any event. This is a
particular avenue through which funds flow across national borders, but that is going on all the time anyway. These dollar markets are very well connected, and these are to the best of my
knowledge, dollar loans, impacting on dollar markets, worldwide. I
don't think that you can make a distinction between the international and domestic impact, but it is certain that some of the
money is coming from foreign banks, rather than from domestic
banks.
The CHAIRMAN. YOU stated that there is a question in your mind
as to why this is happening. Does it not occur to you that it might
be as a result of the policy of benign neglect that has been announced by the Department of Justice with respect to antitrust
cases from here on in? And don't you think that these tremendous
takeovers do impact on your attempt to control the money supply
and to have an effective monetary policy? Although you are an
independent agency, don't you think you should consult with the
administration on this new attitude they are taking and the effect
it is having?
Mr. VOLCKER. I would not want to suggest that the impact on
monetary policy or the credit markets at this point has been of
such a degree that we could even isolate it. There are a lot of
commitments, as you pointed out. I know of only one large one that
has actually been drawn upon, with the money employed. That
money has been placed back in the market; it is not typical to draw
down a bank loan and put the money back in the market, so the
net impact on the credit markets is more limited than the usual
case.
But there are questions that arise out of this general degree of
flurry. It raises the old questions that have been with us a long
time, about the treatment of equity investment. Our treatment of
savings and investment has not been kind in the Tax Code, generally, but I think it is particularly adverse so far as equity investment is concerned.
As a result, you get relatively depressed equity prices which may
help create conditions that make some of these takeovers attrac-
189
live. There are a lot of issues that arise when you look at the
situation.
The CHAIRMAN. Mr. Volcker, I look at a chart—I think it is out
of the New York Times—under the urge to merge. It says from
January to June 1981, $35.7 billion has already been expended on
major corporate mergers, $35.7 billion.
Mr. VOLCKER. I don't know where those figures are from. We
have tried to identify, in the recent banking figure, how much
bank loans have been going up due to large takeover situations; we
have not been able to identify very much. There is some increase,
but not a very large figure so far. My impression is that these
announcements in the press recently of large amounts are for
commitments and not actual drawdowns.
The CHAIRMAN. These are actual drawdowns. I would like to
include my recent letter to you, and several articles, because my
time has expired.
[The referred-to letter from Chairman St Germain and newspaper articles follow:]
190
FERNAND J. ST GERMAIN, WJ, CHAIRMAN
t, WILLIAM STANTOM. OHIO
HENRY S. REUSS. WIS.
CHALMERS F. WYLIE. OHIO
HCNRY B, GONZALEZ, TEX.
STEWART B. McKINNCY. CONN.
JOSEPH G^JGWISH. NJ.
Eg£,,\
™. PATTERSONTCAUF.
GEORGE HANSEN. IDAHO
U.S. HOUSE OF REPRESENTATIVES
S™E^
COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
SH^TNI^RIC
JAMES J. BLANCHARO, MICH.
CARROU- HUBBARD, JR., KY.
JOHN J. LAFALCE. N.Y.
DAVID W. EVANS. IND.
NORMAN E. D'AMOURS. N.H.
STANLEY N.LUND1NE.N.Y.
NORMAN O. SHUMWAY. CAUK.
NlNETY-SEVEKTH CONGRESS
STAN PARRIS. VA.
.
CO WEBER, OHIO
2129 R A Y B U R N H O U S E O F F I C E B U I L D I N G
WASHINGTON,
MARY ROSE OAKAR. OHIO
D.C.
20515
BILL MCCOLLUM. FLA,
ORCCORTW CARMAN. H
C E O R < W C ^ T
.
JIM MATTOX. TEX.
BRUCE F.VENTO.MINM.
DOUO BARNARD, JR.. GA.
-1-1
« " IjT
I t
10,
1001
11*01
ROBERT GARCIA. N.Y.
MIKE LOWRY. WASH.
CHARLES E. SCHUMER. N.Y.
BARNEY FRANK. MASS.
BSLL PATMAN. TEX.
WILUAM J. COYNE, FA.
STENY H. HOYER. MO.
Honorable Paul Volcker, Chairman
Board of Governors
Federal Reserve System
Washington, D. C. 20515
Dear Mr. Chairman:
As you know, the pages of the newspapers have been f i l l e d in recent
weeks with reports of multi-billion dollar financings involving the takeovers
of large corporations. One publication referred to the activity as "mob
psychology" that promises to generate more billion dollar credits.
Among the activity have been lines of bank credit approaching $15 billion
and centered on maneuvers involving oil and gas mergers, including the highly
publicized efforts to acquire Conoco. Texaco is reported to have received
bank credits totalling at least $5.5 billion; Mobil $5 billion; Shell Oil Company
$3 billion. A number of other multi-billion dollar credits apparently are being
processed in this takeover mania.
Such activity would require close scrutiny at any time, but at a time of
highly restrictive monetary policy i t is particularly questionable. Many areas
of the U. S. economy, particularly housing and many sectors of the small business
community, are at near collapse because of a severe shortage of credit ~ a shortage
clearly not shared by the huge oil companies who desire funds for an international
game of monopoly.
I t is interesting, and a somewhat sad commentary on our priorities, to
note that the credit extended by commercial banks to just two oil companies —
Mobil and Texaco — for merger activity almost equals the $11 billion in budget
reductions this Committee is required to make in assistance to housing programs
for low and moderate income families in FY 1982.
This Administration and the Federal Reserve insisted on pursuing a tight
money, high interest policy and have asked, in effect, that everyone in the economy
"bite the bullet" in fighting inflation. Public support for such a policy requires,
at a minimum, a perception that everyone is sharing in the hardship. Anything
less destroys public confidence. These huge multi-billion dollar extensions of
credit for non-productive international oil and gas takeovers are bitter pills
for small business people who face bankruptcy because of a lack of credit on
reasonable terms.
191
The Federal Reserve and this Administration cannot escape responsibility
for the imbalance that is so clearly apparent in the credit markets. While
I am sure there are lengthy dissertations available about the limits of the
Federal Reserve's authority, I do know that i t is possible for you and the other
members of the Federal Reserve Board to make i t clear to the nation's money
center banks that this is a very inappropriate moment for huge chunks of the
nation's available credit to be used for corporate takeovers and other
non-productive purposes. The Federal Reserve has many implied powers and no
banker w i l l ignore a clear signal from the nation's central bank. I f the Federal
Reserve wants to put an end to the "mob psychology" of corporate takeovers fueled
by unlimited bank credit, i t clearly has the power and influence to do so.
Sincerely,
ternand J. St Germain
Chairman
f
(New York Times, July 19, 1981)
Clarifying Some Mixed
Signals on Antitrust Law
ByROBERTPEAR
WASHINGTON — When officials from the antitrust division of the Justice Department met with
staff attorneys last week, they had to correct some
misunderstandings about the Reagan Administration's antitrust policy.
Abbott B. Lipsky Jr., a deputy assistant attorney general, said the lawyers were getting "woefully incorrect signals" if they thought that Wil
liam F. Baxter, the Assistant Attorney General for
antitrust, was "soft on enforcement." With corporate mergers sweeping the business world — the
bidding for Conoco in recent weeks is the most dramatic example — Mr. Baxter and Mr. Lipsky emphasized that the Administration was not flashing
a green light to all such takeover bids.
The signals were, however, easy to misread. Mr.
Baxter and Attorney General William French
Smith have been promising a policy more sensitive to concerns long expressed by business. Last
month, Mr. Smith vowed to root out "misguided
and mistaken concepts" that discourage competition in the name of promoting it. "Bigness in business does not necessarily mean badness," he said;
"efficient firms should not be hobbled under the
guise of antitrust enforcement."
Two other Reagan appointees sounded similar
themes last week. John S. R. Shad, the chairman
of the Securities and Exchange Commission, said
that corporate mergers were often healthy for the
economy, because they facilitated capital formation. And Treasury Secretary Donald T. Regan
said he was not particularly concerned about
mergers involving big oil companies or financial
institutions. "Let's face it," he said, "our economy
is growing, our nation is growing and the world is
growing. So why shouldn't companies grow?"
Last week, the Mobil Corporation, the nation's second largest oil company, ioined Du Pont and the
Seagram Company in the bidding war to acquire
Conoco, the nation's ninth largest oil company.
Federal officials have substantial latitude in enforcing antitrust laws. The language of the major
statutes is broad, even vague. Moreover, antitrust
policy usually depends heavily on economic analysis and often expresses a social or political philosophy on the ownership and control of the nation's
productive assets. Many people, such as Mr. Baxter, see economic efficiency as a primary purpose
of the antitrust laws. Others take a populist view,
contending that the laws were designed to protect
small businesses from the predatory practices of
giant competitors.
Principle and Practice
Avoiding novel interpretations of the law, the
Reagan Administration is taking antitrust enforcement back to basics, focusing on corporate
activity to which liberals and conservatives both
object. What this means, in practice, is continued
vigorous prosecution of "horizontal" price-fixing
and other restraints of trade by companies that
would ordinarily be competitors — but much less
opposition to "vertical" restraints, that is, arrangements between one company and another in
its production, supply or marketing chain. Horizontal restraints, the classic type of cartel behavior, artificially restrict output and raise prices to
consumers. There is less agreement about the consequences of vertical arrangements.
This month, the Justice Department dropped a
civil suit against Mack Trucks Inc., which was accused of conspiring with independent distributors
to fix the prices of parts. The arrangement failed
to meet Mr. Baxter's test for illegal vertical restraints: It did not facilitate collusion and did not
have any "horizontal effects," he said.
Some critics, such as Lawrence Anthony Sullivan of the University of California at Berkeley,
say the Administration approach apparently rep-
resents a decision not to enforce a well-established
area of the law. Mr. Sullivan said that Administration officials "are trying to turn antitrust law into
applied Chicago School economic theory and, in so
doing, have drastically oversimplified many problems." However, Donald F. Turner, chief of the
antitrust division under President Johnson, said
that "Mr. Baxter is a very tough fellow and he's
notth^retojjeJhmWtrusj^i^
_-_ _
S~ The perception of a more favorable climate in
Washington is widely believed to be a factor in the j
current "merger mania." The future course of the /
Federal Trade Commission, an independent regu- /
latory agency that shares responsibility for en-/
Jarcjn^hejuTtitrus^ja^^
President Reagan has norHInated^James C.
Miller 3d, executive director of the Presidential
Task Force on Regulatory Relief, to be chairman
of the five-member board. David A. Clanton, the
acting chairman, said recently that the agency,
while not shying away from big cases, would try to
define its legal theories more clearly .\ Last month,
staff lawyers recommended that the commission
drop its eight-year-old antitrust case against the
country's eight biggest oil companies.
The outcome of the Justice Department's biggest case, to break up the American Telephone and
Telegraph Company, may be the ultimate test of
the Administration's antitrust policy. Mr. Baxter
has immersed himself in the case and vowed to
1
'litigate it to the eyeballs.''
Defense Secretary Caspar W. Weinberger and
Commerce Secretary Malcolm Baldridge would
be happy to see it dropped. The Pentagon regards
the existing telephone network as an asset to national security. The Commerce Department wants
to end uncertainties in the communications industry and strengthen its ability to meet foreign
competition. Mr. Baldridge is among those who
say that Congress, rather than the courts, is the
proper forum in which to decide the future structure of the industry.
The Senate Commerce Committee last week approved landmark legislation to deregulate and restructure the telecommunications industry. The
Justice Department is opposed to any measure
that would change the status of A. T. & T. before
the antitrust case is resolved, but Mr. Baldridge
has endorsed the "general thrust" of the bill.
to
to
193
The urge to merge
197S
2,297
$11.8
14
1976
2,27S
$20.0
39
1977
$21,9
41
1978
$34.2
80
1979
2,128
$4$.$
*S3
1980
1,889
$44,3
94
taei*
1,184
$35.7
55
*Jan. to June
Source: W.T. Grimm & Co.
194
(New York Times, June 3, 1981)
Credit Needs Cited
For Oil Industry
LONDON, June 2 (Reuters) - .
The petroleum industry will require
more than $700 billion from world
credit markets in the 1980's to meet
oil demand, according to a Chase
Manhattan study released here
today.
This would possibly force some
economic dislocations and continued upward pressure on interest
rates, Patrick Keenan, a bank vice
president for energy economics,
said in the study prepared for a
Financial Times energy meeting.
The study said oil would remain
the dominant energy source, and
predicted that crude prices would
rise at about 3 percent above inflation to reach $102 a barrel by 1990.
Oil industry capital investments
would grow 17 percent, reaching a
cumulative total of $3.2 trillion by
1990, the study said.
Expected strong net income
growth would allow the industry to
finance 73 percent of capital requirements from internal cash
flow, with the balance generated by
borrowing, the Chase study said.
195
(Wall Street Journal, July 7, 1981)
Merger Mania
High Borrowing Costs
Fail to Stem Interest
In Takeover Activity
Cash- Laden Oil Firms Are
Both Buyers and Targets;
Bolder Corporate Tactics
Not Just Shedding a Turkey
By TIM METZ and BILL PAUL
Staff Reporters of T H E WALL STREET JOURNAL
NEW YORK-As every professional on
Wall Street knows, or used to know, sky-high
interest rates sharply restrict corporate-,
merger activity.
When interest rates began to spiral in
early 1980, savvy investment bankers and
takeover lawyers predicted an end to the acquisition binge that began in the mid-1970s.
One law firm that specializes in mergers,
Skadden, Arps, Slate, Meagher & Flom,
even accelerated its diversification to lessen
its reliance on takeover activity.
But as this week's merger news indicates, the professionals were wrong. Despite
the high costs of money, with the prime
lending rate around 20%, the merger mania
is becoming even more manic. Du Pont
Co.'s agreement to acquire Conoco Inc. in a
record $6.9 billion transaction came on the
same day that Societe Nationale Elf Aquitaine of France increased its offer for Texasgulf Inc. to $2.74 billion.
W. T. Grimm & Co. of Chicago, a merger
broker that keeps track of acquisition announcements, says second quarter activity
kept Dace with the first quarter, when corporate purchases set a record of $17.5 billion, up
from $7:2 billion a year before. Tomislava
Simic,, Grimm's research director, says,
"There's every possibility that the full-year
1980 record total of $44.3 billion will be surpassed by the end of the third quarter."
iMany mergers in the current wave are
undertaken by oil companies that have large
cash reserves from recent record profits.
Some other oil companies, such as Conoco,
are takeover targets because chemical companies and other large oil consumers want
to avoid another shortage like the one they
endured in the 1973 oil embargo.
Rorrowed-Money Mergers
But many of today's mergers rely on
high-priced borrowed money. Du Pont, for
instance, said it will borrow S3 billion from
a group of banks, although the terms
weren't disclosed. The reasons for many of
these mergers are less clear.
Merger specialists, however, have some ,
theories about why the merger activity remains so brisk with interest rates so high:
-Long-term corporate strategies have
become bolder as expectations of continued
high inflation rates have become entrenched.
-Corporations and merger experts have
become more familiar with, and more
amenable to, takeover tactics, even if the
acquisitions are hostile.
-Companies paying high rates "now to finance their acquisitions hope to refinance
the loans if rates fall as expected.
-Foreign buyers are getting in on the
act because of the relative stability of the
U.S. economy.
-Prices of some oil and natural-resource
takeover targets are bargains now compared with a year ago.
-The antitrust climate is more favorable
under the Reagan administration (see story
in column one).
-And, according to one expert at least,
the big acquisition has become a way for
chief executives nearing retirement to leave-*;
iheir mark an che corporation.
Oil Companies' Activity
Whatever the reasons, the beat goes on.
^all Street insiders say that a number of
buyers, led by cash-rich foreign comand U.S. oil giants, are close to anng other big takeover plans.
1
Texaco Inc., which ended the first quarter with $3.6 billion of cash, is widely rumored to have just arranged a $5 billion line
of credit for an acquisition. Since its merger
with Conoco was rebuffed last week, rumors
about Texaco's possible target now center
on Cities Service Co., but neither company
will discuss the matter.
No one on Wall Street is sure that Standard Oil Co. of California has given up its
designs, on Amax Inc.,' the big mining concern, despite its recent withdrawal of a $1
billion bid that Amax shunned.
And Seagram Co. of Canada, with more
than S3 billion of cash and cash-equivalent
assets on hand, seems certain to make a
major acquisition soon, following its presumed loss to Du Pont in the high-stakes
bidding for Conoco.
E
196
The Reagan Role
The prominent role of big oil companies
in the merger wave largely reflects the
more favorable investment climate under
the Reagan administration. Moreover* many
oil companies, laden with cash from record
profit levels, are rethinking their long-term
corporate strategies with an eye toward
more diversification.
Oil-company profits have surged since
the hefty oil-price increases instituted by the
Organization of Petroleum Exporting Countries and President Reagan's decontrol of
U.S. petroleum prices.
Until recently, the oil firms didn't have
many investment opportunities because almost everything they locked at raised antitrust questions. But last month, Federal
Trade Commission crosecutors advised the
commission to drop its seven-year-old antitrust case against the nation's eight largest
oil companies, a suit that some lawmakers
had hoped would lead to the breaking up of
the oil giants.
That move, plus other indications by the
Reagan administration of a more relaxed
antHiUSt stand, has prompted oil companies
to become acquisition-minded again. In fact.
Wall Street oil analysts say Conoco and Texaco wouldn't have discussed a possible
Hierger last week unless they felt there
wouldn't be an antitrust problem.
The improved investment climate in the
U.S. contrasts sharply with the Canadian climate. The Canadian government is seeking
greater control over U.S. companies' operations there. U.S. oil executives are increasingly trying to shield themselves from all
foreign interference, especially in the Mideast
Their approach generally is to strengthen
oil and natural-gas holdings in the U.S. This
has led to an unprecedented amount of domestic drilling and also to an unprecedented
courting of companies with promising landholdings for oil and gas exploration. Companies considered to be such takeover targets
include Texas International Co., Pogo Producing Co., and Louisiana Land & Exploration Co. Spokesman for all three denied their
companies are involved in any merger talks.
Oil companies also want to diversify, to
become 'natural resource" companies with
mineral holdings as well. This had led to the
acquisition of a number of mining firms by
oil companies, and continued speculation
about several others.
"I'll be surprised if there are any independent mining companies left by the end of
the year," says Donald W. Mitchell, a Boston-based management consultant, only halfkiddingly.
Cash-Rich Companies
Among the oil companies that have billions of dollars in the till,.plus the ability to
raise billions more in credit markets, are
Exxon Corp.% Mobil Corp. and Standard Oil
Co. of California. Texaco Inc. also has cash,
and many oil analysts are betting Texaco
will buy somebody before long. "They
(Texaco) look like they're in the mood,"
says Arthur Smith; an oil analyst at First
Boston Corp.
Bache Halsey Stuart Shields Inc., a unit
of Prudential Insurance Co. of America, yesterday began circulating to its brokerage
easterners a list of oil-company stocks that
it said may benefit from future takeover
bids. Included on the list: Marathon Corp.,
Qties Service Co., Kerr-McGee Corp., Pennzoil Co., Union Oil Co. of California and Sun
Co.
Another aspect to the merger wave is
what analysts refer to as "backward integration." That's when a company such as
Du Pont, which relies heavily on petroleum
as a feedstock, acquires its own source of
oil, in this case Conoco. Elizabeth Sospenso,
an oil analyst at Thomson McKinnon Securities Inc., thinks pharmaceutical and textile
companies may also try for backward integration, though she believes some other big
chemical firms-Celanese and Allied Corp.,
for example-are in a better cash position to
make an acquisition. Allied *s stock price
spurted up $5 yesterday afternoon, but the
company said it didn't know why.
Foreign interest in U.S. investments Js
also evident in the acquisition boom. Worries about the newly elected Socialist government in France and about unrest in Poland and the Mideast have spurred European companies to step up their acquisitions
in the U.S., where conditions are relatively
stable, investment bankers say.
Figuring the Cost
The high cost of borrowing to finance
mergers has certainly had an effect, although it hasn't seemed to slow the
stampede.
"Managements a few years ago estimated the long-term cost of money at anywhere between 8% and 10%," says Eric
Gleacher, the head of the mergers and acquisitions department at Lehman Brothers
Kuhn Loeb Inc., which is having a record
year in the merger-advisory business. "Now
they're routinely calculating it at around'
13V* Yet, rather than pull back, "they are
raising their requirements for the growth
rate ol potential acquisition targets," Mr.
Gleacher says.
\
Executives also look for a decline in longterm interest rates. **You can't justify borrowing at 20% to do a deal when your longterm money-cost estimate is 15% unless you
think that the acquisition borrowings can be
refinanced later at a lower cost,** says
Barry Friedberg. the mergers and acquisitions director of Warburg, Paribas, Becker
Inc.
197
(Wall Street Journal, July 14, 1981)
MergerBpoinFinds BdnUI
SpdrkingTeafdn CreditMarheUlHealth:
gy DANIEL HEKTZBERC and TIM
Z
Staff Kep&rters of THE WALL STREET JOU&NAJL'
NEW YORK-Wall Streetis fetest merger
boom has found banks willing to open thefr
credit spigots wide, and some fear the credit
markets could be flooded.
, Some economists and, nonbankers say
heavy borrowing could conflict with President Reagan's economic program by keeping interest rates high and diverting funds
from investment in new productive facilities. They also say the high rates could
:ause trouble for other borrowers.
There "could be a crowding out" of lesscreditworthy companies if acquisitionminded concerns exercise their credit lines
and later refinance at lower rates in the
bond market, said Thomas S. Johnson, execJtive vice president at Chemical Bank.
Undaunted by high borrowing costs, play;rs in the merger game already have lined
lp more than $20 billion in bank lines of
:redic Du Pont Co. and Seagram Co., batMng for control of Conoco Inc., each has a
$3 billion credit agreement with U.S. and international banks.
Conoco has lined up its own $3 billion
bank line, which would allow it to buy its
own stock to keep away from unfriendly
suitors. It also could use the funds to make
an acquisition that might make it less attractive to its suitors.
Mobil Corp., indicating it's ready to join
in the Conoco bidding, said yesterday that it
was arranging for bank credit through a
syndicate led by Citibank. The amount
wasn't disclosed. Texaco Inc. last week arranged a $5.5 billion credit line, which it reportedly hopes to
use to buy Conoco or another major concern, possibly Cities Service Co.
Among the other companies making loan
arrangements, Societe Nationale Elf Aquitaine has a $1.9 billion credit to help finance
its acquisition of Texasgiilf Inc. Canada Development Corp. has a $1.75 billion line to finance its planned purchase of Texasgulf s
Canadian assets, in conjunction with the Elt
MAJOR CREDIT LINES
CQVPAW
CRBDH
ARRANGED
BANVS
Conoco
$3 billion
" Syndicate led by Bank of America,
Chase Manhattan Bank and ;
.. Morgan Guaranty Trust C a
Seagram
$3 billion
3 t North American and European
. banks led by Citibank, Manufac.. turers Hanover Trust and Bartk
;r of Montreal
^ , ,7.
. \\
ESI Aquitalne.
$t.9 billion
Texaco.
$5.5 billion
Syndicate fed by Chase
. Manhattan Bank
$3 billion
- .Syndicate led by Chase
Du Pont
Fonnzoli
$2.5 billion
* $1.75 billion
Canadian
Development
20 U.S. and Canadian banks *
Syndicate led by Citibank
Syndicate led by Bank of
Montreal, Bank of Nova Scotia
£>nri Rr»\/al Rank nf P.anarla
198
Aquitaine transaction.- Pennzott Co. said <it
arranged ta',borrpwi. $2.5. billion so, it could
take advantage of any sudden acquisition
opportunities."There are certainly large companies
around that can line up amounts in excess of
a billion dollars in a day's* time." Mr. Johnson said.
• —'
• " s o m e analysts^say the surge in takeover
lending comes at a difficult .time for the
credit markets, which have faced near-record interest rates recently. Business demand for short-term credit has been heavy,
with borrowings from banks and the commercial paper market growing at a steamy
30% annual rate in the past eight weeks.
Large takeover loans "add to the upward
pressure." warns Lacy Hunt, chief economist at Fidelity Bank. Philadelphia.
*
The loans also could complicate the- Fedcra! _R.«vw»rv«? Board's task of controlling the
money supply, experts say. in .T.aking a
loan, a bank simply credits a borrower's account, adding that amount to the money supply unless it is offset in some fashion.
— Many of the loan commitments are being
booked in overseas bank branches, including
the S3 billion credit line Seagram arranged
last year and Texaco's $5.5 billion line.
Lenders have increasingly sought Eurodollar loan arrangements because the rates are
mrrently lower than TJ.S. prime, or base.
rates: Bankers like the arrangement, too,
because such loans in some cases don't have
to be backed with reserves/ as domestic
loans must be.
• -**
•• I
Some business officials say the takeover
lending commitments also are exacerbating
the U.S. housing industry's trouble ^arranging loans.
. . .
*
].
William C. Smith, a Pittsburgh real estate developer and home builder who has
Been following U.S. funds flows closely during the past two years, complained that
"our economy is shipping out its savings
dollars for use by the likes of Seagram and
Texaco in takeover loans/'
Money transfers, he contended, are stphoning dollars from US. thrift institutions
to Eurodollar deposits, which in turn are
being lent to both foreign governments seeking to finance their budget deficits and to
big multinational corporations on an acquisition binge.
Last year, in imposing short-Hved credit
controls, the Fed warned against loans for
such "unproductive" purposes as takeovers
where a clear growth in earnings power
wasn't likely. However, proponents of mergers point to economies of scale and potential
productivity growth through agglomeration.
"It isn't unproductive investing." said
Alan Greenspan, a former chairman of the
President's Council of Economic Advisers.
"It's basically a restructuring of the ownership of existing assets. And, as such, it neither contributes nor detracts from- funds for
real investment."
Because some suitors are seeking the
same corporate bride, many of the credit
lines may never be used, and bankers say
the size of the lines is deceptive anyway.
"The accumulation of the bidders makes
the number look astronomical," said William Griggs, senior vice president at J.
Henry Schroder Bank & Trust Co. But he insisted that in the vast sea of U.S. and international credit markets the latest takeover
lor» ' ommitments represent just-"a- ripple.'
noi a tidal wave"."
""'-'•'•:":'"""}
199
(New York Times, July 14, 1981)
Chase and Citibank
Help Raise Billions
In Takeover Stakes
By ROBERT A. BENNETT
When it comes to raising really big
money, the nation's largest corporations have been coming home to their
traditional bankers, Chase Manhattan
and Citibank.
""* Over the last few weeks, these two
banks have arranged to raise almost
$19 billion for a handful of companies
.seeking to acquire other large companies or trying to stave off such acquisitions.
Only a month ago, a $1 billion line of
credit was considered to be extraordinary. But since early this month,
credits of $5.5 billion have been arranged for Texaco, $5 billion for Mobil,
$3 billion each for Conoco and Du Pont,
and 52.5 billion for Pennzoil. And it
was learned yesterday that the Cities
Service Corporation, a takeover target, has begun to arrange a credit of
about $1 billion.
With the exception of the Conoco
deal and the Cities Service loan, still in
the early stages, Chase and Citibank
have received the mandates for pulling the giant credits together, although most of the financing is expected to come from foreign banks.
•A Worldwide Effort
And even in the Conoco transaction.
Chase is one of three co-managers, together with the Bank of America and
the Morgan Guaranty Trust Company.
As of yesterday, according to banking
sources, it appeared that Morgan
would be chosen to lead the Cities
Service syndicate, but it was not yet
certain.
"Credit, especially In larse
amounts, calls for a worldwide effort," said the treasurer of a leading
oil company,
who asked not to be identified. M We need a bank that is entirely
capable on a global basis," he added.
"It has to have the kind of staff that
can handle the huge amount of paper
work, and it has to be a bank that has
done this kind of thing before."
When the Houston-based Pennzoil
Company decided to raise $2.5 billion,
it turned to Citibank, one of a handful
of banks with which it has had a close
relationship. "The managing bank has
a sizable oil, gas and mineral department," said J. Hugh Liedtke, Pennzoil
" chairman, in a phone interview yesterday. "Citibank is known to be outstanding in that area."
Withinthe oil business, Chase Manhattan has at least as strong a reputation. Thus, Chase was named to lead
the Texaco credit, even though Morgan traditionally has been Texaco's
lead bank. Some banking sources, report that officials at Moxgan were incensed that they had received only a
$50 million chunk of the $5.5 billion
Texaco deal. Morgan declined to comment yesterday, saying that its policy
forbids it to discuss individual clients.
Bank of America is the largest bank
in the United States. Citibank is second, with Chase third, Manufacturers
Hanover fourth and Morgan fifth.
Fed Regulations a Factor
Although the lead banks and the
. companies involved are American^it
is estimaledthat foreign banks will
supply "most of the monevTrhis is be»
cSuseTederal Reserve regulations,
which apply to all major American
banks, prohibit them from lending
more than 10 percent of their capital
and surplus to any individual borrower. Thus, at present, the most that the.
50 largest American banks, combined,.
can lend to any one customer is $3.91
billion, far less than the amounts being
sought by Texaco or Mobil.
<
Most foreign banks do not have lending limit restrictions, nor many other
rules that bog down American banks.
In the recent loans, for example, it
generally took only a few hours for the
foreign banks to respond to a request
to join the syndicate, while it usually
took at least a day for an American
bank.
Bankers say that these loans, in
200
TOTAL AMOUNT
OFLOANS
CHASE MANHATTAN
70
CITIBANK
6B
$13,3 Wilton,
BARCLAYS 8AHK
37
$ 1 1 . 2 billion
$15,1 bfHkm.
3O >
$11.tbiffion
MANUFACTURERS I i * OVER
,
56 ;
$11.1 blltton :
BANK of AMERICA
:
52
BANK of TOKYO
• 59
? $1O.abiiIton;
PAMY
J.R MORGAN & COVPAMY
> 31>
310.7 bHUorr
BANQUE NATIONAL d* PARIS
$ 1 0 . 8 billion
ARAB BANKING CORPORATION, London
34
$ 9>5b«Hon
BANK 0/ MONTREAL
27
$8,3 bllifon,
Sourca: Apefl — International Bo*dtermr and Euroaxnncy Financing Review, London
themselves, are not lucrative for the
banks. They contend that participating banks do so either to protect their
current business with the borrower or
to develop new business.
On its eight-year, $5.5 billion loan,
Texaco would have a number of options concerning the rate on the loan. It
could pay the prime rate, now 20^ percent, or three-eighths of a percentage
point above the cost to banks of borrowing in foreign markets. After the
fifth year, this would rise to one-quarter of a percentage point over prime,
or one-half a percentage point over the
overseas rate,
In addition, the borrowers must pay
certain fees. A "management fee" is
paid to the managers for putting the
deal together. In an ordinary syndication, this is often one-half of a percent-
age point of the amount borrowed. On
a $5.5 billion loan, that could amount to
a whopping $27.5 million, but bankers
indicated that the actual fee would be
far less.
Banks also charge a *'commitment
fee" on any unused portion of the
credit. In the Du Pont loan, this would
be one-quarter of a percentage point
for the first six months, and threeeighths of a percentage point after
that. •
In giant loans that are organized
rapidly, there also are so-called dropdead fees that the borrower must pay
if it decides not to go ahead with the
lean. It is not known how big the dropjteadftt might be.
201
(New York Times, July 14, 1981)
S.E.C.'s Chief Gives
flessing to Mergers
ByJEFFGERTH
Special to Tbe N«w Yor* Tlroa
WASHINGTON, July 13—John S.R.
Shad, the chairman of the Securities
and Exchange Commission, today
gave his blessing to the recent wave of
corporate mergers and takeovers,
echoing the general theme of the Reagan Administration that "bigness in
business does not necessarily mean
badness."
Mr. Shad's remarks at his first news
conference emphasized the role of the
S.E.C. in "facilitating capital formation" and contrasted in some respects
with the philosophy of his predecessor,
Harold M. Williams.
Mr. Williams, while encouraging
capital formation, also raised questions during his tenure about whether
corporate takeovers diverted credit
and capital from more productive and
innovative uses.
While Mr. Shad did not comment
specifically on recent mergers or take*
over offers, such as the contest to acquire Conoco Inc., he did express a
"belief" that there is "a net economic
gain" io large mergers.
In other remarks, Mr. Shad seemed
to be charting for the S.E.C. a course
of deregulation with a minimal involvement by the commission in corporate affairs, a continuation, for the
most part, of many of the policies oH
Mr.WUliaxns.
• j
i While the S.E.C. has limited jurisdiction over mergers, it does review
5 e adequacy of disclosure statements
S t e l with the commission in ccnnectiorVwith acquisitions and Mr. Shad;
promised to simplify that process by]
•'reducing excessive registration, reporting and other regulatory burdens."
Specialized in Acquisitions
Before his appointment as S.E.C.
chairman, Mr. Shad, as vice chairman
of E.F. Hutton & Company, specialized in mergers and acquisitions.
Speaking abcwt corporate governance, another issue that Mr. Shad
had experience with in the private sector, where be was a director of several
public corporations, the S.E.C. chairman questioned the effectiveness of
outside directors in reforming corporate behavior.
Mr. Williams had frequently urged
corporaticns to add independent directors, and the enforcement division had
sought such relief in many of its cases,
but Mr. Shad disclosed today that the
commission, under his tenure, was increasingly questioning changes in corporate boards as a sanction in enforcement actions.
He also echoed the priorities of his
new enforcement chief, John M. Fedders, by calling for emphasis on the
narrower issues of policing the marketplace for lraud, manipulation,
abuse of insider information and organized criminal-activities.
Meetings With Commodity Aides
Mr. Shad also said that there had
been private meetings between top
S.E.C. officials and their counterparts
at the Commodity Futures Trading
Commission in hopes of "quietly" settling jurisdictionai disputes.
He called reports of poor morale in
the enforcement division since the
departure of Stanley Sporkin "exaggerated" and said attitudes vouid improve when Mr. Fedders takes over
next week.
Mr. Shad said the S.E.C. would announce within the next month further
simplification of disclosure and registration requirements by the division of
corporate finance.
He added that, while the S.E.C. was
moving toward more self-regulatjc/n
by the securities industry, the commission did need to "improve oversight" in the investment company adviser area and fill in gaps in inters ar- j
ket surveillance.
202
The CHAIRMAN. Large corporations are able to obtain all the
money they wish for prospective bidding wars, yet small businessmen have difficulty getting credit. Has the Federal Reserve studied
the differences in impact of current monetary policy on large corporations and small businesses? And if the study has not been
undertaken, would you give serious consideration to it?
Mr. VOLCKER. We have attempted to look at that from time to
time in the past. It is a difficult area to pin down statistically. We
are certainly aware of the problems and complaints of the small
businessman as alluded to here this morning. We hear about them
every day. Certainly different businesses are impacted differently. I
would be glad to supply for the record what information we do
have on this, but I will tell you, we don't have right up to date
The CHAIRMAN. Would you give consideration to attempting another study?
Mr. VOLCKER. We do that more or less continuously. I think we
have something underway at the moment. Let me update you on
that.
The CHAIRMAN. Thank you.
[Mr. Volcker subsequently submitted the following information
for inclusion in the record of the hearing:]
203
(Response received from Mr. Volcker)
A three-part study is now underway, under the direction of an
Interagency Task Force on Small-Business Finance, in response to the following provision of an act (Public Law 96-302) approved July 2, 1980:
"In consultation with the Administrator of the'Small
Business Administration and the Bureau of the Census> the
Board of Governors of the Federal Reserve System, the Comptroller of the Currency and the Federal Deposit Insurance
Corporation shall conduct such studies of the credit needs
of small business as may be appropriate to determine the
extent to which such needs are being met by commercial
banks and shall report the results of such studies to the
Congress by January 1, 1982, together with their views and
recommendations as to the feasibility and cost of conducting periodic sample surveys, by region and nationwide, of
the number and dollar amount of commercial and industrial
loans extended by commercial banks to small business.
Reports shall, when transmitted to the Congress, be referred
to the Senate Select Committee on Small Business and the
Committee on Small Business of the House of Representatives."
The first part of the study comprises a group of background papers
which are now in final draft.
These papers cover a broad range of subjects
related to small-business financing, including sburces and characteristics
-••'.
v
!
of small-business credit,' the impact of various laws and regulations^ the
/'' •
effect of changes in bankingj structure, and the relation between firm size
I
and bank lending terms.
The second phase of the study, subject to approval'by the Office
of Management and Budget, will consist of personal interviews in early fall
1981 with lending officers at a national sample of commercial banks.
The
proposed survey questionnaire is designed to provide a profile of commercial
bank practices and experience with respect to their lending to small business.
It asksjfor information about availability of small-business credit at the
bank and in its market area, and about the nonprice characteristics of the
bank's small-business loans.
It also includes detailed questions about the
204
way the bank prices its loans to small business and how this varies with
changes in interest rates generally and how it compares with pricing of
loans to large business.
The third part of the study will be the recommendations requested
by the Congress with respect- to future collection of data on bank loans to
small business.
They will take into consideration the data needs revealed
by the background studies and the information obtained in the survey of commercial banks.
In drafting these recommendations, the interagency task
force tfill be examining a variety of options with respect to their feasibility, cost and usefulness.
The CHAIRMAN. Mr. Stanton.
Mr. STANTON. Thank you.
Mr. Chairman, it has now been about 21, 22 months since October 1979, when you shifted your focus from interest rates to controlling bank reserves. And because of this change of policy, I
would be the first to point out that there is a decrease in the rate
of inflation. Since you have been given so much criticism today and
in the press in general, you should be given credit for that.
But I think there is a consensus that as a result of these operational changes, we see more fluctuation in interest rates than at
any other single time. You could say that interest rates have
changed maybe in a year or in 1 week, 2 weeks, more than you
have in several years. We have had a recent experience of that
type of fluctuation in the last week alone.
What you also have seen is a lessening of the historical relationships of interest rates to the rate of inflation. I was taught there is
a historical relationship: Sometimes interest rates lag behind the
rate of inflation as they did a year ago, or vice versa. Now, of
course, you see the interest rates considerably higher, 4, 5, 6 points
higher than the rate of inflation.
Also, on that point, one has to be concerned at the actions of last
Friday reflected in the marketplace yesterday, when interest rates
rose in response to last week's bulge in Mi-B. You seem to have
made your point all right in regard to the need for controlling
bank reserves in that people now take weekly changes in the
money supply as gospel. There is more reaction—I will put it that
way—more reaction to that weekly number than if we pass an
historic reconciliation bill a week from Friday.
It just seems that the market is more concerned in responding to
your weekly money supply figures than they are to what the
Congress does in terms of budgetary and fiscal policy. My question
is: Do you see any change in the weeks or months ahead in this
scenario of the volatility of interest rates—will they continue to be
as volatile?
Second, what do you think it will take to bring the rate of
interest down? This seems to be disputed among many people.
205
Everybody agrees that certainly interest rates are historically high.
What is it going to take to bring interest rates down?
Third, what scenario would you put together where you see
interest rates actually coming down?
Mr. VOLCKER. Let me respond to the volatility point first, Mr.
Stan ton.
I think it is fair to suggest—and in fact it was anticipated—that
the operating techniques we now use would create more volatility
in the short-term markets. We have certainly had more volatility
in the long-term markets as well during this period. But what you
cannot distinguish is the volatility that is there as a technical
matter—which, while I think is there, I wouldn't want to overemphasize—from the volatility that may be inherent in a period
when we are trying—and I think with some early signs of success—
to change the very deeply seated inflationary trend that has built
up over at least 15 years. You could argue it has existed over 30 or
40 years.
This is a period of unusual uncertainty. What is the price outlook? What does that mean for interest rates over a period of time?
I don't think people are totally convinced yet, as I suggested in my
statement, that the inflation rate is going to come down. They may
be beginning to think that maybe it will; there is a little more hope
than before, as I read the situation.
The situation is very volatile in terms of expectations or confidence. That may be inherent after a long period of inflation where
everybody became convinced it was just going to go on and on
forever. This situation could turn into a period of shaking that
conviction, into a period, I hope, of convinction that inflation will
decline.
We don't have a firm base of expectations as we had for many
years—certainly up until the 1970's and to a degree, through a
good part of the 1970's. Until those expectations settle down, until
there is more conviction that indeed, inflation will come down, I
think the market will be prone to react to very short-term impacts,
like last week's money supply figures, which obviously had no
significance in terms of the basic inflationary outlook. But the
market is looking for something to trade on for the next week, or
at least the next 3 days, until it begins worrying about the next
week's money figure.
The volatility is a reflection of the underlying uncertainty which
is there, but which our policies and hopefully your policies are
designed to deal with over time.
What does it take to bring the interest rates down? What it is
going to take is basically two things. More confidence that the
inflation rate will, in fact, come down; and, more important than
that, the evidence that it is coming down. Expectations can have
an important influence on interest rates.
I have been looking a little bit at this real interest hypothesis,
which I don't want to deny. I think expectations are important in
interest rates. Certainly during the postwar period there has been
a certain stability in the so-called real interest rate. Part of the
problem with that analysis is that it really depends upon what
inflationary expectations are, and they are very hard to measure.
But if you look back in history, very sizable fluctuations in real
206
interest rates extending over months or even years are not at all
unusual.
There is no magic that says that if the inflation rate is 8 or 10
percent this year, and then interest rates will be 12 or 14 percent.
If you look at the long sweep of history, they have been all over the
lot. I think there should be a tendency toward lower rates, but just
how long that tendency takes to develop is what is at issue. We are
restraining the supply of money; velocity is going up. That will
happen when we have a high rate of inflation and economic
growth, and that is normally associated with high interest rates.
The way to get around this obviously, ultimately—the only way
to get around it that is at all satisfactory—is to get the rate of
inflation reduced. Then we will have enough money to finance real
growth at lower interest rates. But I can't wave my hand and have
that come about. You can increase the money supply, which presumably will increase the inflation rate and not help at all. Otherwise, you can undertake those policies—monetary, fiscal and
others—that are going to reduce the inflation rate, and that is
what is going to bring interest rates down.
The only final point is also an obvious one. The bigger the
Government deficit, the less money there is for financing small
businesses, homebuilders, home buyers, and everyone else in the
private economy. So the deficit is an important factor.
The CHAIRMAN. Mr. Reuss?
Mr. REUSS. Thank you, Mr. Chairman. Welcome, Mr. Volcker, to
this Humphrey-Hawkins session in which you have the Federal
Reserve's 7 Governors, and its 12 reserve bank presidents, tell us
what you think is wrong with the American economy, and we of
the Banking Committee are under statutory obligation to declare
what we think is wrong.
I note with interest in the issue of this week of U.S. News and
World Report, July 27 issue, a statement on page 12:
The biggest economic puzzle in Washington: Top Reagan economic advisers, as
well as officials of the Federal Reserve Board, which manage the money supply,
can't figure out why interest rates stay so high while the economy is so sluggish.
Well, I think I can figure it out. It is because the policies of the
Federal Reserve System and the Reagan administration are wrongheaded and in violation of the Humphrey-Hawkins Act.
Specifically, there is no reason in my judgment for lowering
what were already very tight and austere 1980 targets this year.
Yet the Federal Reserve, with full administration support did so,
against the recommendation of the Democrats of the Joint Economic Committee. We warned against exorbitantly high interest rates.
The warning was disregarded. And now we have what we have.
Second, the administration is now embarked upon a budgetary
scenario by which massive and abrupt increases in military spending, and massive and abrupt decreases in tax revenues are going to
produce deficits in 1981, 1982, 1983, and far as human eye can see.
I think the Federal Reserve, the 19 officials that I am talking
about, have a duty to speak out against that kind of fiscal policy, in
which borrowing by the Federal Treasury results in short-stopping
savings which would otherwise enhance inflation-fighting investment.
207
Yet, so far as I know, there hasn't been 1 ounce of criticism or
even analysis of the administration's deficit-prone program.
Those who are given independence and don't use it, may not
deserve it. I am disappointed that this deficit policy, which is so
obvious to the markets and to the friends and allies of the United
States the world over, somehow escapes the attention of the Federal Reserve.
The third point in which I think the Fed and the administration
are in violation of the Humphrey-Hawkins Act concerns the second
half of the element of monetary policy.
The first half is control over the supply of money. I am for that—
no criticism of that general principle.
But you also have to look at the demand for money and credit.
And the Federal Reserve and the administration haven't been
doing it.
The Federal Reserve facilitated the enormous commodity silver
speculations of Bunker Hunt. And it continues to sit still for those
in similar commodity speculations.
The Federal Reserve has not, so far as I can see, taken any
particular interest in the problem that Chairman St Germain
raised, the enormous amount of the Nation's credit which is now
going to unproductive takeovers and mergers.
Finally, the Federal Reserve remains oblivious of the fact that a
large part of America's credit is hijacked and skimmed off by very
questionable foreign lending, both in the transmittal of American
bank balances to the Eurodollar market, and more recently, in the
direct invasion of American regional banks by the big New York
banks who skim off their lending power and plunk it down overseas in Eurodollar and Asian dollar markets.
I suggest the Federal Reserve has a duty to look at the demand
for money and do something about it, as well as the supply of
money. In connection with the merger matter that Mr. St Germain
talked about, I know that you tend to pass aside the effect on the
diversion of credit by these mergers by saying that these huge
sums, $35 billion, was mentioned, of bank funds available for takeovers are just commitments, and that since many of them represent commitments for the takeover of the same company, they
won't all be honored. Doesn't that really miss the point? If these
commitments are made, in a sum many times what the actual
takeover would cost, doesn't that mean that the hard-pressed
homebuilder or businessman who wants to put productive investment on line, or the construction borrower or the farmer or the
small businessman, doesn't that mean that they can't get the
credit?
I wish you'd respond to that. I think the standby is just as bad as
an actual loan. Indeed, it is worse, because it immobilizes five
times as much.
Mr. VOLCKER. Let me respond as best I can. I must say, at the
start, that I don't recognize some of your strictures in terms of
what the Federal Reserve has or has not been doing. You do not
appear to have any basic disagreement with the idea that we need
to have restraint on money and credit.
208
Mr. REUSS. Right, though I have said that I think you could have
let it go at last year's restraint, which brought two points of 20percent interest rates.
Mr. VOLCKER. We do want to move, and I don't think it would be
helpful not to move, in the direction of reduced growth of money,
because I don't think doing otherwise would be helpful in terms of
conditions in the financial markets or of interest rates over time,
as I suggested. I certainly think that we have expressed caution on
the fiscal policy side repeatedly.
That doesn't say there isn't a case to be made for tax reduction
in particular. But if I have had any theme in my comments to the
Congress, it is about the importance of expenditure restraint in
order to make tax reduction responsible, and also that the limited
amount of funds available for tax reduction should be made as
efficient as possible in terms of the legitimate objectives of reduction.
Mr. REUSS. Yes; but it isn't.
Mr. VOLCKER. I think I have spoken out on that repeatedly. So
far as the demand for money and credit is concerned, I assure you,
we realize that there is a demand as well as a supply, and that
constantly preoccupies us.
I think it is a reversal of truth to say our policies have facilitated
speculation. I suspect that the movement of prices and conditions
in more speculative-prone areas of the economy would prove just
the reverse, that our policies have pretty well helped deflate those
areas. In the area of foreign lending—and I will get to takeovers in
a minute—there is a very big two-way flow of money. I do not have
the impression that on balance, American money is flowing out;
quite the contrary.
Chairman St Germain referred to the amount of foreign money
that may be involved in these takeover situations. But there are
many other channels through which foreign money is coming here.
And, of course, that has given rise to a certain amount of discomfort and complaint from our trading partners.
On the takeover point itself, I have expressed concern, last week
to you and here this morning, about some aspects of this. One of
the aspects that would concern me, as I said last week and say
again today is, if a very large volume of these commitments are
being made rather rapidly, are the banks prudent, and I hope they
are. Also those tie up a certain amount of commitment and lending
capacity, and can have implications for banks' own internal operations which we have to be concerned about here and abroad as
part of our normal supervisory responsibility.
I do not deny that, to some degree, lending of this sort can affect
the distribution of credit in the economy. That does not contradict
the general point that, to the extent the money isn't drawn down
or is drawn down and goes back into the market, the overall
balance of credit demand and supply may not be appreciably
changed.
But there are still influences on the direction in which that flow
is going.
Mr. REUSS. My time is up. I did want to express my concern. I
think I have.
The CHAIRMAN. Mr. Wylie.
209
Mr. WYLIE. Thank you, much. Mr. Volcker, my question is somewhat repetitive. I recognize that.
Mr. Reuss and you both touched on it, but I want to take a little
different approach, which suits my purpose a little better. It has
been my impression over the years that the size of the Federal
deficit, in and of itself, constitute problems for the conduct of
monetary policy.
That is, the greater the deficit, the greater the problem for the
Federal Reserve. And more recently, the emphasis of concern
seems to have shifted from the size of the deficit to the growth rate
of Federal expenditures.
Congress is now deciding whether to have a tax cut extending
over 3 years, with the 1 year possibly contingent on the favorable
performance of selected economic indicators.
Some are saying that the size of the Federal deficit should be one
such indicator. My question is, in your opinion, to what extent does
the size of the Federal deficit limit the Federal Reserve in its
conduct of a noninflationary monetary policy?
Mr. VOLCKER. I think it all depends upon the economic circumstances, Mr. Wylie. I would accept, as a very broad generalization,
your comment that, all things equal, the deficit complicates things,
or at least makes it more difficult for competing borrowers in the
market.
The practical effect of that depends, I think, entirely upon the
context in which that deficit takes place. Just to put it in extreme
form, in the day of the depression, or in days of very large recessions, when private credit demands are not strong, Government
deficits can be readily financed without the kind of impact upon
interest rates that are disturbing.
That is not the situation we are talking about; we are talking
about the impact of deficits when credit markets are already extremely tight and we are in an inflationary recession.
What deficits do then is put more pressure on the market, lead
to the kind of concerns that have been so eloquently expressed by
the committee so far this morning, and in that sense, create a very
real problem.
Mr. WYLIE. Money market funds are having a great impact on
the financial markets right now. What are the implications of
these funds on the conduct of monetary policy?
Mr. VOLCKER. In a technical sense, we have to make some judgments—as I unfortunately had to touch upon in my statement
although it is a rather technical matter—as to whether the growth
of these funds, and particularly the extent to which they are used
as transactions balances or substitutes for transactions balances,
impinges upon the supply and demand of what we arbitrarily
define as Mi. I say arbitrarily, it is the best definition we can
make. But you are dealing here with a matter of more or less. We
have put money market funds slightly outside that definition, but
you have to consider the implications for the funds that are inside
the definition. It is a difficult judgment to make.
We think the impact so far has been relatively small, but it is in
the direction of reducing the growth and demand for defined Mi.
That kind of judgment has to be made. In that sense, money
market funds complicate our life, and the issue would become
210
much more important if money market funds were to develop
actively in the direction of being used as transactions balances.
There are some funds with extended check-writing privileges, and
perhaps even more speedily, these funds are moving into the credit
card area and the like, where they, basically, can be used as a
substitute for transactions balances.
Somewhat in the opposite direction, to the extent people are
investing in money market funds, which we include in M2 and M3,
instead of investing in Treasury bills or other securities in the open
market, those numbers are artiflcally inflated. A little bit of that
has been going on, too.
Mr. WYLIE. I think we need to know where these funds are
coming from, and if they are, in fact, causing disintermediation
among financial depository institutions. Last week, I might state in
that connection, Chairman Pratt had some rather pessimistic views
about the future of S. & L.'s and mentioned that as a possible
source of difficulty for the S. & L/s.
I might say I asked for Chairman Sprague's position on Chairman Pratt's proposal. You are familiar with his proposal.
You have been before us with a proposal of your own. And he
said,
That I am not even going to have time to address his proposal at the present time.
We have our own proposal before you, and we would like to go off in that direction
first before we get into something else.
Have you been able to sort the two out, or have an opinion on it?
Mr. VOLCKER. My view on that is quite clear. We developed a
regulators bill. By "we," I mean the regulators. The Federal Reserve's role was primarily a coordinating role.
Provisions of that bill were strongly supported by the FDIC and
the Federal Home Loan Bank Board.
It is a bill which, in my opinion, gives regulators tools that they
need during this very difficult period of strain and tension for
dealing with the situation. I would urge the Congress to go ahead
and provide the regulators with those tools that seem to me to be
necessary and desirable.
The kinds of issues that Mr. Pratt raises further, and I am not
familiar with all the details, go to a basic restructuring of the
thrift industry. I am sure there are legitimate issues there. Those
issues do not, in my judgment, to any really significant extent, bear
upon the viability of those institutions in the time horizon of the
next year or more. There may be some particular provisions that
do, but by and large, the major restructuring is not going to bear
on the earnings and viability of those institutions in that kind of
time frame.
These seem to be matters that can and should be looked at by
the Congress. But they don't have the same urgency as the provision of the tools that, in my judgment, the regulators really need
and could usefully use at this point.
Mr. WYLIE. My time's expired, but I do think Congress has a very
difficult obligation which concerns me greatly. I thank you for any
help you can give us on it.
Thank you.
The CHAIRMAN. Mr. Gonzalez.
Mr. GONZALEZ. Thank you, Mr. Chairman.
211
Mr. Chairman, thank you for being with us. Whatever I say
subsequently, I hope you don't interpret personally. [Laughter.]
Mr. VOLCKER. I may find that difficult, but I
Mr. GONZALEZ. When I use the word "you," it should be understood that I mean you and the Board or the majority of the Board.
Of course, I certainly have long been one of those raising elements,
or maybe all of the congressional litany you have heard.
There is no question that you, that is, the policies, have nationalized, have legalized usury beyond any kind of conscionable limit.
You have sacrificed on these bloody alters the lifeblood of the
small businessman. I am not talking about the United States
Chamber of Comtnerce.
The last time they appeared before the Small Business Committee I belong to, they admitted that over 80 percent of their executive board represented not small business, by any definition. And
the Fed is the same way.
Of the 14,000 or so banking institutions that the Fed says it is
responsible to and is actually supposed to be the one controlling—
Mr. VOLCKER. If I can just
Mr. GONZALEZ. I haven't seen any record other than a strict
subservience to the interest of less than David Rockefeller, Chase
Manhattan, First City, and the like, absolutely prostrated, first and
foremost their interest.
Let the devil take the hind post. They are going to be taken care
of. It doesn't surprise me after the role of the Fed in permitting the
banking institutions of this country to repeat the grave errors
before the pressure of 1929, the wholesale entry into the most
speculative yet controlled market, the gold, silver, how much banking resources were lost just in the last few gyrations in the gold
markets, God only knows.
Certainly the Congress gets no accountability. Your predecessor,
in private, voiced concern when, on the urgings of the then administration and Secretary of the Treasury and majority of the Congress, voided the 1932 law without providing safeguards in that
respect, and your predecessor voiced private concerns about the
fact that perhaps the banking institution would be substantially
involved in speculative ventures of that kind.
The fact that the rather despicable role of the Fed in the case of
H. L. Hunt's ventures into the speculation and others, and continues, taking of vital banking resources, and everybody forgetting
why banks are chartered to begin with.
Banking institutions are the most privileged institutions, in fact,
more privileged and the only privileged class in this Nation. In
some respects, insubordinating the inherent constitutional powers
of the Congress.
So that all that litany, you know, is repetitive. A couple of
generations of Americans are being cheated out of such things as
homeownership. Interest rates that by all accounts are not only
unprecedented. Even at the height of the Civil War, you had no
such thing.
Yet you, that is, the Fed, the Board, told us that it is you who
are in control, you are the central bank. You are independent and
you boast of it.
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We have craven Congresses and craven and controlled presses,
and therefore the people's interest is totally forgotten.
Now, I know the philosophy, and I don't want to dispute that.
You have expressed it. The last question I had, you stated the
ordinary folk can wait, and they should wait until this other big
demon, inflation, has subsided and we can address ourselves to
their needs.
Also, you were quoted as saying at the outset of the policy
changes, Mr. Stanton referred to a couple of years ago, that, of
course, what it meant and what was inherent in meaning was that
the standard of living of some Americans would have to be sacrificed, or depressed.
Well, the question is, what Americans? Certainly not the most
affluent sector of our country. So that I have come to the conclusion, and all this litany is fine and all these protestations and
incantations and everything else, but I think we have reached the
point where it is proper to prepare a bill of impeachment for you
and the majority of the Board because of the callous disregard for
the basic overall interest of the greatest number of this country.
And you know, it is fine to say, well, look, you are permitting
these mastodons, dinosaurs, to—predatory dinosaurs to struggle
over these corporate ventures by sucking up again billions and
billions and billions of banking resources which the banks were
chartered to serve a public need, necessity and convenience.
Everybody forgets that, it seems to me. So that I have three
questions. I ask unanimous consent that I be permitted to extend
and revise my remarks and submit three specific questions in
writing to Mr. Volcker for the record, if he could address himself to
them.
The CHAIRMAN. IS he allowed to bring his counsel to the table for
his defense?
Mr. GONZALEZ. Well, I have started the preparation of the bill of
impeachment. So we have to wait for that
The CHAIRMAN. Without objection.
Mr. VOLCKER. I am permitted a brief period of time, I hope, to
respond, Mr. Chairman. [Laughter.]
I won't respond in any great length
Mr. ANNUNZIO. That is before you are impeached.
Mr. VOLCKER. I am afraid Mr. Gonzalez' remarks reflect a quite
different conception than mine of how the Federal Reserve is run
and what its purposes are and how it is controlled.
I would only, perhaps, invite him to hear some testimony by the
banking community in the United States and see whether they
think they are in charge of the Federal Reserve and how much
time we spend in trying to protect what they conceive of as their
own interest.
We have quite a few interesting discussions with bankers on that
point. I just want to deny completely any implication that our
policies in any way, are motivated by or influenced by the interest
of the banking system in a narrow sense, certainly not by the
interests of the big banks in a more particular sense.
I would hope our policies are, over time, in everyone's interest in
the broadest sense. They are not parochially designed.
213
Let me just pick up the point on the standard of living. There
was some discussion about my remarks on this some time ago. My
point was a very simple one; if productivity in the economy is
declining, there is no room or ability to increase people's standard
of living. We had to realize that, that was what was going on. In
fact, that was an outgrowth in large part of the inflationary problem and the related distortions that had appeared.
Our object is quite the opposite, to create conditions in which we
can have growth, we can have employment, and we can have a
rising standard of living. You are not going to be able to do that if
the economy is operating with poor productivity and poor performance in many respects.
I think you have entirely misconstrued the object of the policy
and the sense of those statements I have made from time to time
when asked about the implications of low and declining productivity in the economy.
I think we have to face up to those implications. If we want a
more stable financial market and a prosperous economy and lower
interest rates we have to do something about inflation.
I think, even if I am going to be impeached, you are still going to
be left with the question of how to go about accomplishing that
very task effectively, and the hard dilemmas and the hard problems are going to remain, whether I am sitting here or somebody
else is going to sit here.
The longer those problems go on, the more difficulty you are
going to have and the Nation is going to have in the years ahead.
Mr. GONZALEZ. Will the chairman yield at that point?
I think it is perfected in—it is the culprit blaming the victim, as
page 3 where you state,
But in the economy as a whole labor accounts for the bulk of all costs and those
rising costs in turn maintain the momentum of inflationary pressures.
In other words, what we are getting at here is certainly, yes, I
know there is cause and effect, inflation and pressures and the
like. But you are blaming the victim.
Mr. VOLCKER. I am blaming the situation.
Mr. GONZALEZ. YOU are coming back to the same old nostrum
that labor is to blame for whatever.
Mr. VOLCKER. I did not suggest that. I suggested it is going to be
in everybody's interest, including labor's interest, to get this economy working better, and that labor's standard of living is going to
increase as we deal with inflation.
The CHAIRMAN. Mr. McKinney.
Mr. MCKINNEY. Thank you, Mr. Chairman.
Chairman Volcker, to paraphrase an old expression I guess, if it
walks like a duck and swims like a duck and quacks like a duck, it
must be a duck.
Now we have more and more money market funds that look like
a bank, act like a bank, have transactional accounts like a bank
even to the point of turning themselves into payroll accounts.
Do you feel as Chairman of the Fed that we better start looking
at money market funds that wish to engage in all of the activities
that a bank engages in and start calling them banks and start
requiring that they have some reserves?
How do you feel about that?
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Mr. VOLCKER. I wouldn't call them banks, but I did present some
testimony 3 or 4 weeks ago before Mr. Fauntroy's subcommittee
where I made what I think are some intelligent proposals in this
respect. [Laughter.]
Given some of the characteristics that you refer to, it would be
useful to set a framework for the operations of these funds for the
years ahead. And the particular proposals that we made were
really twofold:
First, considerations of both monetary policy and equity among
institutions suggest that money market funds should have the
same reserve requirement as depository institutions, to the extent
they are running a transactions business. At this point I think that
is a relatively minor part of their business and it wouldn't have a
very large impact on their operations. But it would establish a
framework along the lines that you are suggesting.
Second, we also suggested that not only for money market funds,
but for other institutions, we should be careful about drawing a
line, as best we can, between transactions balances and essentially
liquid savings types of funds. We should, in general, try to distinguish between a transactions balance payable on demand—payable
to third parties, payable by check or credit card or whatever—and
liquid savings balances, which money market funds are today to a
predominant extent.
As a corollary of that approach, I would not burden money
market funds with a lot of banking regulations that I think are
either peculiar to "banks" in the true sense of the word, or in some
cases, are regulations on the banking system that we ought to be
relaxing.
Let's not go in the direction of putting every regulation on
money market funds, but let's look at what is really necessary for
banks and consider what regulations are appropriate for banks, but
not for money market funds.
Money market funds do not make loans to individual customers.
The whole panoply of safety and soundness regulations we apply to
banks doesn't seem to me appropriate to money market funds.
But, in the case of reserve requirements on transactions balances, where there are both equity and monetary policy considerations, I think the logic that you express is hard to refute.
Mr. MCKINNEY. One of the things that fascinates me about the
money market funds is that what I consider to be large banks in
Connecticut are certainly not money center banks, but their attitude towards the money market funds and what they are dong to
them is rather interesting.
If you say to someone from Manhattan, or Chase, or one of our
big money center banks that you think we ought to do something
about money market funds they go into a long litany of how
wonderful they are because, of course, they are hand-in-glove as far
as sharing the profit is concerned. But your—I don't like to name
local banks, but if you take a good size State bank as Connecticut
National Bank or Hartford National, they have a real concern.
Is there any possible way that the Fed can go so that all the
advantages of this accumulated money doesn't just go to money
center banks, which is where, quite frankly, I feel that these purported set-asides for a Conoco takeover are coming from?
215
Mr. VOLCKER. Some of the money market fund people have been
working on arrangements of various sorts where their outlets
might be expanded beyond a few of the major banks in the country,
so that CD's from smaller banks might be more available to them
on terms and conditions that they would find competitive.
There are difficulties in that process, but a good deal of work is
going on, and I think that that is constructive in the light of the
concerns that you expressed. The impact of the funds is differential—there is no question about it—on different types of banks, and
we would encourage in spirit that kind of effort because it does
smooth out the impact; it is not dramatic but moves in that direction.
Mr. MCKINNEY. One last question. Not as Chairman of the Fed
but as a Government official, do you feel that the Government
should move in on mergers of the size suggested by du Pont and
Conoco, this tremendous transfer of money for no productive purpose?
Mr. VOLCKER. I don't think I could comment helpfully on that,
Mr. McKinney. It is in an area that is obviously outside my particular authority. Your questions are legitimate, but I haven't got any
basis for a judgment as to whether the particular kinds of mergers
or takeovers that are under discussion now are healthy or unhealthy in terms of industrial structure, or more narrowly, on
antitrust grounds.
This is just simply not an area in which I can express a judgment, other than that those are relevant considerations.
Mr. MCKINNEY. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Mr. Volcker, I have been here almost every time you have appeared before this committee. Virtually without exception, your
testimony and that of your predecessors, to be fair has been along
the same lines. I want to congratulate your department that runs
the mimeograph machines. They seem to turn the pages over. But
you never learn anything when you get through.
Mr. VOLCKER. It is a study in consistent monetary policy.
Mr. ANNUNZIO. That is right. It goes something like this: "Our
policies of tight credit have not achieved the result that we would
like, but we do see some signs of improvement in the economy."
You always see improvement, but no one else seems to see any
improvement. Ask a homebuilder. Come to my district, any district,
walk out on the streets.
I mention these groups because every time I read the paper
somebody from the Fed is addressing the Chamber of Commerce or
some big bankers organization. But I don't read where you are
addressing a labor group or a senior citizens group or a much
smaller group, an unemployed group.
Mr. VOLCKER. I would be glad to send you some of our press
notices in that respect, Mr. Annunzio.
Mr. ANNUNZIO. I would be glad to look at them. Ask a homebuilder. Ask an automobile dealer if he sees an improvement. Ask
a young couple trying to buy a home if they see improvement.
Walk out on the street. Stop 100 people. Ask them if they see
improvement.
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I don't think you will find anyone who shares your view of there
being improvement. Is it possible that your policies are dead
wrong? I want to get serious about that. And you just will not
admit it, none of you fellows.
In my 17 years on this committee I have never heard anyone
from the Fed admit they have made a mistake. And I think that is
what is hurting this country. Your course of action is wrong. It
must be wrong.
When the dollar was weak abroad and all the central bankers
complained about the dollar being weak, what happened? We
helped them, we used francs, we used marks, we bought up American dollars, we stabilized the dollar so that the dollar is now
strong, and it is helping the people from this country who travel
abroad. They can get more for their dollar abroad.
The multinationals now can get more for their dollar abroad. But
the Americans who live here get less for their dollars.
I would like to know what kind of a policy it is that shows
improvement when we help people abroad and not help people at
home. I would like to know how you can say your policies are
working, when no one else—and I am not trying to be critical.
[Laughter.]
There isn't anybody at all who says you are right.
Mr. VOLCKER. Is there a question there, Mr. Annunzio?
Mr. ANNUNZIO. The question is, you said your policies are working. Your statement is replete with how they are working. On page
3, as Mr. Gonzalez brought out, here is a $35 billion line of credit,
that is not inflationary.
You give the workingman 10 cents an hour in a contract and
that is inflationary. Now I want to know the difference between
$35 billion given to these large corporations and 10 cents given to
an American worker that creates inflation in your mind. Now
explain that to me, why $35 billion doesn't create inflation and 10
cents does create inflation.
Mr. VOLCKER. I have not given $35 billion to American corporations.
Mr. ANNUNZIO. Line of credit.
Mr. VOLCKER. I have not made it easier for them to raise $35
billion.
Mr. ANNUNZIO. Have you come out against it? Does your policy
say to these bankers, you are wrong for establishing this line of
credit because it is going to create inflation? I haven't read one
word. But I have read a lot of words every time there are labor
negotiations going on, if there is a 10-cent raise.
Mr. VOLCKER. I expressed concern about this matter this morning. I expressed concern about it last week. I don't have any easy
answers to the problem.
The CHAIRMAN. Mr. Leach.
Mr. LEACH. Thank you, Mr. Chairman.
Mr. Volcker, as someone who doen't look for your impeachment,
it seems that some of the problems you have may be created here
on the Hill.
I wonder if you can advise us on a particular issue we are going
to be voting on in the next week or 2 weeks that hasn't been
subject to much by way of hearings, but which touches very much
217
on your particular profession. That involves the issue of a taxexempt savings certificate. One of the subissues all of us are going
to have to deal with is whether or not to make this tax-exempt
certificate which we think is likely to pass directed in any sense.
Should institutions that take in this money allocate their resources in a particular direction such as housing, agriculture, small
business, whatever?
Would you have any comments on how the tax-exempt certificate
should be structured?
Mr. VOLCKER. Let me say first of all, that I think I understand
the problems of the thrift industry very well. We have proposed
legislation and have concerns about that problem.
I have not thought that the tax-exempt certificate is an effective
or efficient way to solve that problem. There will be limited help
for the thrift industry, as I see it, per dollar of revenue loss, and I
don't think it really does anything for the overall savings rate.
Having expressed all those doubts and problems with the bill as
a whole, my impression is that this is some kind of backdoor way
to inject more money into those institutions—rather inefficiently,
as I suggested.
I think you probably will run into more problems by distorting
flows among institutions and in the credit markets and by trying to
trace this money to particular outlets, which is a very difficult job.
That is an additional complication and negative aspect of the bill
in terms of its impact on financial markets.
Mr. LEACH. Let me just ask one more question then. Chairman
Pratt announced last week that he is working with you on the
notion of establishing more effective ways for the savings and loans
to approach the discount window. Have those negotiations been
successfully completed, and can you clarify what is taking place?
Mr. VOLCKER. Let me clarify the situation. The Federal Reserve
posture all along has been—and the law, of course, requires—that
if these institutions have liquidity problems they can come to us
and, provided they are going concerns but facing liquidity needs
potentially over a considerable period of time, we are ready to lend
to them.
That has been the policy from the start. What is different now is
that the Home Loan Bank Board took the view that had enough
money to lend to them, and since funds were available elsewhere
there was no need for Federal Home Loan Bank members to come
to the Federal Reserve.
The Bank Board has changed its view in that respect. I would
anticipate a good many of these institutions coming to the Federal
Reserve. We have not quite completed but are pretty close to
finalizing our policies in this regard. Home loan banks would adopt
policies—and we would adopt the mirror image of those policies—
covering which institutions might come to the Federal Reserve, to
what extent, and which portions we would respectively continue to
handle of the liquidity needs that exist.
Mr. LEACH. Thank you very much.
The CHAIRMAN. Mr. Fauntroy.
Mr. FAUNTROY. Thank you, Mr. Chairman.
Mr. Volcker, my first question has to do with a followup to a
question raised by the distinguished chairman of the Joint Econom-
218
ic Committee, Mr. Reuss. In preparation for assuming the role of
chairman for the Domestic Monetary Policy Subcommittee, I quite
frankly became convinced of the wisdom that you have been giving
us for several years; namely that in order to really regulate inflation you need, not only to regulate monetary policy, but cooperation from the Congress and the President in fiscal restraint that
balances the budget and that reduces deficit spending. Therefore,
as a function of my role as chairman of the Congressional Black
Caucus I was able to convince my colleagues in fashioning a constructive alternative to the Reagan administration's proposals to
come in with a proposal that was balanced indeed, gave $7 billion
in surplus. A budget that eliminated altogether deficit spending in
an effort to cooperate.
What puzzles me, as puzzles the Chair of our Joint Economic
Committee, is that as an independent agency, while you have
praised the action thus far by the Congress and the President, in
spending, you have not exercised the authority of the independence
that you have in judging administration and congressional actions
that are pending that will substantially increase the deficit over
the long run.
Why we can't have that independent voice raised as a caution to
a policy that is going to substantially increase military spending
and at the same time reduce the revenues available to the country.
Mr. VOLCKER. Our role is monetary policy, as you point out.
Other factors impinge upon any given monetary policy, and on
financial markets. We have, I think, in all our statements, made
this relationship clear: If one were working in a vacuum, and the
only concern were the condition of financial markets, then the
smaller the deficit, the better off we would be.
I don't think we can produce a balance budget next year, but
certainly, from the point of view of the Federal Reserve in the
conduct of monetary policy, that would desirable and helpful.
At the same time, it is obvious there are other priorities, other
purposes, served by Government. Take defense spending. It is a
profound political decision as to how many resources we want to
allocate to defense spending and what is required for the defense of
the country.
The sole concern of the world is not the condition of financial
markets as important as that is, and it is not for us to decide how
high defense spending can be. We can point out that the higher the
deficit is, other things equal, the harder the job of the financial
markets and, in some sense, the harder our job is in restraining
money and credit consistent with low-interest rates. I would repeat
that this morning; that is, I think, our proper and appropriate role.
Mr. FAUNTROY. Well, you correctly point out the administration
is planning a large and rapid increase in defense spending. You
pointed out, moreover, that one of the problems has been the fact
that while the cost of living is moderating, falling below 10 percent
as an annual rate, wages and compensation costs have not fallen
commensurately.
Yet, you know, this enormous increase in military spending for
warships and tanks and planes and for higher military salaries is
certainly going to increase the demand for skilled engineers and
219
workers and managers and drive up the very wages that you have
expressed concern about.
I just wonder why from your independent posture you can't
caution us, as we have been cautioned about Federal spending,
about maybe meeting those needs in the nature of defense and
security with increased taxes, rather than increased deficits.
Mr. VOLCKER. There are legitimate, necessary reasons for reducing taxes. Again, we come to a matter of balancing priorities. How
fast does the Nation want to move in that direction, recognizing
that in the short run—not necessarily, in the long run but in the
short run—it has consequences for deficits and for financial markets?
I have repeatedly urged, and would urge again this morning,
that in assessing those priorities, the Congress and administration
be careful in targeting and arranging a program that has maximum favorable impact per dollar of revenue loss.
There is great debate, obviously, about the precise way in which
each tax proposal may fit into the general scheme of things. I
expressed the opinion a minute ago that not all the proposals seem
to me to be very efficient. Again, there are reasons for moving
ahead with tax reduction, but we can't do everything we want to do
at the same time.
And, to the extent the tax reduction moves ahead of or moves
out of phase with expenditure reduction, you are creating more
troublesome problems in financial markets than would otherwise
exist. That is the kind of choice we have.
The CHAIRMAN. Mr. Paul.
Mr. PAUL. Thank you, Mr. Chairman.
Mr. Volcker, on page 10 you say,
You and I know that after a decade and more of disappointment there is a
persisting skepticism and doubt about the ability of the Nation to persevere in the
anti-inflation program.
Then you further add you believe this skepticism is unwarranted.
There certainly are a lot of people in the country who still believe
that we are not persevering. There are some who even believe it is
impossible to do so under today's rules as far as the rules we are
operating under in managing our money.
Since 1971, since the closing of the gold window, we have had
literally a managed irredeemable paper currency. Under those conditions we have done poorly.
History suggests that we are not likely to do very well, when you
take into consideration that we have only tried that two other
times, one when we had a continental dollar. That currency was
destined to destroy itself. Then we had a greenback era in the Civil
War period. Following this we had to mend our ways to get back a
sound backing of the currency.
Now we have lived 10 years in the era of the modern greenback
currency.
There are some in the country who would not advocate impeaching the Chairman of the Federal Reserve Board but they might
suggest that the paper-dollar standard should be impeached.
Since 1971, the dollar has literally lost more than 50 percent of
its value. It has been depreciated to that extent by the increasing
220
of its supply. Stocks have lost their value in real terms. Bonds have
been destroyed. Savings and loans are in trouble.
The pension funds—once the exact condition they are in is revealed to us, we will realize they are not much better off than the
bond market. And yet, we did have people in the early part of the
1970's, when gold was still $35 an ounce, saying this is exactly
what would happen.
They would say, "You know, that type of skepticism is unwarranted." Yet, during that 10 years we saw the dollar value in terms
of gold go from $35 up to $800 and now back to $400. Still, a vote of
no confidence in the dollar.
Now, those same people who were rather accurate in their predictions, are saying that the same thing will continue. And that in
a few years, 5 years, 6 years, 8 years, we will be going from a base
of $400 now and we will further depreciate our currency to the
point where it will be $2,000 and $3,000 and maybe $4,000 to the
ounce of gold. Not that the price of gold will change but only the
devaluation of the dollar will continue. Gold always stays the same;
it is the "golden constant."
Now we see many individuals, many economists coming out of
the woodwork, so to speak, reputable members of the academic
community advocating some sort of a connection between paper
and gold. There have been legitimate polls done in this country and
we find gold-backed currency is a very popular idea.
About 60 to 70 percent of the people advocate a sound dollar
backed by something of real value. Strangely enough, a large
number of American citizens still believe the dollar has a backing
to it.
Now my question is this: Do you foresee any time or any conditions under which you would ever consider supporting the use of
gold in the monetary system?
Mr. VOLCKER. Let me say that we are, I think, dedicated to
avoiding the kind of scenario that you have outlined. I am much
more optimistic and hopeful than you are, although I don't suggest
we have an easy job whatever technique we use. I think the restiveness that has been expressed by some members of the committee suggests it is not an easy job to turn around the inflationary
situation you have described that has built up over the past 10
years.
The element of truth in and the sympathy that I would have
with your approach is that you are looking for a way to further
assure the kind of broad discipline that I think is necessary in
economic policy.
I would question whether the price of gold has been all that
stable. It has been quite unstable, in real terms as well as in
nominal terms, in recent years. I think it has shown a certain
amount of instability throughout history. But I appreciate the
point that this is one theoretical way, at least, of trying to impose
discipline. Of course, discipline requires adhering to the standard
you set.
One of the fundamental questions you have to deal with in that
respect is whether it is really meaningful and convincing in the
present day and age to try to set a fixed dollar price for gold, given
all that has happened. Would it really last, because if it doesn't
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last, you haven't accomplished your purpose. If it does last, and if
all policy is directed toward maintaining that price, you have a
different set of problems.
I would think that the course we have set ourselves on monetary
discipline embodies the most important fundamental principle in
your suggestion and offers more promise to do the job.
I am not as pessimistic as you are.
Mr. PAUL. Thank you.
Some would claim gold is unstable; others would say that, of
course, it is the instability of the dollar, the anticipation of what is
happening to the dollar rather than the gold itself being the problem.
Mr. VOLCKER. There is some element of truth in that.
The CHAIRMAN. Mr. Neal.
Mr. NEAL. Mr. Volcker, I have come to think that the tax-cutting
fever that's claimed us on both sides of the aisle is going to result,
it seems to me, inevitably in very high interest rates next year.
Let me tell you why I say that, and then ask you to comment on
it. Here's what we have done.
We have started with a current services level of spending of $711
billion. From that, we exempted from cuts $264 billion in that basic
social safety net, about $200 billion for defense spending, about
$100 billion for interest on the national debt, leaving about $147
billion for everything else that the Federal Government does, education, science, trade, and everything else.
From that $147 billion figure, we cut $37 billion, or about 25
percent. Now, this time next year, it seems to me, we will be
looking at a deficit of about $40 billion that the Reagan administration says we will have.
There is good evidence that we have underestimated defense
spending considerably, so I imagine instead of the $40 billion, it
will at least be another $10 or $20 billion on top of that.
If we pass the tax cut bill—and I am talking about the multiyear
personal tax cuts, not the business and the targeted personal tax
cuts—if we pass the whole package now, then we will build into the
system an additional $75 billion in personal tax cuts for 1983. That
indicates to me that we will be facing this time next year a budget
deficit of somewhere between $60 and $100 billion.
And we are going to have to make some very difficult choices.
Now the choices will be as follows, it seems to me. Either we will
go into that basic social safety net, social security retirement program, disability program, and there is some indication that the
Reagan administration wants to do that. But I think that the
Congress will reject that approach.
Or we will go into defense spending, and I think neither the
Congress nor the President will want to do that. We can't go into
the $100 billion of interest on the national debt. So we will be
looking at now $110 billion.
In other words, already cut 25 percent, for everything else the
Federal Government does, we will look at that to cut, or we will
have to raise taxes. Or we will have to let the budget deficit ride.
And if we let the budget deficit ride, and you don't monetize it,
then it seems to me we are going to face very, very high interest
222
rates which will then choke off what recovery there has been in
home building and autos and so on.
That is the most likely scenario that I see, and I just wonder if
you would comment on the accuracy of that. And if you agree, then
what do you suggest?
Mr. VOLCKER. I can't comment on the accuracy of your figures. I
haven't got any insight into whether defense spending or some of
these other expenditures that you suggest will go up more rapidly.
I would note that the administration and the Congress, in developing the spending program, have recognized that, in line with
reducing the deficit and eventually returning to a balanced budget,
there were going to have to be some very sizable further spending
cuts. That consequence is there, and you have reiterated it this
morning.
Mr. NEAL. Wait a minute, you mean further spending cuts
beyond those that we have already made?
Mr. VOLCKER. Beyond those we have already made.
Mr. NEAL. Well, where will they come from?
Mr. VOLCKER. It is not our job in the Federal Reserve
Mr. NEAL. The purpose of those spending cuts would be to reduce
the deficit, isn't that correct?
Mr. VOLCKER. Those spending cuts are assumed in the administration's program. They haven't been identified yet. But when you
move into 1983 and beyond, the administration program has a line
that is for future spending cuts of large size, necessary and consistent with its own estimates of defense spending and these other
factors.
I fully agree with the implications of your comment: There is a
lot more spending cutting that will have to be done, consistent with
both the tax program and other elements in the outlook—not to
mention the contingencies of misestimates.
Mr. NEAL. SO what you are saying is that if we don't say that,
this time next year, cut deeper into
Mr. VOLCKER. Into something—maybe defense, but into something.
Mr. NEAL. Somewhere, then you would agree we would have
these very high interest rates?
Mr. VOLCKER. We will have high deficits and that will be a factor
on interest rates. How high interest rates will be, I think, depend
on two other factors, apart from the deficit: How much progress
have we made on inflation, and what is the current strength of the
economy? It is obviously unsatisfactory to have low interest rates
because the economy is weak; a weak economy is not a basic
answer to the dilemma, although it is important in determining
just what the level of interest rates will be at any point in time.
But it is not a real answer over time from the standpoint of
economic policy.
Mr. NEAL. It is certainly conceivable, though, that we would have
a situation—if we don't make deep further cuts in spending—that's
very similar to the situation we have now, which, by any measure,
inflation is under 10 percent, yet the prime rate is 20 percent.
Mr. VOLCKER. I can't rule that out. But if we make better progress on inflation, I would be more hopeful than that analysis
suggests.
223
If you told me the budget's going to be in much worse shape,
then I would assume you'd have another problem.
Mr. NEAL. What are you assuming?
Mr. VOLCKER. I am not assuming big overruns in the defense
area. I would assume—but I just have to reiterate it is an assumption—that there will be sizable further expenditure cuts. And I am
also assuming that as the tax program completes its way through
the Congress, there isn't going to be a lot added to it. I know there
is a lot of discussion about that.
Mr. NEAL. I wasn't talking about adding anything.
Mr. VOLCKER. Right, I am thinking about additions beyond, say,
what the administration proposed in May or whenever the compromise proposals came forward.
Mr. NEAL. What you are saying then is that if we don't make
further deep spending cuts, it would not be unreasonable to anticipate very high interest rates this time next year?
Mr. VOLCKER. Interest rates will depend upon how well the economy is doing. If the economy is moving ahead strongly under those
conditions, making only limited progress on inflation, I think that
kind of an implication is there.
The CHAIRMAN. Mr. Shumway?
Mr. SHUMWAY. Thank you, Mr. Chairman.
Mr. Volcker, you have essentially given us assurances that the
policies we have embarked upon are the right ones; that they will
eventually lead us into a better economic situation in America and
we need to stay with them.
It seems to me that if this, indeed, is the case, the question is just
how much of the cure America's economy can stand. I am sure you
can tell from those of us on this committee who are exposed to
public reaction to these policies and other economic problems in
America that there are some very difficult times ranging there.
I think perhaps your position, as distinguished from ours, is
somewhat shielded from those harsh realities which we, as politicians, necessarily have to confront.
Certainly, in our case, we are not given the privilege of relying
solely on numbers or statistics. We really have to respond to
people. It is very obvious in America today that people are hurting.
I don't say this in particular criticism of your policy, but just in
reference to many of the questions that have been voiced on this
panel today and to the economic situation as a whole.
I think, however, that it is very easy for you to say that interest
rates are somehow tied to inflation, and so long as inflation continues out of hand, we will not have a real answer to high interest
rates, and that the base causes for inflation are either psychological on the one hand, or relate to continued deficit spending by the
Government on the other hand.
In some respects, it seems to me that this approach and that
answer is simply an attempt to solve the problem by shoving it into
a closet and then closing the closet door.
There are some nagging questions that bother me. One is the
fact that Congress has indeed taken some action, albeit not finished
at the present time, but Congress has reduced considerably the
budget authority for the coming year and has given great indica-
224
tion to the American public that it wants to get out of the pattern
of deficit spending.
Why is it that there still is a gap between the public performance and response to what Congress has done, and why haven't we
been able to narrow that gap and perhaps curb some of this psychology of inflation?
I am concerned about what we might yet do and what remains
undone.
Mr. VOLCKER. I would suspect you are narrowing the gap, Mr.
Shumway.
Mr. SHUMWAY. We haven't yet succeeded in doing that.
Mr. VOLCKER. YOU haven't succeeded in convincing everybody
that the inflation is going to go away promptly and speedily, I
think simply because of a background of years where the opposite
has been happening. The American people have been fooled, in a
sense, by seeing a higher inflation rate than they really anticipated, certainly a higher inflation rate than either economists or
successive administrations told them was likely, for the last 15
years.
They have seen efforts to cut back before that have not been
carried through. I happen to think the effort that you are making
in the Congress this year is, as I said in my statement, without
parallel to any I have seen in Washington during the years that I
have been in and out. I think it is both courageous and constructive. But it hasn't had instantaneous results. The problem is also
very great.
Mr. SHUMWAY. HOW long do you think it will take before the
efforts of Congress to date are successful in closing that gap?
Mr. VOLCKER. It will take a shorter period of time to the extent
that both we in the Federal Reserve, and you in the Congress, and
those in the administration, carry through with real conviction. I
think this is the answer the people are looking for in markets and
elsewhere right now. They see, in many respects, that things are
not very happy in the economy; of course, we had a big growth
most of the past year, but it is quite sluggish at the moment. And
some areas of the economy, as have been amply reflected in this
discussion this morning, are under extremely heavy pressure. So
many people are saying, "Now we have got the first whiff of
gunsmoke and they will back off."
Is it going to be a repetition of the same old policies we have had
pretty much throughout the postwar period? As soon as we fear
some short-term consequences, will we back off from the policies? I
think we have learned that will have more adverse consequences in
the long run.
You raised the question in the way which I am sure many people
see it: can we stand the cure? I would like to turn that around.
Can we stand not to cure this problem that's gotten a grip on us,
progressively, in the past 10 or 15 years? If we back off now and
say, "Well, we are not up to dealing with inflation," then the
outlook would obviously be poor.
I don't think that is going to happen. I don't think we can permit
that to happen because we have had too much experience behind
us with just that kind of approach, landing us just where we are
now. I think that is precisely the issue that is before us.
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Mr. SHUMWAY. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Blanchard.
Mr. BLANCHARD. Thank you, Mr. Chairman.
Mr. Volcker, I would just like to repeat a warning or a caution
that I made to you a year ago here, and also privately, which is, I
think, very clearly you are going to become a scapegoat for kind of
a schizophrenic economic policy, both from Democrats and Republicans.
I note that privately recently Murray Weidenbaum, at a conference board symposium, indicated that the Fed wasn't doing enough
in the area of monetary restraint. Yet publicly in Canada and
Ottawa, the President has seemed to disassociate himself from the
independent policies of the Federal Reserve Board.
I know, hearing my colleagues, Chairmen Gonzalez and Annunzio talk, that they do, in fact, reflect the feelings of many Americans in small- and medium-size businesses in terms of their concern for the tight money policies of the Fed.
So I simply want to repeat that because I know that you believe
that something more is required in fighting inflation than simply
monetary restraint.
My concern is that when you add up all the various policies we
are pursuing, we do indeed place excessive reliance on monetary
policy to fight inflation.
Now, before this committee, David Stockman said that any deficit as a result of a tax cut or high defense spending would not be
inflationary, or at least necessarily inflationary, unless the Fed
chose to monetize that debt.
Steve Neal was pursuing, I think, a line of questioning which
many people are concerned about, which is you don't have any
choice but to monetize that deficit as I understand it, or you are
going to be putting enormous upward pressure on interest rates.
So my question would be, are you planning to monetize this
year's deficit, and don't you think it is foolish to talk about the fact
that you shouldn't monetize the deficit?
Mr. VOLCKER. I am not always quite sure what "monetizing the
deficit" means. It doesn't make any difference whether we monetize private or public debt in some sense, but we happen to operate
in Government securities.
Let me just phrase your question a little differently. The purpose
of this hearing is for us to tell you what our monetary targets are.
That tells you in broad dimension what we intend to do in terms of
increasing reserves and increasing the money supply. What I have
told you this morning is that we intend, over time, to bring down
money creation. That is not consistent with increasing the money
supply simply to facilitate Treasury financing; we don't intend to
do that. If that policy is, in the opinion of members of the committee, wrongheaded, or we should be going faster or slower, I would
expect to hear that. But we have attempted to quantify our objectives as best we can in line with the Humphrey-Hawkins Act, and
we think they are appropriate, and we intend, over a period of
time, to keep reducing the trend rate of growth in money and
credit.
I continue to feel that is appropriate.
226
Mr. BLANCHARD. I want to pursue this. You state on page 8 that
more fundamentally what recent experience also confirms is that
demands for money and credit growing out of an expanding and
inflating economy pressing against the restrained supply will be
reflected in strong pressures on interest rates and credit markets,
and so on.
Now, if the Federal Government borrows this tax cut on the
private credit markets, which as I understand is what will happen,
will any kind of credit demand which we presently have, wouldn't
that put upward pressure on interest rates?
Mr. VOLCKER. I think we see that situation to a considerable
extent now. We have had a reasonably strong economy. It is sluggish right now, but we have had good growth in the economy in the
past year or so. We have had high deficits; we have had restraint
on money and credit creation; and as a result of all these things we
have had high interest rates.
Mr. BLANCHARD. HOW are we going to get the various sectors of
the economy which are especially credit-sensitive out of the
swamp? As you know, it is expected tomorrow that Chrysler Corp.
will announce a modest profit which, in view of the circumstances,
is rather miraculous.
How in the name of economic sanity will Chrysler and the
dozens of other businesses, not just autos, survive with continued
high interest rates?
Mr. VOLCKER. The answer in the end—and I must keep coming
back to it because I know of no other answer—is that you can't
have things working together properly without the inflation rate
coming down. That is the answer. We can't finance inflation if we
are going to have room for the vigorous real growth that we all
want.
Chrysler is a kind of laboratory example of both some of the
problems and some of the solutions, if I could suggest that. The
automobile industry has done poorly in the second quarter and
continuing into early July. Chrysler took a lot of measures, as you
well know, to reduce the scope of their operations, to reduce their
costs. They have done somewhat better than the other automobile
companies. I think all those companies are suffering first and
foremost from a very rapid increase in car prices in the past 4 or 5
years that startles people when they go in to buy a new car if they
haven't bought a new car for 4 or 5 years. They say, "I don't want
to pay that much for a car."
That has certain lessons for us all. There is an industry where a
certain amount of self-help is in the interest of the companies and
the workers and the jobs.
The CHAIRMAN. Mr. Parris.
Mr. PARRIS. Thank you, Mr. Chairman.
Mr. Chairman, I think your statement this morning was excellent. It is generally encouraging. Particularly on page 9 where you
talk about the outlook for interest rates. I, like my colleagues,
believe there is a rapidly approaching liquidity crisis for small
business in the United States.
But I would like to address for just a moment the psychology of
the inflationary expectations as it impacts on financial markets,
and remind you that some in the financial community were consid-
227
erably optimistic after the adoption of Gramm-Latta, and some of
the actions that have been taken in the Congress on budgetary
restraint, your monetary policy.
Instead of a beneficial reaction from all of that, the stock market
went down, interest rates went up. We got exactly the opposite
result that many of us had hoped.
And certainly the experts, Dr. Sprinkel, Dr. Ture, testified before
the task force on economic policy that interest rates and inflation
will abate after the market is convinced that the Federal Reserve
is serious about controlling the money supply.
Your statement on page 10 apparently is very consistent with
that. I would like to ask you the question that I believe is on the
minds of most Americans, certainly as reflected by my mail, and
the conversations that you hear around the Halls, around this
place. It may be slightly redundant, but let me try it on you.
Your statement before the Joint Economic Committee was that it
would not be prudent to expect interest rates to drop quickly.
Given a couple of assumptions, Mr. Chairman, assuming that the
Congress continues to go on its recent course, assuming that—in
terms of budgetary restraint.
Assuming that your monetary restraints or policies are consistent and successful, could you give us some idea of a timetable on
the expectations of amelioration of interest rates? Will it be closer
to 6 months or 2 years?
Mr. VOLCKER. I hesitate to respond to that question in any way
that might be interpreted as a forecast. Let me just say, again, that
I don't know
what you mean by "the economy as it is at the
moment/7
Are you implying a level economy, a growing economy, a declining economy? I raise that question because I think, in the very
short run, that tends to be the dominant influence on credit demands and interest rates, and even to some degree, on expectations.
The outlook is a bit uncertain, but the kind of assumptions you
made are all in the direction, over time, of lower interest rates.
Just when that will come about depends upon two factors: First,
how business is performing in the short run, before the inflation
rate actually comes down and comes down convincingly, so there is
a lot more room for real activity in financing demands; and second,
on the degree and speed with which expectations change.
I think those expectations may well be in the process of changing
but I don't think they have dramatically changed as yet. When
that might happen, I suspect, will depend upon further evidence—
of actual price performance—bearing out the more favorable signs
we have seen recently, and also on a feeling, as I just said, that the
administration, the Congress, and the Federal Reserve are going to
stick to policies that promise that result in the long run.
By "long run," I don't mean forever, I mean into next year.
Perhaps that is the most important of all. If that sense of confidence that these policies are going to be maintained is shaken, you
will simply delay the improvement in financial markets we would
like to see.
Mr. PARRIS. Mr. Chairman, I submit to you, though, that how
business performs in the short run is a self-fulfilling prophecy in
228
terms of how they perceive the posture of the Congress on fiscal
restraint and your posture on monetary supplies and the like.
Doesn't it all somewhere come together?
Mr. VOLCKER. They interact back and forth with each other,
which is what makes it so difficult to make estimates for any short
period.
Mr. PARRIS. But it is real tough to tell a guy who runs a hardware store in Springfield that, as soon as the economy gets to
performing adequately, then interest rates will come down on his
inventory.
Mr. VOLCKER. That's right. That is the box you are in. That is
the box we have been in the past year. That is the box you will
remain in until you put in the other ingredient, namely, an inflation rate that is coming down. That is the only way I see of getting
out of that box.
Mr. PARRIS. HOW do guys like me say to guys like him, look, just
hold out another x period until such time as everybody gets economically healthy here and it will be all right?
And he says, "Is that 3 months, 6 months, 2 years, 10 years?
What is that?"
Mr. VOLCKER. It is not 10 years.
Mr. PARRIS. Let's hope not.
Mr. VOLCKER. I hope it comes, obviously, I would love to see it
come tomorrow. But I don't think it is particularly useful to try to
specify a precise timetable.
Mr. PARRIS. I understand.
Mr. VOLCKER. When this thing gets revolutionized. You have to
stick at it until that happens. And it will happen.
Mr. PARRIS. Thank you. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Hubbard.
Mr. HUBBARD. Thank you, Mr. Chairman.
Mr. Volcker, thank you for being with us. Why are interest rates
at 20 percent nowadays when inflation is only at 10 percent?
Mr. VOLCKER. I think several factors enter into that. First, let me
just note as a preliminary, we have never had an inflation rate like
this, entrenched as it is, with expectations as they are, and with
monetary policy pushing in the other direction and a tax structure
pushing people into very high brackets.
You say interest rates are 20 percent, but they are not 20 percent for a lot of people. That was driven home to me again the
other day by a middle-level employee at the Federal Reserve who
told me she had gone out and bought some land. I said, "How'd you
finance it?" She took a mortgage. I was a little surprised that she
was willing to pay 16 percent or more for the mortgage. I said,
"Why?" She said, "I want one of those tax breaks." So it was not
16 percent in her mind, and I think to a lot of people, it is not 16
percent.
In fact, it is not 16 percent if you are a taxpayer. We have never
had this kind of interest rate before with this kind of tax structure,
which impinges upon the real after-tax rates of interest. Let me
just say that as background.
Second, I don't think that 20-percent rate should be surprising,
during a period of high inflationary momentum, when expectations
have been in the direction of expecting more inflation, when so
229
much burden is put on monetary policy in the sense of restricting
money and credit, and when you have a low ratio, historically, of
money to activity and a low ratio of expansion of credit and money
to the expansion of the nominal GNP that is reflected in high
interest rates. That is the ratcheting device.
Mr. HUBBARD. Mr. Chairman, do you expect that the Reagan
economic program, if enacted by the 97th Congress, will produce
more inflation?
Mr. VOLCKER. No; I think the inflation rate is headed down. I
think the question that we are struggling with here this morning
to a considerable degree is how long will it take?
From my perspective, the shorter the better. That depends upon
a lot of other policies.
Mr. HUBBARD. YOU said earlier that you believe sincerely that
major budgets and spending cuts by the 97th Congress are, indeed,
courageous and constructive. Do you believe that the tax cuts
proposed by President Reagan, and he's the one who first mentioned major tax cuts, 3-year tax cuts, are these suggestions courageous and constructive?
Mr. VOLCKER. I think there are constructive reasons to have tax
reduction. I think that is one factor all bound up in this problem of
our economic performance and even the inflation. The point's been
made over and over again: I think what you have to do is balance
the tax side against the expenditure side.
Mr. HUBBARD. HOW can the tax cuts, which will produce more
deficits, be constructive?
Mr. VOLCKER. Because they do have implications for incentives
and for costs and all the rest. The degree to which they are constructive depends upon the total budgetary picture. That is where
the spending side comes in; these have to be put together in a
pattern.
Mr. HUBBARD. Are you saying that even the third year tax cuts
proposed by the Reagan administration will be constructive to the
overall economy and to the deficits?
Mr. VOLCKER. I don't know precisely what the economic situation
will be in the third year, which is the issue in that consideration.
There are advantages in having the program spelled out. If spending or economic activity went in a direction that was not assumed,
you would have a different kind of a problem. The question is how
much conviction you have as a Congressman that indeed the spending cuts, in particular, will be as planned, that you recognize the
implications, and that you feel confident that the program can be
attained.
Mr. HUBBARD. If we don't know what the third year economy
will be and we are fearful of it, is it wise to have this huge third
year tax cut adopted as a part of the Reagan economic package?
Mr. VOLCKER. I would put the emphasis more on the spending
side, although these other questions are not irrelevant. Again, you
have a balancing act; there are reasons to do that cut. It is the
Congress in the end that is going to decide whether and where the
spending side of the budget matches the tax cut. If you feel that is
an impossible approach, I think you would have legitimate doubts
about the tax cut. If you think it can be done—and many do—and
it is a reasonable objective, then maybe you are less doubtful.
230
Mr. HUBBARD. I yield back the balance of my time, Mr. Chairman.
The CHAIRMAN. Mr. Weber.
Mr. WEBER. Thank you, Mr. Chairman.
Mr. Volcker, I believe if I can just paraphrase your testimony,
you are telling us that inflation is our No. 1 priority in fighting
inflation because inflation inhibits economic growth and the creation of jobs. I certainly agree with you.
I believe, implicitly, in your testimony you are telling us that we
have more than just monetary policy as a tool to fight inflation.
We also have fiscal policy, income policy, and productive policy. Of
course, you have expressed your view on monetary policy. I support
that view.
You have expressed your views on what Congress fiscal policy
should be. You have implicitly, I think, addressed an income policy
by pleading for letting the world competition determine wages and
prices. I take it that you would be opposed to wage and price
controls. Am I right?
Mr. VOLCKER. Yes; I noted the importance of that dimension, but
suggested there are ways of approaching it entirely consistent with
the competitive market rather than through controls, with regards
to which I think our history has not been encouraging.
Mr. WEBER. I agree with you. You have also mentioned the need
to increase productivity in American industry. I take it regulatory
relief and tax incentives would be the methodology there?
Mr. VOLCKER. Yes, sir.
Mr. WEBER. For my own
clarification, can you explain the interrelation between the incentives for savings for which, at one point
in your testimony, you pointed out a need, which I assume would
go into M2 and M3, and the Fed's attempts to restrain growth of M2
and M3. I am a little bit perplexed by what seems to be a paradox
there.
Mr. VOLCKER. Some savings do and some don't go into M2 and
M3. If the net result of the increased incentive to save is more
productivity, and that in turn helps to relieve the price pressures, I
think that would be consistent with the kind of targets we have for
M2 and M3. These targets tend to be related over a period of time,
when savings are high or when savings are low, to the growth in
the normal GNP. If the normal GNP is reduced, hopefully by
reducing the rate of inflation—which is, of course, the object of the
whole exercise over time—then I think we can manage the increased flow of savings within the framework of that target.
Mr. WEBER. We have got maybe four monetary aggregates here,
Mi A and Mi-B, and M2 and M3. Mi is below the target range you
have set. M2 and M3 are over your target ranges.
Mr. VOLCKER. M2 is just about there.
Mr. WEBER. The higher range?
Mr. VOLCKER. Right.
Mr. WEBER. Which of these aggregates is most important to your
monetary policy?
Mr. VOLCKER. I think over time we have tended to look at the
first instance at the Mi which has the special characteristic of
being transactions balances. I think we are in a period where
231
because of institutional change, we have to be very careful in
interpreting the shortrun movements in Mi.
These other aggregates are important too. I think we would
make a mistake if we just picked out one and said it were of
overwhelming importance, because it is just too likely that institutional changes will render the movement of a particular aggregate
in one direction or another less meaningful economically.
The British ran into this problem a year or so ago, you may
recall, where they put tremendous emphasis on one of the aggregates. They have several aggregates, as we do, but they put tremendous emphasis on Sterling-denominated M3 which is roughly similar in concept to our own M3. Their range was 7 to 11 percent, or
something like that, as I recall it. For the past year, sterling M3
ran at about 20 percent. However, there were certain institutional
changes in the United Kingdom that were producing a very high
Sterling M3, while Mi, for instance, was quite low. Sterling M3 was
not giving a fair reading of their economic policy.
You point out that Mi has been running low this year, as I
indicated it has. I was interested in seeing one of Milton Friedman's articles in Newsweek a few weeks ago where he said, "Don't
forget, M2 is running quite high." I was well aware of that before
reading the article, but it was interesting that he was attaching
importance to M2 as something you had to look at, while he has at
other times focused on other aggregates.
Mr. WEBER. On page 12 of your testimony you make mention of
the fact there are certain industries suffering from problems of
their own making and therefore, should not receive governmental
assistance or that sort of thing. Would you care to name what
industries you have in mind when making that statement on page
12?
Mr. VOLCKER. We had some discussion—just to pick an industry
out at random—of the automobile industry a moment ago. There
you have an industry with a great many problems because of
change in demand and product mix. I think there have been Government policies that have not been at all helpful in terms of that
industry. But they have also had some problems of their own
making, I would say both pricing policies and wage policies. You
have an industry where, understandably I think, the wage level is
higher than the average for very good reasons. But it is much
higher than the average and has been rising through the past
decade relative to other wages, so it is not entirely an accident that
that industry is one that is at the cutting edge of the problems
now; their own competitive position has been impaired.
The CHAIRMAN. The Chair would take note of the fact that we
have a vote in progress. There are nine members who have not
inquired of Mr. Volcker yet. We could go vote and then return
immediately, hopefully within 10 minutes. How long can Mr.
Volcker stay with us?
Mr. VOLCKER. I think I can stay more or less indefinitely.
The CHAIRMAN. We are all going to lose weight. The committee
will be in recess for approximately 10 minutes, and we will recognize Mr. D'Amours.
[A short recess was taken.]
The CHAIRMAN. The Chair recognizes Mr. D'Amours.
232
Mr. D'AMOURS. Thank you, Mr. Chairman.
Mr. Volcker, I welcome you and I thank you for being willing to
stay all this time with us.
In the beginning, very quickly, in response to a question Mr.
Hubbard asked you, I am not sure, but I think you said something
about the advisability of predicating the third year tax cut in the
administration's tax package on the performance of the economy.
Are you suggesting that it would be wiser to condition the third
year tax cut on the economy meeting certain minimal performance
standards, as has been and is being discussed around here currently?
Mr. VOLCKER. I think what I said was that, in concept, I understood that point, but I don't know specifically what kind of tests for
the economy you would condition the third year cut on. In my own
mind, the most critical factor is the degree of commitment and
conviction the Congress itself brings to what I see as the implication of that approach; namely, that there also have to be big
additional spending cuts. If you are committed to that approach,
the outlook is different than if you are not. I wouldn't want a third
year tax cut if we don't get that kind of spending performance.
Mr. D'AMOURS. Are you suggesting then that it would be wise to,
whatever indices one wants to use, it would be wise to find some
credible indices, and condition the third year tax cut upon them?
Would that or would that not be a wise move?
Mr. VOLCKER. I am not going to answer that question for you. I
think you have to answer it yourself, in terms of balancing the
advantages that do exist in a third year tax cut against what you
feel is possible and feasible and what will be done on the spending
side of the equation.
From the standpoint of pressures on the financial markets that I
am most directly concerned with, the smaller the deficit and the
more caution in spending, the better, but there are other considerations.
Mr. D'AMOURS. Could you tell me anything that would be wrong
with conditioning a third year tax cut upon economic performance?
Mr. VOLCKER. I think there are two considerations on the opposite side. Those people who advocate a 3-year tax cut see a added
assurance of stimulating the results they want to get from tax
reduction by promising it in advance for an additional year. There
are also those who think that if you put that 3-year cut in place,
you will have a further assurance that the spending policies will be
complementary, but if you don't put it in place, you will not get the
spending policies that make it possible.
Mr. D'AMOURS. Don't we get both by passing tax cuts now that
are conditioned upon economic performance? Doesn't that solve the
problem by giving us both?
Mr. VOLCKER. That doesn't give you both. It is one possible
approach, but it doesn't have the additional assurances of that of a
promised third year tax cut, which is what the proponents want.
Mr. D'AMOURS. But nobody is suggesting that there should be a
third year tax cut if the result is a huge deficit are they?
Mr. VOLCKER. I agree. That brings in the other side of the argument, that a planned 3-year cut will encourage the spending reduc-
233
tions that are needed. I expressed 6 months ago the thought that
this kind of thing ought to be examined.
Mr. D'AMOURS. What kind of thing, the conditioning of the third
year?
Mr. VOLCKER. Making it conditional on spending cuts, yes.
Mr. D'AMOURS. SO you have in the past suggested such a course
for consideration?
Mr. VOLCKER. I suggested that that be considered, and it is being
considered.
Mr. D'AMOURS. Mr. Reuss earlier suggested the leadership he
was looking to Fed for in terms of speaking out and exercising its
independence. You responded that in fact you have been speaking
out. On the other hand, one of the more critical questions facing
this country today is the fact that apparently, the whole burden of
monetary policy and of interest rate fighting falls upon the Fed.
And that seems to be a policy that is generally being aided and
abetted by not only the administration, but by the Ways and
Means Committee so far as I interpret their tax proposals.
I haven't heard you say anything today that would give me any
guidance as to what your personal feeling is about this. I happen to
think that both the Ways and Means Committee and the Reagan
tax proposals are very inflationary insofar as they include about
$35 billion in personal tax cuts that your predecessor, by the way,
thinks is inflationary. Now, if your predecessor, Mr. Burns, can
speak out on this, with all of your independence, why can't you?
Mr. VOLCKER. Let me describe the situation as I see it. I think, by
the force of events, there is a great burden on monetary policy at
this point. There are large deficits. There is a lot of built in
momentum in the economy. There are not other instruments that
are readily adaptable to dealing with inflation in the short run,
and all these pressures are reflected in the financial markets. I
don't think it is quite fair to say that no other actions are being
undertaken or are in prospect. I don't think that is the case. I
think the regulatory side is a clear case.
Mr. D'AMOURS. Let's keep our target on the ball, which is a
deficit. You have been ignoring it and the country has been ignoring it and the administration has been ignoring it and everybody
has ignored the darn thing. You are not speaking out on it. You
are pretending to speak out on it. We are looking to you for
leadership. People like what Paul Volcker is saying, they look
toward him for leadership. They think he is tough and independent.
You keep saying you are speaking out, but frankly, I know the
issues fairly well, because I work with them everyday and I can't
hear what you are saying because you are saying a little bit for
everybody. You are not enunciating a clear policy in terms of what
we ought to be doing about balancing the budget. And it can be
done.
Hopefully there is going to be something introduced as a substitute, to the tax bill, to accomplish that purpose, to give productivity tax cuts to business and give personal tax cuts to offset inflation and bracket creep and the like. But that leadership isn't
coming from you. Yet you are out there all by yourself fighting the
battles with the entire burden on our shoulders.
234
I know what is being said because you are thinking well, by
keeping interest rates high, we are putting pressure on the administration to do something about balancing the budget. I know you
are not saying that publicly.
Might I wish you would start saying things publicly, because you
are a leader in this field and you are being awfully silent in spite
of your protestations to the contrary.
My time has expired. Mr. Volcker, I happen to admire you and
happen to like what you are doing, but you are not speaking out on
these issues as you say you are.
Mr. VOLCKER. I understand what you are saying.
The CHAIRMAN. Mr. McCollum.
Mr. MCCOLLUM. Mr. Volcker, I can assure you that being on the
other side of these television cameras may put me out of the
limelight but there is just as much heat over here.
I wanted to ask you some questions. Before that, I can't resist
commenting on the fact that my judgment is that you are speaking
out on the issues.
You have done so very ably this morning and very specifically.
We appreciate it very much.
Last week, we had a situation where Chairman Pratt unveiled
the proposal to assist thrift institutions in the long run in large
part by granting them extensive new asset powers. In answering
questions I asked, he specifically said that in the long term, he
would like to see the lines just completely destroyed between commercial banks and savings and loan institutions by and large.
I also asked him about the desirability from an equity standpoint
of permitting savings and loans to accept demand deposits. He
proposed that, as a matter of fact.
The Chairman replied he could understand banks opposing the
proposal in their own self-interest. How do you view the matter
with respect to savings and loans accepting demand deposits and
the entire concept, in the long term at least, of removing the
guidelines and separations between commercial banks and savings
and loans?
Mr. VOLCKER. In the past, I frankly have been of the view that
the idea of some specialized institutions—with the corollary, I
think, that they had special regulations which historically have
been advantageous to them in some respects and maybe less than
advantageous in other respects—was a good idea.
The viability of savings and loans in the present kind of financial
environment has obviously been questioned, and the opposite philosophy, that you homogenize the institutions and give them all a
lot of flexibility, has come to the fore. I think that argument
becomes very powerful, more from the force of circumstances than
from any kind of ideal concept of the way in which you would want
the financial system to go. I think this is a matter of legitimate
debate. It's got all kinds of competitive implications and is something that is going to have to be looked at because of the circumstances that exist, regardless of what my predilections might be in
a more ideal kind of world.
I don't think any emergency legislation is needed because I don't
think it is particularly relevant to getting out of the current
235
squeeze in the short run. You are talking about a long-term structural reform.
Mr. MCCOLLUM. Which you would encourage us to look at?
Mr. VOLCKER. Yes.
Mr. MCCOLLUM. In
a related matter, regulators recently restricted the ability of depository institutions to offer NOW accounts to
business or sole proprietorships. Despite the fact Congress has
never narrowed the class of institutions which could offer NOW
accounts.
What is the justification for this new regulation particularly in
light of what we just discussed?
Mr. VOLCKER. The new regulation is not in effect. I think it is
going to come before the Board very shortly. We have had a lot of
comment on it, and I can tell you what we have done in putting it
out for comment.
The NOW account legislation basically says such accounts are
open to individuals and to charitable institutions and to a list of
other kinds of nonprofit institutions. Historically, in New England,
because of the practical difficulty of making a distinction between
a personal account and a single proprietor account, that was interpreted as meaning the single proprietor would not be policed, in
effect. As a single proprietor, a person can have a business account,
but it is to be counted as a personal account. We got a lot of
complaints, frankly, that that was too broad an interpretation, and
that we shouldn't allow any business accounts because the plain
language of the law said "personal accounts" and "nonprofit institutions."
After listening to that side of the story, we put the regulation
out for comment and, I suppose predictably, we had a great many
comments—from members of this committee and others—that existing policy was an appropriate policy and certainly was sanctioned by the history in New England.
We will be looking at that issue again very carefully. I think
there is a lot to be said for maintaining the historical approach. It
is simply a matter of interpreting what those words in the law
mean by personal accounts.
Mr. MCCOLLUM. With respect to that, the Fed has been considering a proposal to permit commercial banks to acquire savings and
loan associations. What is the status of that? Am I correct?
Mr. VOLCKER. This is a question that arises under the Bank
Holding Company Act, which the Board of Governors some years
ago interpreted as not permitting a commercial bank takeover of a
savings and loan, at least in ordinary circumstances.
Language of the statute says that we should permit activities
that are related to banking to the extent they are a proper incident
thereof. I think the Board at that time arrived at a judgment that
savings and loans were related to banking but were not a proper
incident thereof because of different regulatory treatment and so
on.
The CHAIRMAN. The American Fletcher and Baldwin cases?
Mr. VOLCKER. Yes, exactly. That decision has been questioned,
and it has been questioned increasingly recently. It came up in
congressional consideration, perhaps on this side, certainly in the
Senate, last year.
236
In effect, we suggested, that you not do anything about the law,
but that we would make a study of what appropriate policy would
be and submit it to you. That study is about completed, but I
haven't seen it yet. It will be submitted to the Congress fairly soon.
Mr. MCCOLLUM. Thank you very much.
The CHAIRMAN. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Volcker, we do appreciate your staying so we do have an
opportunity to visit with you about these important issues.
Mr. Chairman, one of the points that's been brought up is that
the new administration, the Reagan administration, has a more
relaxed attitude with regard to mergers and deregulations and
decontrol.
In my opinion, these administration policies will put them waistdeep in their own economic quagmire. They are creating a situation that has its own problems which they ought to be willing to
face up to in my judgment.
Their problems are complicated by the monetary aggregate
policy that you have pursued since October 1979. Lately, there has
been enough demand by large corporate entities to absorb a disproportionate amount of credit, hence support high interest rates.
In a sense, if we would like to look at it from a qualitative
standpoint, they are able to prioritize credits at reduced rates. The
chairman went through the scenario in terms of what is a prime
rate and what is the actual rate being paid.
You pointed out the tax differences and so forth yourself. The
disparity today is created by a very unique phenomena in which
the inflation rate is very low and interest rates are very high.
So isn't it really a phenomena in which you have less control
with this type of policy when you are pursuing it in an environment in which the Reagan administration is freely permitting or
encouraging, I guess overtly, changes in terms of what is going on
with corporate mergers?
Your policy really doesn't even speak to that. It doesn't talk
about equity with regards to who gets credit and who does not.
Mr. VOLCKER. I think that's right. Our policy does not speak to
that question. I don't have any knowledge of administration policy
on this point and whether the "whether-or-nots" you posed about
that are fair characterizations or not. It is true our policy does not
speak to allocating credit.
Mr. VENTO. The point is, the monetary policy you pursue does
create a disparity between interest rates and the financial institutions, as an example, or the bond market, can provide a more
advantageous rate on a priority basis to those large corporations, a
lot of which have immense profits. You know, 40 percent of the
profit last year went to oil companies.
I guess we all know the reason for that, but they have large cash
balances and certainly are having their impact.
Mr. VOLCKER. I am not sure it is providing a more advantageous
rate. I don't know what the rates are on all these arrangements. I
assume they are market rates.
Mr. VENTO. I don't think anyone knows.
Mr. VOLCKER. They are perfectly willing to pay the rate.
237
Mr. VENTO. The point is that because of the monetary policy we
are pursuing, the Fed is less involved than before in terms of
providing leadership in terms of interest rate, is it not?
Mr. VOLCKER. Less concerned with providing leadership with
interest rates, yes.
Mr. VENTO. I think that is important. Maybe we can correspond
more about it. Another concern I have is that our high interest
rate policy flies in the face of world needs and western European
needs. International dialog or agreement on interest rates, and
monetary policy, would be helpful, would it not?
I recall the 1978-79 circumstance, where especially West Germany maintained high interest rates. I think almost everyone
would agree that the impact on us was negative.
They thought we needed that medicine. In essence, we are telling
them the same thing today, that they need the medicine.
Wouldn't we be better off being somewhat sensitive to the problems and concerns expressed today by our trading partners?
Mr. VOLCKER. I think we should be sensitive to those problems,
and over a period of time—looking toward a more stable future—I
would hope we wouldn't see the kind of thing we see in rather
extreme form today. But I think it would really be an illusion to
think that, given the state of play today in terms of the economy
and markets, that we could manipulate interest rates or fine tune
interest rates in accordance with some kind of international standard. I don't think we are able to do that in current circumstances,
and our priority has to be to do what is necessary to deal with the
basic sources of the instability. If we fail in that job, we will find
ourselves constantly in this kind of a state, rather than having
achieved anything constructive from either the national or international standpoint.
Mr. VENTO. Let me shift gears now. I am sorry about the rapidity
of this, but here is a changed perception. One of the things we face
is the different types of depository institutions, different financial
institutions., and this whole money market fund phenomenon. Of
course money market funds are not the same. You don't multiply
money with them. They are a special type of investment, and
really I mean we are talking about arguing over the bones back
here in terms of the regulatory side of the equation for financial
institutions.
On the other side, we are facing a phenomenon in which, I
believe, there is a permanent modification in the financial behavior
of savers. Consumers have had a taste of money market funds and
like what they offer and the brokers have the names of the folks
that are interested in them. What I really mean is I think we had
better address MMF's in some manner and I am not saying reserves is the answer.
Mr. VOLCKER. That is precisely why we raised the issue and
made the policies that we did, and I think it would be constructive
to address the issue, considering that these are, I am sure, a
permanent part of the financial landscape now.
I won't expect them to grow at the rate that they have been
growing. That is partly a phenomenon of the present distortions; in
large part their growth is stimulated by the present changes in the
market. But not only do I think it legitimate, I would even urge
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you to sit down and look at it, and ask, "Now we have a new
phenomenon here. What is the appropriate regulatory approach, if
any?"
The CHAIRMAN. Mr. Wortley?
Mr. WORTLEY. Chairman Volcker, is the money supply your primary criterion in determining interest rates?
Mr. VOLCKER. YOU say, "in determining interest rates." The
money aggregates broadly conceived are a primary influence on
our provision of reserves over a period of time. What interest rate
comes out in the market is up to the market. That is the nature of
the policy.
Mr. WORTLEY. But you are in fact establishing interest rates for
the banks and the system, your interest rates, your charges.
Mr. VOLCKER. We establish a discount rate.
Mr. WORTLEY. Right, discount.
Mr. VOLCKER. We don't establish the market rates.
Mr. WORTLEY. But in effect, your actions have a bearing?
Mr. VOLCKER. It has.
Mr. WORTLEY. On the
Mr. VOLCKER. It has
marketplace?
an influence on it, but the market rates
deviate widely, and the margin between the discount rate and the
market rate varies widely over time. The discount rate is an influence but
Mr. WORTLEY. Your discount rate, does it play a primary role in
determining what the market rate is going to be on interest?
Mr. VOLCKER. I would not say a primary role. The primary role is
played by the interaction of the demand for money and the supply
of money, whatever the discount rate is. The discount rate has an
influence, but I would not say the primary influence.
Mr. WORTLEY. But everybody looks to the Federal Reserve and
says, "Well, their rates are going up."
Mr. VOLCKER. That is right.
Mr. WORTLEY. That is the reason we are for it. The bank says it
is costing me money to borrow.
Mr. VOLCKER. Psychological influences apart, the discount rate
also has a real influence on the market. I would say that it is not
the primary influence.
Mr. WORTLEY. Does inflation and unemployment, budget deficits
or your perception of them, play a role in setting the rate, setting
your discount rate?
Mr. VOLCKER. Setting the discount rate, no, not in any direct
sense. The discount rate tends to be set in the light of some
evaluation of what market rates are already doing. That is the
most immediate reason for setting or changing the discount rate.
Mr. WORTLEY. IS there anything this Congress or this administration can do that would convince you to lower the interest rates,
which are really strangling businesses?
Mr. VOLCKER. YOU raise the question in such a way that I am
inclined to answer "no," because we are not setting the rate in the
way that the question implies. There are things that can be done
that will reduce the market rates.
Mr. WORTLEY. But the corner banker always blames the discount
rate.
239
Mr. VOLCKER. Yes; the corner banker is going to find it convenient to put the blame elsewhere in talking with his customers.
That doesn't mean that his economic analysis is always precisely
correct.
Mr. WORTLEY. Don't you think if you lowered your rate he would
lower his rate?
Mr. VOLCKER. If we lowered our rate, the market would react, I
presume. I am not sure in which direction; let's presume they
reacted in the direction of lower rates in the short run. But, over
time, what is going to influence the market rates is not whether we
have lowered the discount rate by 1 percent or not, but the interaction of supply and demand for money and credit. If we lower the
discount rate but do not change the provision of reserves into the
market, if everything else is unchanged, that lowering of the discount rate is not going to have a persisting effect on the market.
Mr. WORTLEY. Thank you. Thank you, Mr. Volcker.
The CHAIRMAN. Mr. Barnard?
Mr. BARNARD. Thank you, Mr. Chairman. Chairman Volcker,
your patience has been well tested today and the one satisfaction is
that there is not much to go. I have been very much interested,
and I am sure that most of the Members of Congress have been, in
the criticism that our allies have made as to our high interest
rates. What are they doing to achieve lower interest rates? Are
they achieving lower interest rates?
Mr. VOLCKER. It depends upon the country. In the continent of
Europe interest rates have generally been rising over the perspective of some months. In the United Kingdom, over the perspective
of months, rates have tended to decline, although there has been
some increase recently. In Japan, rates have tended to decline.
Mr. BARNARD. Has this been brought about by their central
banks monetizing their deficits, or has it come about because of
control of deficits?
Mr. VOLCKER. The countries in which rates are rising have had a
variety of problems, I think, and the rise has reflected all of these
things. Those countries have large government deficits, by and
large, particularly in Germany. Japan does, too, as a matter of fact.
They have had depreciating exchange rates; interest rates have
had something to do with that, but other factors enter in, too,
including, that fact that they have had, by and large, big current
account deficits.
We have been pretty much in balance in our current account.
There have been some political uncertainties in the background in
Poland and elsewhere, and of course France had had a change of
government. All those things have influenced exchange rates, influenced the inflationary situation, the inflationary outlook, and, to
some extent, those factors have been reflected in increases in interest rates. Among those factors is a desire not to have their currencies depreciate too much.
Mr. BARNARD. Those that are keeping low interest rates, aren't
they pretty well traveling the same road that we have been traveling the last 10 years; that is, causing a
Mr. VOLCKER. Again, you have to look at each country separately. The leading example of a country with interest rates moving
lower in the last year or 6 months has been Japan. Japan has had
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both a sharply improving current account and a very much improving price situation. They had very restrictive monetary policies
some time ago, but in the past year their wholesale price index has
actually declined a hair. Their consumer prices are going up, but at
a rather modest rate of 4 or 5 percent, as I recall. They have had
wage increases in the 5 or 6 percent area, as I recall, so their
inflationary situation has been looking quite good. Among all the
leading countries, Japan has been doing pretty well, and they have
combined this with a considerable expansion of the economy.
Mr. BARNARD. They have also, I believe, a very high savings
rate?
Mr. VOLCKER. They have a very high savings rate. They have had
substantial governmental deficits in recent years, but those governmental deficits don't look as big when you look at a savings rate in
the vicinity of 20 percent.
Mr. BARNARD. What about West Germany?
Mr. VOLCKER, West Germany also has a relatively high savings
rate, more in the order of 14 to 15 percent. They also have had
much larger deficits in recent years, which they are not very happy
about, and their economic performance has not been as sterling in
the last few years as it was earlier, but they certainly do have, by
our standards, a high savings rate.
Mr. BARNARD. We have got enough problems of our own without
trying to tell them what to do, but it is interesting to compare
their criticism of us when it looks to me that they seem to be
somewhat on the same path.
Mr. VOLCKER. There is no question that they have problems of
their own, but it is natural and human, and also right, that dealing
with their internal problems—which are already difficult—they
would not want external influences further complicating their life.
Mr. BARNARD. And back to interest rates again, on table 1 it
shows that M3 has grown at a rate of 11.5 percent through the
second quarter of 1981, and in June it was 11.1 percent. Of course
this actually means now that that part of the money supply is
going into nondepository institutions paying higher returns.
Mr. VOLCKER. Yes.
Mr. BARNARD. And
we have heard so much said this morning
about how housing has been hurt, how homebuilding has been
hurt, how people have not been able to buy automobiles, how small
businesses have been hurt, so consequently we just find that this is
an unfortunate but normal phenomenon of inflation.
Mr. VOLCKER. I think what you see here, is quite adequate
growth of M2 and M3, but there are so many credit demands out
there on the market, including by the U.S. Government, that somebody is getting squeezed out. The person who says "uncle" first
tends to be the home buyer or someone else in the weakest position. How do you deal with that problem? Do you try to create
more money and create more credit supply to take care of that? In
that case you are going to end up with a prolongation of inflation
and more inflation, and you will be in the same situation but at a
higher level of inflation. Do you try to deal with the problems that
are giving rise to the excessive demands, which in a general sense
flow out of the inflationary process?
241
Mr. BARNARD. I can't help but comment in closing, Mr. Chairman, that if I had been sitting in the seat that you are sitting in,
and so many of the criticisms have been about the contention that
you are not speaking out, I might ask the question, who is listening. I have been here through three chairmen of the Federal Reserve, and I have heard all three of them talk about being fiscally
responsible, the balanced budget, and yet I see so many of our
colleagues in the Congress still not understanding that that is the
primary problem with the economy today. I think that we need to
remind the public time and time and time again, the plight that we
are in today is not something that just occurred in the last 5 years.
It has been building over the last 12 or 15 years, and it is going to
be a long time pulling out of it, but nobody wants to acknowledge
that fact. That is my rhetorical statement, Mr. Chairman.
The CHAIRMAN. Mrs. Roukema?
Mrs. ROUKEMA. It is difficult to understand what is being left
either to ask or say at this hour, but I am going to ask a couple of
questions anyway. I will find them. Mr. Chairman, quite to the
contrary to some of the statements that have been made today,
there are those who feel that perhaps too heavy reliance has been
placed on using monetary policies to correct and control inflation,
and that if anything perhaps the Fed hasn't been doing enough or
has been required to do too much, but for different reasons than
your critics have suggested. Would you be willing to comment or
give your own personal view as to whether too heavy reliance is
being presented on our present program on your policies.
Mr. VOLCKER. From my point of view, there is no question that
too heavy reliance is being placed on monetary policies. If all this
reliance were not placed on monetary policies, I would have a more
pleasant job in testifying before you. Having said that—and this is
the point I don't want any confusion on—and whether the reliance
is too heavy or not, I think we have to do what we have to do, and
that is to carry out our responsibility to try to deal with this
inflationary problem by restraining the growth of money and
credit. My job is also to tell you what I think the consequences of
that are; and it is true, the higher the deficit, the bigger the
problem is.
Mrs. ROUKEMA. I agree with you, and I am sympathetic to that,
and I am trying to get to the point of what other ways we in the
Congress and the administration can be helpful in terms of resolving the problem. You have stated, and I think these were your
words, that there is a responsibility on the part of the Congress to
reconcile the tax programs with the deficits.
Mr. VOLCKER. Right.
Mrs. ROUKEMA. I would like to hear any further commentary you
might have, particularly since we will be discussing tax policies
and voting on it within the next 2 weeks, from the point of view,
not the general point of view but from the point of view of being
supplementary and complementary to the efforts that the Fed is
making.
Mr. VOLCKER. There is obviously a desire to have some tax reduction, and there are, as I have said repeatedly, good, legitimate
economic reasons why tax reduction can be helpful in these circumstances. That statement has a few corollaries: First, that the
242
deficit is a problem, so the more tax reduction you do the more
spending cutting you have to do; and, since there is a limit as to
what spending cutting you can do, I would only want to take that
tax reduction that you think has a real payoff in terms of productivity and incentives. There is a great debate about what that is, I
recognize that, but I certainly would not add things to this tax bill
that did not have a very clear rationale in terms of getting more
savings, reducing costs, or other purposes of that kind. If you make
tax cuts, to put it very bluntly, that may be nice to have but that
are difficult to rationalize in terms of the overall economic situation, then you are making the job of the Federal Reserve—but,
more importantly, you are making the pressures on the financial
markets—greater, without getting anything in return in terms of
economic performance. Maybe you have got other objectives in
mind, but then don't complain about the additional burden put on
financial markets.
Mrs. ROUKEMA. Aside from the targeting or lack of targeting in
the tax program, is the total aggregate number, would you say that
that is a number that you could live with, the tax reduction?
Mr. VOLCKER. I am not quite sure what that number is now.
Frankly, as I understand it, the program that was being discussed
in May or early June—when it still looked like there was some
chance of an agreed program—provided for a reasonably modest
reduction, a 5-percent reduction, with some of the business tax
deductions before the middle of next year. Of course, there was a
much bigger reduction in the bill in the middle of next year.
With that coming in about 1 year from now, the question that of
course arises is how does that fit in with the expenditure trend at
that time? The Congress has done valiant work in cutting back on
expenditures. From my point of view, it is probably marginal under
that set of circumstances as I know them now. I don't know what
has been added to it since then, but it makes me very uncomfortable to see things added to it.
Mrs. ROUKEMA. My time has expired and I never got to the
question that no one has covered on the question of income policies
in terms of labor contracts that will be coming up. I am sorry for
that. Perhaps I could submit that to you.
The CHAIRMAN. Without objection all members will be allowed
the opportunity to submit questions in writing to the Chairman. I
am sure as always he will be more than happy to receive the
questions and reply.
Mrs. ROUKEMA. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Schumer?
Mr. SCHUMER. Thank you, Mr. Chairman, and thank you for
your patience, Mr. Volcker. I don't know if Volcker is a Dutch
name, but a number of my constituents see you as the little Dutch
boy with your finger in the dike. However, they also see that your
playmate down the road on Pennsylvania Avenue is the one who is
creating all the waves, and is going to force you to keep your finger
in that dike for a longer period of time than you might have to.
My questions relate to how high can you go. Last week I think it
was, Helmut Schmidt said that interest rates are higher than at
any time since the birth of Christ, and of course when I was in the
State legislature, when we used to hear of a 20-percent interest
243
rate, we immediately thought of a loan shark, and so my basic
question is if the present tax cut and limited budget cuts don't curb
inflation, will you try to push interest rates higher than they are
now, significantly higher? How much higher, and if not, what then
can we do?
Mr. VOLCKER. We are not trying to push interest rates anywhere,
if I may just repeat that point. Interest rates come out in the
market. Now you talk about interest rates not ever having been
higher. I don't know whether that is true or not in Germany, but if
you want to see the relationship between inflation and interest
rates, look south of the border, where you have countries that have
experienced inflation rates above 100 percent with interest rates
exceeding 100 percent. Thus, if you are going to have a high rate of
inflation you are going to have high interest rates. Inflation, unfortunately, was not invented just yesterday.
I don't know how I can constructively answer your question.
Interest rates are already high relative to the inflation rate. I
think they are particularly high relative to the prospective inflation rate. The fundamentals of the situation suggest interest rates
should be going lower, but just when that will happen, how that
will happen, depends ultimately upon that inflationary trend and
the conviction that inflation is going to come down and does come
down, combined with action on the deficit and all the rest. Interest
rates are already very high, and they are high enough, apparently,
to exert a strong restraining effect on the economy, which suggests
it is not likely they are going to go a lot higher.
Mr. SCHUMER. That is good news. I hope we are right. My second
question relates to a question I have had in my mind, and I haven't
heard adequately answered. We have seen, because of high interest
rates, dramatic changes in where money is going. You know the
money market funds have had such a huge increase, and they in
turn buy Treasury notes and CD's. Where does all this money
ultimately end up? Is it long-term money that is now turning into
short term in terms of corporate borrowing or Federal borrowing?
Has the Fed done any studies of that?
Mr. VOLCKER. I don't know if it is possible to do a study to
answer all the questions you might raise, because, in a complicated
financial market, the effect of one factor is almost impossible to
trace. I will just make two comments.
First, the whole inflationary environment, and to some degree
the instability in interest rates, I think, has fostered the tendency
for more and more borrowing to be short term, whatever the
demand is. In any event, the borrowing becomes short term when
you put it on a fluctuating rate basis; some of it is literally short
term. I think that is unfortunate, in terms of the basic financial
structure of the country. It is one of the symptoms of the malaise
that we have.
Money market funds grow partly out of that phenomenon. They
offer a very short-term liability; people feel that they are not
making any long-term commitment and can get a high interest
rate. Funds, in turn, put the money in very short-term securities.
It is true that they go around the country at something like a
vacuum cleaner or branch office bank. We have nationwide banking without branch offices, through the mail, and the funds move
244
into a central point and tend to be put in a rather selected list of
securities, which to a limited extent are Treasury securities and
agency securities, and to a considerable extent CD's or market
CD's. The credit doesn't disappear, but it gets rechanneled, and it
does appear in the wholesale money market instead of in the retail
markets where it is sorted out.
Mr. SCHUMER. And where does that lead us to?
Mr. VOLCKER. Presumably competition then spreads the money
out again but, all things equal, it is a little less available at the
country bank or the S. & L., and it is more available at your friend
in New York City.
Mr. SCHUMER. My final question is you know each week when—
my time has expired. I will send the last question in writing.
Thank you, Mr. Chairman.
Mr. VOLCKER. I will give shorter answers.
The CHAIRMAN. Mr. William Coyne.
Mr. W. COYNE. Thank you also for your patience.
In learning from my predecessors I will try to put out all my
questions at the beginning and let you take up the balance after
my 5 minutes.
I have heard you called everything from calloused tool of the
silver speculators or the bankers or the oil companies, candidate
for impeachment or someone who is just crying wolf or trying to
put your finger in the dike. More than anything else I think you
are being a scapegoat for many of the ills and problems of our
country.
I hope a better fate will fall upon you than fell upon the ancient
messengers in Greece that were promptly assassinated as soon as
they delivered the bad news.
I have several questions that you might be able to help us with
the relationship between inflation and interest rates. Four or 5
years ago it was always said that inflation was the cause of high
interest rates.
Now I hear you and others saying that high interest rates may
be the cure for inflation, so we are obviously seeing different sides
of the cause-and-effect or cure-and-effect relationship.
To me it seems more that inflation and interest rates are inevitably coupled together in sort of a self-regulating almost zero mechanism type of relationship.
Mr. VOLCKER. I agree with that.
Mr. W. COYNE. And there is in effect no cause and effect trying
to figure out what did what to whom, we will eventually come back
to the discipline that you were talking about earlier.
I am especially concerned about the lack of discipline both
within our financial institutions and with the regulation and deregulation of many of these institutions, and with regard to the proposals for new fiscal resonsibility here in Congress, and I would
like you to address first the issues surrounding the S&L's.
We have heard a lot of comment about how they have been
forced into accepting regulation Q for all these years, and how they
are victims of Government regulation.
Now, of course, they are crying out for more regulation. Is this
inconsistent with your perception of discipline?
245
Second, we have seen in the Senate a proposal for indexing our
income taxes. Many people point to indexing as a form of discipline, at least upon Congress itself.
Do you support that kind of self-regulatory discipline on Congress obviously expensive habits? Some of my colleagues on the
other side seem unwilling to accept the 20-year record that we have
of consistent deficits or feel that we can somehow believe now that
the Democrats are serious about controlling them.
Third, I would like to see your comment or your view about the
intense concentration of our financial institutions that has occurred in the last 3 years.
My colleague, Mr. Schumer, alluded to this, and it is very troubling to me. We have had a body to make sure that our financial
institutions don't become overly concentrated. Are you now changing the Fed's policies to say no, you are willing to accept more
concentration, or do you want to maintain the same vigilance
against this that you have in the past?
Fourth, I have a very small question on behalf of one of my
constituents regarding your pricing for automated clearinghouse
services. Many of my constituents feel you are practicing some
predatory pricing, if you will, underpricing the services for the
clearinghouse, to the subsequent detriment of some of the private
producers in clearinghouse services.
Sorry to give you a lot of questions but I wanted to get them out
before my 5 minutes were up.
Mr. VOLCKER. I can't even read my own writing now in answer to
your question No. 3.
Mr. W. COYNE. The concentration.
Mr. VOLCKER. It began with a "C" all right. Let me take your
questions up in reverse order. On the automated clearinghouse
question, very quickly, most of the Federal Reserve Banks do have
a role in the electronic payments systems and, in fact, there have
been public polls to encourage that as a more efficient, effective,
quicker way to make payments. The banking system has generally
wanted to go in that direction because of its inherent long-run
efficiencies. So, in developing prices, we did consciously say that we
would price that particular item—and that is the only one we took
this decision on—at a price that will return the cost in what we
call a "mature environment/' when the volume approaches some
kind of a reasonable trend level, which we would expect to reach
in, say 4 or 5 years, as I recall it. If you don't do that, that is a high
cost operation when the volume is very small. Therefore, we want
to price for the economies of scale and efficiency that are inherent
in the system when it matures.
The banks have been very alert in policing us, if I may say, to
make sure we didn't underprice the services, because they want to
compete with us; on this one they want it priced on a long-term
basis, because they recognize that otherwise the service isn't going
to go forward.
There has been some expression of concern from people printing
checks who feel that this will impair the volume of checks. Our
own analysis says the check volume is going to go upward, so you
are not talking about suddenly decimating the volume of checks in
the country. Of course, the long-range problem we face is that at
246
some point these paper payments are going to be impossible to
handle, just because of their sheer volume, so I think it is in the
interest of efficiency in the country—and it is entirely consistent
with pricing—to cover costs, including all those wrinkles of private
capital-equivalent costs as the volume increases.
If the volume never increases, if people don't want the service,
then this policy won't be appropriate in the long run; but we think
people will want the service, and it will be more efficient in the
future.
On the question of concentration, I can only give you a very
personal reaction. I do not feel that the concentration that I see
going on in the financial community has reached a stage where
concentration in and of itself is a problem.
There are a great many other things going on technologically
that are forcing enormous change and forcing some mergers and
takeovers, with existing institutions gong into new fields, but concentration, per se, I do not think is a problem generally in the
financial area.
It is a highly competitive area. Interestingly enough, as you
probably know, the Federal Reserve has a reputation of being
extremely tough on concentration in terms of its regulatory decisions. We have lost a few court cases recently which say we are too
tough; and I don't know what that reflects, but it is the fact of the
matter.
On indexing, I simply must
Mr. W. COYNE. I just want to make a remark.
The CHAIRMAN. The time of the gentleman has expired.
Mr. W. COYNE. Then I will not expand upon it.
I thank the chairman.
Mr. VOLCKER. On indexing, I will be very short and say that I am
generally opposed to indexing of all kinds. I don't see any reason to
exempt indexing income taxes from that general stricture. I could
give you a lot of reasons, including technical reason that basically
the construction of an extremely imperfect consumer price index
doesn't warm the cockles of my heart, but I think there are other
public policy reasons for not thinking we can escape our real
problems by simply indexing things, that only disguise the real
problems.
What discipline or lack of discipline there is in financial institutions is a very interesting question to me, and we could sit here
talking about it all day.
Let me just say I don't think it is very fruitful, just as it is not
with the interest rate question, to go over history and attempt to
specify to what extent the problems of the thrift institutions are of
their own making or to what extent they are a reflection of public
policy in the past. Like everything else there is some combination
of the two. There certainly is an element, of public policy to blame
the fact that they were encouraged to undertake long-term assets.
Without saying anything more, I think this whole inflationary
process during the post world war period, and the fact that we
have had an enormously favorable record economically against all
the past history—we haven't really had a very serious recession for
40 years, since World War II—changes people's behavior. It
changes the way people look at things. I suspect financial institu-
247
tions are not as disciplined in some ways as a good, conservative
central banker would like to see them.
A banker is encouraged to take more risks, to leverage capital
more, to have less liquidity, to engage in types of lending that
perhaps should be looked at a little more carefully. To some extent,
one wonders whether this great willingness to provide all these
merger commitments isn't a symptom of that kind of relaxation of
discipline.
Financial institutions, I think, like and take great comfort in the
fact that their liabilities are insured and that the Federal Reserve
sits there as a lender of last resort. I am not sure they always
recognize that the logical consequence is that those who get left
holding the bag when something goes wrong have a legitimate
interest in what is happening before things go wrong.
Mr. W. COYNE. Thank you very much.
The CHAIRMAN. Mr. Frank.
Mr. FRANK. Thank you. Thank you, Mr. Chairman, for your
patience. I will try not to repeat questions, but, frankly, I forgot
what most of them were. I would like to get back to the tax
question, and you have spoken out legitimately and given us advice
in part, and here again, saying we ought to be cutting spending
and cutting spending is good and I think it is perfectly reasonable
for you to make an equal degree of recommendations with regard
to taxes.
Now the problem I have is with regard to the future tax cuts we
may be doing, and that is what has become controversial. You
stressed expectations. You said earlier that in fact interest rates
are higher than the fundamentals would dictate, that there appears to be an expectation of continued inflation built in that is
keeping rates up, say particularly in long-term bonds that is a real
problem for us.
You say on page 9 of your statement that in the long time frame
interest rates will depend on confidence that inflation will be controlled.
The President has expressed exasperation with Wall Street and
with the failure of interest rates to come down.
You said, and I think a lot of people are surprised that Congress
did do the cutting it did, but already there is some slippage. We
just came back from voting to restore the minimum benefit, at
least a very large majority, about 90 percent of the House did that.
My problem is this: If we were to adopt now, ironclad, a third
round of personal income tax cuts, what would you think the effect
of that would be on these inflationary expectations, given, as you
said, that part of our problem with higher interest rates now is a
set of expectations that is really deviling us?
Mr. VOLCKER. Well, it is simply a matter of reporting, I suppose—some people in the market would say that makes them more
skeptical as to whether the budget will be balanced.
There is also a strong view in the market, partly offsetting that,
that tax reduction will force some additional discipline on spending.
Mr. FRANK. Although as a banker in Massachusetts said to me,
that latter viewpoint is one they expressed but the former view-
248
point is the one they invest according to. Investment behavior
then, it is a fair statement
Mr. VOLCKER. I think you will find both views reflected in the
same manner; that is correct.
Mr. FRANK. And, obviously, investment behavior is what is going
to affect us. Particularly, I worry about long-term bonds which
have behaved in a way that has puzzled us and caused economic
effect.
Am I correct now in saying that your reportorial statement, not
a statement of your personal preference, is that locking in a third
round of tax cuts now will lead a significant number of people in
the financial markets to be more skeptical of our ability to balance
the budget, and that will, everything else being equal, lead to
higher interest rates than we otherwise have for long-term instruments particularly?
Mr. VOLCKER. YOU have got to look at it in the context of all the
other things you are doing.
If you can do something to get out there and convince people
more that you are going to have
Mr. FRANK. That is not my question.
Mr. VOLCKER [continuing]. Spending cuts.
Mr. FRANK. With respect, Mr. Chairman, we have only a little
time. That wasn't my question.
Mr. VOLCKER. AS a reportorial statement, I think some people
are bound to think that.
Mr. FRANK. SO that everything else being equal, again you know,
if my aunt was a man she would be my uncle. I mean we are all in
favor of certain things happening, but you do say, and I quote from
your statement and from what you said earlier, we are plagued by
a skepticism on the part of the financial community and perhaps
the country at large.
Mr. VOLCKER. It is against that background that I make that
observation.
Mr. FRANK. SO that it is fair to say that your view is that a third
round of tax cuts now, since we cannot take action constitutionally
and legally to lock in future spending cuts for fiscal year 1983 and
1984 in a very effective way, a third round of tax cuts will add
somewhat to inflationary expectations?
Mr. VOLCKER. I would not put the quantitative importance of
that as high.
Mr. FRANK. HOW high would you put it?
Mr. VOLCKER. That factor alone?
Mr. FRANK. HOW high would you put it, that high, that high? Let
the record show how high your hand is.
Mr. VOLCKER. The decision could go either way without your
seeing an impact on the market the next day that you could
identify.
Mr. FRANK. I didn't ask for it the next day, Mr. Volcker, and I
think that is a strawman. Let me get back to Mr.
Mr. VOLCKER. I don't have to rely on the next day; if you look at
it over a period of months I don't think you are going to be able to
look back and say that decision had an important effect.
249
Mr. FRANK. Mr. Volcker, you don't think that the amount of the
deficit, people's expectation of whether or not we are going to
balance the budget in 1984
Mr. VOLCKER. Yes; but I ask for what they read into that particular decision.
Mr. FRANK. Right. And I think this is the frustration that Mr.
D'Amours expressed.
Mr. VOLCKER. I understand.
Mr. FRANK. YOU seem to me to be more willing to speak out on
the interest rate implications of spending cuts than of tax cuts, and
I would just ask for an equal free willingness, and I think that—it
seems to me you can do that legitimately in your reportorial function and also say as a matter of personal preference you would
rather cut on the spending side than hold back the tax cuts.
Mr. VOLCKER. I think the effects on the deficit in some sense are
similar and that they have similar impacts. Looking at this strictly
as an economic matter, in terms of economic policy—not as social
policy, which enters into this—the tax reduction in itself has benefits that spending does not.
Mr. FRANK. All tax reductions?
Mr. VOLCKER. Tax reductions do serve a purpose.
Mr. FRANK. All tax reductions, 1,000 barrels a day for the independents?
Mr. VOLCKER. I have repeatedly said to concentrate on those tax
reductions that have a favorable effect. You will have a more
favorable impact on inflation, a more favorable impact on the
performance of the economy—and I am not saying there aren't
other considerations, but I am just looking at the overall performance of the economy and of financial markets—from simultaneous
tax and spending cuts that will leave you the same or better off.
Mr. FRANK. That is true if you are talking about simultaneously.
The problem we have got is constitutionally and in every other way
we cannot act simultaneously. We don't have the option now of
making either spending cuts or tax cuts for fiscal 1983. We can
either make tax cuts that are binding for fiscal 1983 or do nothing.
That is the problem from the expectation standpoint.
The CHAIRMAN. Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman.
Mr. Volcker, let me just state a few questions here for you and
maybe you can go back over them and answer them in as short a
way as you can, preferably with a yes or not where that is possible.
First of all, if the present high rates of interest continue, how
long can the country go witout a serious depression?
Second, will tax cuts increase the money supply? Will tax increases decrease the money supply? Will decreases in Government
spending reduce the money supply?
On the balanced budget, should this have a higher priority for
the Congress than would a personal tax cut; a business tax cut; or
any tax cut? Do higher interest rates hinder or handicap our
country's efforts to increase or improve its productivity?
Do you regard high interest rates as one method of controlling
credit?
If you had credit control authority, would you act to restrict lines
of credit that would prevent these takeovers, say, of Conoco and
250
other companies, say the flow of $35 billion into that type of
activity?
In talking today about whether the Fed will choose to monetize
the Federal debt, actually the debt is automatically monetized, isn't
it? I mean the Treasury issues, Treasury bills, whatever is necessary in order to put into the market, either money or evidence of
debt that in effect monetizes the debt.
Last, you have a target for the money supply. Do you have any
targets for interest rates? First of all, how long can we go without
a serious depression at these rates of interest?
Mr. VOLCKER. We can probably go a long, long while; I don't
know whether we would ever have a serious depression if the
inflation rate remained high. We got a dip last summer, but we
have had extremely high interest rates for well over a year now, as
you know, and the surprising thing is that the economy has, for
most of that period, expanded. It declined when we had credit
controls, but it hasn't declined otherwise. The enormous thing that
stands out is the resiliency of the economy in the face of these high
interest rates.
Mr. PATMAN. Will the tax cuts increase the money supply?
Mr. VOLCKER. Both the tax cut
Mr. PATMAN. Just the tax cut.
Mr. VOLCKER. NO; not in the direct sense.
Mr. PATMAN. Yes, no? Your answer is no?
Mr. VOLCKER. If I had one answer, "no," with a lot of footnotes.
Mr. PATMAN. Tax cuts don't increase the money supply?
Mr. VOLCKER. A tax cut does not directly increase the money
supply.
Mr. PATMAN. Well, in effect, does it not? You can put the money
in the bank.
Mr. VOLCKER. YOU can discuss this forever. If I had to give one
answer, I would say "no."
Mr. PATMAN. Will the tax increases decrease the money supply?
Mr. VOLCKER. NO.
Mr. PATMAN. Will decreases in Government spending reduce the
money supply?
Mr. VOLCKER. NO.
Mr. PATMAN. Should
balanced budgets have a higher or priority
for us than a personal tax cut?
Mr. VOLCKER. They both should have priority. If you say
Mr. PATMAN. I am talking about a higher priority, though.
Mr. VOLCKER. It is not an either/or choice, and that is the
difficulty. I certainly would not go ahead willy-nilly with tax cuts
regardless of the impact on the deficit. The deficit is very important in my mind. You are not going to have a zero deficit next year
anyway, so it is not a black and white choice in that sense.
I think you should go ahead with the personal tax cuts only if
you think that you can fit that into a program that will eliminate
the deficit in 2 or 3 years.
Mr. PATMAN. All right, a business tax cut, do you equate that
with a personal tax cut as far as priorities are concerned?
Mr. VOLCKER. AS far as what is concerned?
Mr. PATMAN. Priorities are concerned?
251
Mr. VOLCKER. I think as a matter of priorities, starting from zero
and asking what you do first, you do the business tax cut first,
because I think it is easier to develop some business tax cuts that
will more assuredly have the good effects you want to get from tax
cuts; but you can cut taxes with a higher payoff in the business
area.
Mr. PATMAN. DO you visualize high interest rates as a method of
controlling credit?
Mr. VOLCKER. NO; I don't think that puts it in the right perspective. High interest rates are what result from a situation where
you are restraining money and credit, and there are big demands
for money and credit, particularly when they are growing out of
inflation.
You can call that a method of controlling, but we don't go out
there and say, "I want a higher interest rate to control the credit/'
We control the credit and the market produces the high interest
rates.
Mr. PATMAN. DO the high interest rates or the controls on credit,
as you choose to call them, maybe hamper our trying to increase
the country's productivity?
Mr. VCLCKER. Over time, I think the answer is no, if the policy is
successful. If you look at it in a snapshot way, would you get more
investment right now if interest rates were lower? You would; but
you can't answer the question with a snapshot.
Mr. PATMAN. If you had credit allocation authority, would you
seek to restrict the takeovers and the use of credit in the manner
that we have seen evidenced recently in the movement of $35
billion into some sort of commitments?
Mr. VOLCKER. I haven't yet seen the evidence that would lead me
there. It is a very difficult issue.
Mr. PATMAN. YOU don't regard it as a serious problem?
Mr. VOLCKER. I have considerable concern over what I see going
on in a number of directions.
Mr. PATMAN. Would credit allocation power enable you to stop
it?
Mr. VOLCKER. NO; I think we found out quite clearly last year
when we had takeovers on our list of nonproduct uses of credit
that, first of all, that shouldn't be done; there are many other ways
of financing that other than through the banks that we directly
regulate.
The biggest immediate complaint came concerning all the foreign
banks that are not under our supervision.
Mr. PATMAN. DO you have targets for interest rates as well as
monetary money supplies?
Mr. VOLCKER. NO; we don't have any real targets for interest
rates.
Mr. PATMAN. IS it true that the Federal debt is automatically
monetized?
Mr. VOLCKER. Not by my definition of the word monetized. I
don't find that word very useful, because everybody has a different
meaning in mind.
Mr. PATMAN. Can you send me the correct definition of that?
Mr. VOLCKER. I don't think it is a useful term, but I think what
most people have in mind is purchases either by the Federal Re-
252
serve or commercial banks—and it is not usually clear whether
they mean either or both—of Government securities.
Mr. PATMAN. Somewhat akin to trying to define prime rate.
Mr. VOLCKER. It is considerably more difficult than trying to
define prime rate. I don't think you can say much more than
whether the money supply or Federal Reserve credit is going up
too much or too little; whether that takes the form of a purchase of
Government securities or something else is secondary.
Mr. PATMAN. Thank you, sir.
The CHAIRMAN. Mr. Chairman, we want to congratulate you on
your tenacity. There has been a request for a second round of
questioning that has been denied. The Chair does have other meetings and a conference coming up at 3 o'clock. I think that all the
members have had an opportunity to participate, and I want to
thank Chairman Volcker for his patience and for staying so long so
that we could allow all the members an opportunity. Again, I
repeat those members who so desire may submit questions in writing to the chairman.
The hearing is adjourned until tomorrow morning at 10 o'clock
when we will hear from the witnesses previously announced.
[Whereupon, at 2:10 p.m., the committee was recessed, to reconvene at 10 a.m., Wednesday, July 22, 1981.]
[The following additional material was submitted for inclusion in
the record: A letter from Chairman Fernand J. St Germain, dated
June 12, 1981, to Mr. Anthony M. Solomon, president, Federal
Reserve Bank of New York, regarding Federal Reserve repurchase
agreement transactions, with Mr. Solomon's reply dated July 7,
1981; news articles from various publications regarding bank mergers, and questions submitted by members to Mr. Volcker along
with his responses. The material follows:]
253
t. WILLIAM STANTON. OHIO
FERNAND J. ST GERMAIN. R.I
HENRY S. REUSS. WIS.
CHALMERS P. WYLIE. OHIO
HENRY B. GONZALEZ, TEX.
STEWART B. MCKINNEY. CO
GEORGE HANSEN. IDAHO
JOSEPH O. MjNISH. N J .
WALTER E. F>
STEPHEN L.
JERRY M. P/ TTERSON.CALIF.
JAMES J. BLANCI
U.S. HOUSE OF REPRESENTATIVES
THOMAS B. EVANS. JR.. CEt_
COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
CARROLL HUBBARD,
NINETY-SEVENTH CONGRESS
JOHN J. LAFALCE. N.
DAVID W. EVANS. INI
NORMAN E. D'AMOUI
STANLEY N. LUNDINI
ED
2129 RAYBURN HOUSE OFFICE BUILDING
WEI 5ER. OHIO
BILL M<
CCOLLUM. FLA.
GREGO
GEORGE C. WORTLEY. t
MARGE-. ROUKEMA. N J .
BILL LOWERY. CALIF.
JAMES K. COYNE. PA.
WASHINGTON. D.C. 20515
MARY ROSE OAKAR.
JIM MATTOX, TEX.
June 12, 1981
Mr. Anthony M. Solomon, President
The Federal Reserve Bank of New York
33 Liberty Street
New York, New York 10045
Dear Mr. Solomon:
Federal open market transactions records (Federal Reserve Bulletin, April 1981,
page A10) indicate that the Federal Reserve conducted $1,634 trillion in sales and
purchases of repurchase agreements (including matched securities) in 1980 through its
New York open market desk with governmental securities dealers. (The 34 dealers
operating on this market on April 2, 1981 are attached.) These transactions constituted
99 percent of total purchases and sales at the open market desk. In a year in which
the Federal Reserve was ostensibly on an aggregates target and when Ml-B changed by
$25 billion (December to December), the huge amount of repurchase agreement transactions
poses some questions.
First, to help answer these questions would you provide me a summary for May and
November, 1980, of:
a.
Interest rates, amounts and maturities on repurchase agreements and matched
sales submitted during the auctions at the desk, indicating which were
accepted and which were not;
b.
The Federal funds rate in effect at the time; and
c.
The average repurchase agreement rates in effect during that time.
Second, would you describe the rationale for the Federal Reserve's 1980 open market
desk policy and any changes that are being carried out in 1981?
Third, I assume that you closely monitor the transactions costs to the Federal
Reserve and the gross profits to the government securities dealers which result directly
from these operations. Would you give me your estimate of the gross profits made by
the government dealers from these repurchase agreement transactions during 1980?
I would appreciate your answer as soon as possible so that my staff can study the
material prior to receiving the Federal Reserve's July 20 report.
Sincerely,
Fernantf ds s t Germain
Chairman
254
LIST OF THE GOVERNMENT SECURITIES DEALERS REPORTING TO THE
MARKET REPORTS DIVISION OF THE FEDERAL RESERVE BANK OF NEW YORK
ACLI Government Securities, Inc.
Bache Halsey Stuart Shields Inc.
Bank of America NT & SA
Bankers Trust Company
A. G. Becker Incorporated
Briggs, Schaedle & Co., Inc.
Carroll McEntee & McGinley Incorporated
The Chase Manhattan Bank, N.A.
Chemical Bank
Citibank, N.A.
Continental Illinois National Bank
and Trust Company of Chicago
Crocker National Bank
Discount Corporation of New York
Donaldson Lufkin & Jenrette Securities Corporation
T.he First Boston Corporation
First National Bank of Chicago
Goldman, Sachs & Co.
Harris Trust and Savings Bank
E. F. Hutton & Company, Inc.
Kidder, Peabody & Co., Incorporated
Aubrey G. Lanston & Co., Inc.
Lehman Government Securities Incorporated
Merrill Lynch Government Securities Inc.
Morgan Guaranty Trust Company of New York
Morgan Stanley & Co., Inc.
The Northern Trust Company
Paine, Webber, Jackson & Curtis Incorporated
Wm. E. Pollock & Co., Inc.
Chas. E. Quincey & Co.
Salomon Brothers
The Securities Groups N.Y. Hanseatic Division
Smith Barney, Harris Upham & Co., Incorporated
United California Bank
Dean Witter Reynolds Incorporated
255
FEDERAL RESERVE BANK OF NEW YORK
NEW YORK, N.Y. I O O 4 5
AREA CODE 212 791-6173
ANTHONY M.SOLOMON
PRESIDENT
July 7,
1981
The Honorable Fernand J, St. Germain
Chairman
Committee on Banking, Finance
and Urban Affairs
House of Representatives
Washington, D. C. 20515
Dear Mr. Chairman;
Your letter of June 12, 1981 referred to the
large volume of repurchase agreements and matched salepurchase transactions undertaken by the Federal Reserve
System during 1980, and requested some additional information regarding those transactions which I am pleased
to provide to the extent that I can do so. My comments
follow the outline of the topics raised in your letter.
First, as requested, I am enclosing with this
letter detailed summary information on the repurchase
agreements and matched sale-purchase transactions undertaken during the months of May and November 1980. The
daily summaries provide data on interest rates, amounts
and maturities of both accepted and rejected proposals
presented to the Federal Reserve•s open market Trading
Desk. Also provided is information on the daily Federal
funds rate prevailing in the market, and our Trading
Desk's estimate of prevalent mid-morning rates in the
market for repurchase agreements against Government
securities undertaken by dealers apart from transactions
by our Desk. The daily summaries, you will note, include
not only the repurchase agreements and matched sale
transactions conducted with dealers in the market, but
also the daily execution of matched sale transactions
directly with foreign central banks.
(Indeed, the
transactions with foreign official accounts would account,
during 1980, for $1,071 billion of the $1,634 billion of
temporary-type transactions referred to in your letter.)
256
Second/ your letter asks about the rationale
for the Federal Reserve's 1980 open market Desk policy
and any changes in 1981. Under present reserve targeting procedures, in effect since October 1979, the task
of the domestic Trading Desk is to achieve reserve objectives consistent with the money supply objectives
adopted by the Federal Open Market Committee (FOMC).
At each meeting, the FOMC selects short-term growth
objectives for money supply designed to be consistent
with the Federal Reserve's annual objectives. The
Board staff then works out weekly path values for total
reserves and nonborrowed reserves (i.e., total reserves
less borrowings from the Federal Reserve discount window) that would be needed to support the monetary growth
sought by the FOMC. As the intermeeting period proceeds,
adjustments may be made to the path based, for example,
on updated information about reserve-to-money multipliers.
While the FOMC sets its growth objectives in
seasonally adjusted terms, the weekly path values that
the Desk seeks to meet reflect the considerable seasonal
movements that are characteristic of the real world. For
this reason alone it is often necessary to engage in substantial operations to add or absorb reserves on a very
short-term basis, even in the course of pursuing steady
monetary growth on a seasonally adjusted basis. Moreover,
a large part of the Trading Desk's routine task is to
counter the impact on reserve availability of short-term
variations in Federal Reserve float, currency in circulation, the level of Treasury deposits at the Federal
Reserve, and other factors. Daily projections are made
of these factors, and often changes in these factors
require sizable revision from one day to the next. Cushioning the impact of such short-term variations in reserve
availability explains a large part of the need for substantial activity in the form of short-term repurchase
agreements (to add reserves temporarily), or matched salepurchase transactions (to absorb reserves temporarily).
During 1980, the average weekly change in market factors
affecting reserve availability was on the order of
$1 billion. Meeting a $1 billion reserve need in a week
could well entail short-term transactions several times
that amount, since it is often prudent to meet reserve
needs, which are uncertain, on the basis of providing
reserves just a day or two at a time. Moreover, the recorded dollar volume of temporary self-reversing transactions is enlarged because both the purchase and sale
sides are counted in the total.
257
As noted earlier, another element swelling the
volume of short-term open market operations is the execution of matched sale-purchase transactions with foreign
official accounts. These transactions are arranged on
behalf of a large number of foreign central banks which
maintain a portion of their reserves in the form of
repurchase agreements as a convenient means to deal with
short-term fluctuations in their cash requirements. The
Desk, by arranging short-term transactions with these
accounts, reduces the volume of transactions to be executed
daily in the market, leaving the way more clear for the
Federal Reserve's own operations to achieve reserve objectives.
The daily aggregate matched-sale transactions
with foreign accounts have varied, for the most part,
within a range of about $1 1/4 to $2 1/2 billion. Care
is taken to avoid letting them build up to a volume that
could interfere with attainment of the Federal Reserve's
targets. At times, when it suits the reserve objectives,
the foreign short-term transactions are executed with
dealers in the market rather than with the Federal Reserve's own account, although the latter route is the
more common one. When transactions are arranged between
the Federal Reserve and foreign accounts, the interest
rate is based on prevailing market rates.
Third, your letter asks for our estimate of the
gross profits made by Government securities dealers from
repurchase agreements during 1980. Unfortunately, I cannot be particularly helpful on this point. While you are
right in assuming that we monitor the overall profit and
loss performance of the dealers trading with the open
market Desk, I know of no way, conceptually or statistically, to separate out the portion of their profits or
losses that might be related to trading activity with our
Desk, or related particularly to repurchase agreements.
In general, though, it may be noted that because
of the keen competition among dealers, and the fact that
they often are merely serving an intermediary role between
the Federal Reserve and their own customers, Federal Reserve repurchase agreements or matched sale-purchase
transactions do not represent a significant source of
profitability for the dealers. Dealer profitability,
which has been quite variable in recent years, is
primarily a function of the dealers' market-making and
position-taking roles.
258
Typically, the rates received or paid by the
Federal Reserve on repurchase agreements or matched
sale-purchase transactions are closely in line with
short-term financing rates prevailing elsewhere in the
market at the time. When the dealers serve as intermediaries between their customers and the Federal Reserve
in such transactions we understand that some dealers
charge a small commission from the customer such as
5 basis points (.05 percent); on a $100 million overnight repurchase agreement this would amount to about
$140. In other cases the dealers might impose no
charge, reasoning that they are performing a service
for their customer that will help to build other profitable relationships.
If we can be of further assistance, please
let me know.
Sincerely,
Anthony M. Solomon
President
Enclosures
259
Daily Surrmary
(in millions of dollars)
Date - 5/1/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
$3f023.9
Approximate Market RP Rate for Treasury
& Agency Securities:
11.85%
Effective Kate for Overnight Federal
Funds:
14.07%
Federal Funds Trading Range:
13 3/8 - 17%
260
Daily Summary
(in millions of dollars)
Date - 5/2/80
Type, of Operation - Over-the-weekend
Repurchase Agreements
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
$1,792.0
13.52 - 12.50%
$ 841.2
13.52 - 13.01%
13.29%
$2,890.2
13.52%
13.50
13.45
13.41
13.26
13.25
13.20
13.16
13.15
13.125
13.06
13.05
13.02
13.01
TOTAL
$ 51.0
200.0
24.2
50.0
50.0
142.0
14.0
21.0
168.0
20.0
30.0
10.0
21.0
40.0
§841 2
14.30%
8 - 15%
14 3/4 - 14 7/8%
Bankers1 A c c e p t a n c e s
Propositions Rejected
13.00%
12.88
12.78
12.77
12.75
12.72
12.65
12.50
TOTAL
$310.1
13.875 - 13.00%
$255.1
13.875 - 13.16%
13.48%
12.40%
Treasury & Agencies
Propositions Accepted
Bankers' Acceptances
$600.0
25.0
50.0
11.0
15.0
5.3
19.5
225.0
$9~BTJ78~
Propositions Accepted
13.875%
13.51
13.50
13.40
13.25
13.16
TOTAL
$ 36.6
38.8
63.9
62.7
43.6
9.5
$235TT
Propositions Rejected
13.15%
13.05
13.02
13.00
TOTAL
$15.0
20.0
5.0
15.0
$5375"
261
Daily Summary
(in millions of dollars)
Date - 5/5/80
Type of Operation - 1-day matched sales
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Round #1
Round #1
$4,891.0
11.70 - 13.50%
$2,396vO
11.70 - 12.35%
12.23%
$2,411.1
Round #2
$2,069.0
11.80 - 13.25%
$1,144.0
11.80 - 12.15%
12.07%
11.85%
12.28%
11 - 13 1/2%
12 1/4%
Round #2
Propositions Accepted
Propositions Rejected
Propositions Accepted
11.70% $ 20.0
U.95
25.0
12.00
260.0
12.15
95.0
12.20
123.0
12.23
60.0
12.25
1192.0
12.28
60.0
12.35
561.0
TOTAL $2396.0
12.36% $ 50.0
12.37
i2.0
12.375
10.0
12.39
50.0
12.40
80.0
12.41
75.0
515.0
12.45
12.49
180.0
12.50
18.0
12.60
60.0
12.62
510.0
12.625
50.0
12.66
75.0
60.0
12.69
12.70
50.0
50.0
12.71
12.72
50.0
10.0
12.75
25.0
12.78
12.99
500.0
30.0
13.00
10.0
13.25
13.50
25.0
TOTAL $2495.0
11.80%
11.83
11.90
11.98
12.00
12.03
12.06
12.10
12.14
12.15
TOTAL
$ 160.0
10.0
9.0
25.0
50.0
75.0
100.0
30.0
25.0
660.0
$1144.6"
Propositions Rejected
12.16%
12.20
12.22
12.25
12,45
12.50
13.25
TOTAL
$ 40.0
' 75,0
75.0
680.0
25.0
5.0
25.0
$925.0
262
Daily Summary
(in millions of dollars)
Date - 5/6/80
Type of Operation - 1-day matched sales
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$2,956.0
10.90 - 12.03%
$1,926.0
10.90 - 11.34%
11.09%
$2,146.6
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
11.05%
11.57%
9 - 1 2 1/4%
u - n 1/2%
Propositions Accepted
Propositions Rejected
10.90%
10.91
10.95
10.99
11.00
11.05
11.10
11.12
11.125
11.17
11.20
11.22
11.24
11.25
11.34
11.37% $ 75.0
11.375
60.0
11.40
35.0
11.48
35.0
11.49
20.0
11.60
20.0
11.625
40.0
11.70
30.0
11.73
40.0
11.75
525.0
11.85
30.0
11.875
15.0
11.90
30.0
12.00
25.0
12.03
50.0
TOTAL
$ 19.0
23.0
160.0
100.0
327.0
595.0
65.0
30.0
40.0
25.0
10.0
67.0
205.0
85.0
175.0
$1926.0
TOTAL
$1030.0
263
Daily Summary
(in millions of do]lars)
Date - 5/7/80
Type of Operation - l-day Matched Sales
Ibtal Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$3,859.5
10.00 - 11.00%
$1,573.0
10.00 - 10.30%
10.18%
$2,061.5
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
9.35%
9
-89%
1 - 1 1 1/8%
10 1/2%
Propositions Accepted
Propositions Rejected
10.00%
10.05
10.09
10.12
10.125
10.15
10.17
10.20
10.22
10.23
10.24
10.25
10.29
10.30
Total
10.31%
10.34
10.35
10.37
10.375
10.38
10.39
10.40
10.41
10.47
10.48
10.49
10.50
10.51
10.55
10.60
10.62
10.64
10.75
10.77
10.78
10.81
10.82
11.00
Ttotal
$ 60.0
50.0
50.0
50.0
315.0
300.0
35.0
210.0
40.0
10.0
107.0
76.0
50.0
220.0
$1,57X7
$
50.0
100.0
100.0
226.0
25.0
50.0
125.0
522.0
75.0
75.0
50.0
70.0
160.0
20.0
122.5
126.0
50.0
10.0
100.0
10.0
110.0
50.0
40.0
20.0
$2,286.5
264
Daily Summary
(in millions of dollars)
Date - 5/8/80
Type of Operation - 1-day matched sales
Total Propositions:
Range of Pates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$5,941.0
9.90 - 11.50%
$1,501.0
9.90 - 10.25%
10.15%
$2,112.6
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Propositions Accepted
9.90%
9.95
10.00
10.05
10.10
10.11
10.125
10.13
10.14
10.15
10.16
10.18
10.19
10.20
10.21
10.24
10.25
TOTAL
$ 30.0
100.0
27.0
10.0
380.0
15.0
50.0
15.0
60.0
74.0
60.0
75.0
95.0
25.0
20.0
165.0
300.0
$1561.0
8.75%
10.57%
10 1/4 - 11%
10 3/8%
Propositions Rejected
10.28%
10.29
10.30
10.32
10.33
10.34
10.36
10.375
10.45
10.46
10.48
10.50
10.55
10.58
10.60
10.625
10.65
10.73
10.75
10.85
10.95
11.00
11.50
TOTAL
$ 10.0
55.0
310.0
10.0
10.0
35.0
10.0
1535.0
50.0
100.0
500.0
50.0
100.0
410.0
160.0
5.0
30.0
5.0
10.0
10.0
10.0
1000.0
25.0
$4440.0
265
Daily Sunmary
(in millions of dollars)
Date - 5/9/80
1y?e of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Fate for Treasury
& Agency Securities:
Effective Kate for Overnight Federal
Funds:
Federal Funds Trading Range:
$2,578,7
9.00%
10.80%
I Q 1/2 - 15%
266
Daily Suntnary
(in millions of dollars)
Date - 5/12/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
Effective Kate for Overnight Federal
Funds:
Federal Funds Trading Range:
$2,019.0
8.80%
10.79%
10 - 11 1/2%
267
Daily Surrmary
(in millions of dollars)
P ^ ~ 5/13/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
$769.3
8.75%
Effective Kate for Overnight Federal
Funds:
10,92%
Federal Funds Trading Range:
io 1/2 - 11 1/2%
268
Daily Sunmary
(in millions of dollars)
P ^ " 5/14/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
$484.2
8.00%
Effective Kate for Overnight Federal
Funds:
11.30%
Federal Funds Trading Range:
7 - 18%
269
Daily Sunmary
(in millions of dollars)
Date - 5/15/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approxiinate Market RP Rate for Treasury
& Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
$121.7
8.10%
11.15%
10 3/4 - 12 1/4%
270
Daily Summary
(in millions of dollars)
Date - 5/16/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
Effective Kate for Overnight Federal
Funds:
Federal Funds Trading Range:
$178.0
10.60%
11.42%
10 - 12%
271
Daily Surrmary
(in millions of dollars)
r te
¥
~ 5/19/80
Type of Operation - No Market iictivity
Matched Sales with Foreign:
Approximate Market PP Kate for Treasury
& .Agency Securities:
Effective Kate for Overnight Federal
Funds:
Federal Funds Trading Range:
$395 4
10.65%
10.92%
9 1/2 - 11 1/4%
272
Daily Sunmary
(in millions of dollars)
Date - 5/20/80
Type of Operation - *fo Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
$2,336.4
9.40%
Effective Rate for Overniaht Federal
Ponds:
10.20%
Federal Funds Trading Range:
5 - 1 0 5/8%
273
Daily Sunrrary
(in millions of doJlars)
Date - 5/21/80
Type of Operation - 1-day Matched Sales
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Propositions Accepted
8.60% $ 10.0
8.74
61.0
8.75
30.0
8.95
40.0
8.97
400.0
8.98
125.0
8.99
500.0
Total T., 166.0
Propositions e j e c t e d
9.00%
9.04
9.07
9.09
9.10
9.125
9.14
9.15
9.16
9.20
9.22
9.23
9.25
9.28
9.30
9.34
$292.0
50.0
400.0
207.0
260.0
80.0
235.0
37.3
25.0
415.0
30.0
15.0
160.0
75.0
50.0
50.0
9.35% $ 100.0
9.375
120.0
9.45
130.0
9.48
325.0
9.49
60.0
9.50
285.0
9.55
20.0
9.625
5.0
9.67
200.0
9.70
25.0
5.0
9.75
9.85
200.0
10.00
35.0
Total $3,39173
$5,057.3
8.60 - 10.00%
$1,166.0
8.60 - 8.99%
8.96%
$2,119.9
8.50%
8.44%
2 - 9 7/8%
9
1/4%
274
Daily Sunmary
(in millions of dollars)
Date Type of *(5pSrataon - No Market Activity
Matched Sales with Foreign:
$1,873.8
Approximate Market PP Rate for Treasury
& Agency Securities:
8.50%
Effective Kate for Overnight Federal
Funds:
9.51%
Federal Funds Trading Range:
9 1/4 - 9 3/4%
275
Daily Summary
(in millions of dollars)
Date - 5/23/80
Over-the-weekend
Type of Operation - matched sales
Total Propositions:
Range of Pates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Round #1
$3,323.5
7.95 - 10.01%
$1,105.0
7.95 - 8.38%
8.36%
$1,999.7
Round #2
$1,424.5
7.57 - 10.01%
$1,114.5
7.57 - 8.39%
8.17%
8.40%
8.73%
7 - 9 1/2%
8 7/8%
Round #2
Round #1
Prepositions Accepted
Propositions Accepted
7.95% $ 20.0
7.0
8.25
8.30
10.0
8.34
175.0
8.35
88.0
8.375
65.0
8.38
740.0
Total %., 105.0
7.57% $ 5.0
7.74
106.5
7.75
10.0
8.00
110.0
5.0
8.05
8.09
45.0
8.15
35.0
8.25
603.0
8.30
115.0
5.0
8.33
8.35
35.0
8.38
25.0
8.39 „
15.0
Total $1,11375"
Propositions Rejected
8.39% $106.5
8.40
25.0
8.44
45.0
8.0
8.47
8.48 1,150.0
8.49
70.0
8.50
34.0
8.55
10.0
8.59
110.0
8.60
15.0
8.61
10.0
8.62
15.0
8.625
10.0
8.63
25.0
8.70
30.0
8.75
65.0
8.79
30.0
8.84
50.0
8.85% $ 105.0
8.86
15.0
8.90
20.0
8.94
25.0
8.95
20.0
8.99
35.0
9.00
20.0
9.10
25.0
9.125
15.0
5.0
9.24
9.75
25.0
10.01
100.0
Total $2,2153
Propositions Rejected
8.49%
8.50
8.79
8.87
9.00
10.01
Total
$ 50.0
30.0
35.0
20.0
75.0
100.0
276
Daily Summary
(in millions of dollars)
Date - 5/27/80 - Page 1
Type of Operation - 1-day Repurchase Agreements Treasury & Agencies
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$1,048.0
9.56 - 8.00%
$1,048.0
9.56 - 8.00%
8.72%
$2,135.9
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
9.56%
9.375
9.27
9.13
9.10
9.05
9.02
9.01
9.00
8.90
8.81
8.77
8.75
8.625
8.52
8.51
8.50
8.41
8.30
8.28
8.26
8.25
8.02
8.00
Itotal $]
$36.0
9.0
22.0
5.0
20.0
40.0
190.0
107.0
79.0
35.0
10.0
15.0
10.0
10.0
40.0
15.0
39.0
62.0
145.0
60.0
15.0
20.0
14.0
50.0
$112.8
10.00 - 8.25%
$112.8
10.00 - 8.25%
9.48%
7.95%
9.55%
8 3/4 - 15%
10 1/2%
Bankers1 Acceptances
Treasury & Agencies
Propositions Accepted
Bankers1 Acceptances
Propositions Rejected
- 0 -
Propositions Accepted
10.00%
9.55
$47.6
42.7
8.25
22.5
Total
$11278"
Propositions Rejected
- 0 -
277
Daily Sunmary
(in millions of do] lars)
Date - 5/27/80 - Page 2
Type of Operation - 2-day Repurchase Agreements
Treasury & Agencies
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$1,596.7
9.21 - 7.75%
$1,582.5
9.21 - 8.125%
8.63%
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
9.21% $60.0
9.17
17.0
9.05
200.0
9.00
247.0
8.89
145.0
8.875 25.0
8.76
13.0
8.67
20.0
8.625
17.5
8.56
15.0
50.0
8.53
15.0
8.51
8.50
3.0
8.30
730.0
25.0
8.125
Total $1,38275"
$111.2
9.01 - 8.25%
$111.2
9.01 - 8.25%
8.62%
7.95%
9.55%
8 3/4 - 15%
10 1/2%
Treasury & Agencies
Propositions Accepted
Bankers' Acceptances
Bankers* Acceptances
Propositions Rejected
Propositions Accepted
7.75%
Total
9.01%
$14.4
$TO"
8.75
8.50
8.25
Total
$13.8
46.8
28.4
22.2
T
Propositions Rejected
- 0 -
278
Daily Sumrary
(in millions of dollars)
Date - 5/28/80
Type of Operation - 1-day Repurchase Agreements
Treasury & Agencies
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$2,617.6
9.25 - 7.00%
$2,597.6
9.25 - 8.00%
8.30%
$2,227.1
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estiuated Federal Funds Rate at
Time of Market Entry:
12.23%
10 3/4 - 15%
Treasury & Agencies
Bankers' Acceptances
$531.4
9.76 - 8.25%
$531.4
9.76 - 8.25%
8.92%
8.00%
11 3/4%
Bankers:' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
9.25%
$ 15.0
9.18
13.0
9.05
30.0
8.76
15.0
45.0
8.75
8.67
20.0
20.0
8.63
8.625
17.0
155.0
8.55
13.0
8.53
8.52
50.0
8.51
75.0
8.50
475.7
15.0
8.40
10.5
8.375
8.35
10.0
8.31
10.0
8.30
235.0
8.26
210.0
230.0
8.25
8.21
48.0
8.20
55.0
8.16
24.0
8.13
10.0
8.12
12.0
8.05
63.0
8.02
12.0
10.0
8.01
699.4
8.00
Total $2,39775"
7.875%
7.00
Total
9.76%
9.125
9.00
8.77
8.76
8.75
8.50
8.41
8.31
8.25
Total
$10.0
10.0
$2070"
$96.8
52.5
116.9
10.7
30.3
83.5
24.3
29.3
61.0
26.1
$531.4
Propositions Rejected
- 0 -
279
Daily Suonary
(in millions of dollars)
Date - 5/29/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
$2,067.9
8.25%
10.49%
9 3/4 - 11%
280
Daily Summary
(in millions of do] lars)
Date - 5/30/80
Tyoe of Operas-inn -
Over-the-weekend
repurchase agreements
Treasury & Agencies
$3,656.8
10.50 - 8.60%
$3,258.8
10.50 - 9.50%
9.85%
$2,055.8
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estiirated Federal Funds Rate at
Time of Market Entry:
Bankers' Acceptances
$426.1
10.75 - 9.125%
$365.9
10.75 - 9.70%
10.10%
9.35%
11.06%
10 1/2 - 14%
10 3/4 - 10 7/8%
Treasury & Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
10.50% $ 24.0
10.26
29.4
10.25
70.0
24.9
10.13
10.125 230.0
10.07
8.0
10.06
50.0
10.05
20.0
10.03
24.0
10.02
580.0
10.00
287.0
20.0
9.88
9.875 581.0
9.80
48.5
9.76
181.0
9.75
307.0
9.70
19.0
9.625
25.0
9.61
30.0
9.60
70.0
9.53
6.0
9.52
25.0
9.51
57.0
9.50. 542.0
Total %'
9.50%
9.35
9.27
9.25
9.10
9.05
9.00
8.75
8.60
Total
10..75% $ 68.3
10..375
9.0
10.,125 127.7
10.01
29.6
9.,875
20.0
9.,76
29.0
9.,75
29.2
9.,70
53.1
Total
$3553
$ 10.0
7.0
35.0
25.0
158.0
3.0
5.0
5.0
150.0
$398.0
Propositions Rejected
9.51% $ 35.0
9.50
5.0
9.125
20.2
Total
$ ?0T1
281
Daily Summary
(in millions of do] lars)
Date - 11/3/80
Type of Operation - 2-day Repurchase Agreements Treasury & Agencies
Total Propositions :
Range of Rates Offered:
Amount Accepted :
Range of Rates Accepted :
Vfeighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds :
Federal Funds Tradirsg Range
Estimated Federal Funds Rate at
Time of Market Entry:
$3,067.9
13.41 - 12.75%
$883.0
13.41 - 13.15%
13.19%
$2,528.5
Bankers' Acceptances
$504.9
13.61 - 13.20%
$241.9
13.61 - 13.30%
13.47%
12.80%
14.06%
13 3/4 - 14 3/4%
13 7/8%
Treasury & Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Accepted
13.41% $40.0
13.375
27.0
13.32
50.0
13.26
50.0
13.25
22.0
13.16
530.0
13.15
164.0
TOTAL
$81377
Propositions Rejected
13.13%
13.125
13.12
13.11
13.08
13.07
13.06
13.05
13.03
13.02
13.01
13.00
12.98
12.96
12.92
12.91
12.90
12.875
12.83
12.80
12.75
$64.0
135.0
20.0
4.0
20.0
75.0
44.0
665.6
15.0
133.0
112.5
409.6
50.0
105.0
17.0
18.0
208.2
39.0
11.0
9.0
30.0
TOTAL $ 2,184.9
13.61%
13.56
13.55
13.50
13.36
13.35
13.30
TOTAL
$43.3
43.6
14.6
51.8
20.5
46.4
21.7
$24T3"
Propositions Rejected
13.26%
13.25
13.20
TOTAL
$43.0
172.0
48.0
$25370"
282
Daily Summary
(in millions of dollars)
Date - U/5/80
Type of Operation - 1-day Repurchase Agreements
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Bankers' Acceptances
$1,523.7
14.25 - 12.90%
$1,483.7
14.25 - 13.26%
13.74%
$2,334.6
$440.8
14.56 - 13.51%
$440.8
14.56 - 13.51%
14.15%
13.10%
14.76%
13 - 18%
14 3/4 - 14 7/8%
Treasury & Agencies
Propositions Accepted
14.25% $28.0
14.13
73.0
14.11
34.0
14.06
25.0
14.05
75.0
14.03
43.0
14.02
26.0
14.01
5.0
13.91
70.0
13.90
12.0
13.875
95.0
13.85
200.0
13.80
8.0
13.76
80.0
13.75
15.0
13.69
27.0
13.67
45.0
13.65
16.3
13.625
72.0
13.62
5.0
13.60
12.0
13.56
10.0
13.55
54.4
13.53
41.0
13.52
86.0
13.51
5.0
13.50
108.0
13.43
35.0
13.40
88.0
13.35
20.0
13.32
30.0
13.26
40.0
TOTAL $1,48X7
Propositions Rejected
12.90% $40.0
TOTAL
$20"
' Acceptances
Propositions Accepted
14.56%
14.51
14.26
14.25
14.15
14.10
14.01
14.00
13.90
13.85
13.81
13.71
13.51
TOTAL
$62.4
56.9
12.7
47.8
14.7
15.9
6.4
121.5
34.4
19.5
22.9
22.1
3.6
$430"
Propositions Rejected
- 0 -
283
Daily Summary
(in millions of dollars)
Date - 11/6/80
Type of Operation - 1-day Repurchase Agreements Treasury & Agencies
Total Propositions;
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Propositions Accepted
14.27% $25.0
14.26
363.0
14.16
50.0
14.15
75.0
14.14
130.0
14.13
84.0
14.125
25.8
14.11
43.0
14.10
5.0
14.07
50.0
14.05
30.0
14.03
25.0
14.01
139.5
610.6
14.00
13.95
165.0
13.93
5.0
13.92
22.8
13.90
210.0
13.88
123.0
13.875 673.0
13.86
28.0
48.0
13.85
13.81
10.0
125.0
13.80
13.79
10.0
13.77
45.0
13.76
33.4
13.75
38.0
22.0
13.63
13.625 200.0
TOTAL $3,4TO"
Propositions Rejected
13.55% $75.0
13.52
60.0
55.0
13,50
13.42
25.0
13.38
9.0
13.375
10.0
13.31
4.0
13.25
5.0
13.00
40.0
$25370"
TOTAL
$3,697.1
14.27 - 13.00%
$3,414.1
14.27 - 13.625%
13.97%
$2,392.2
Bankers' Acceptances
$718.3
15.00 - 14.01%
$718.3
15.00 - 14.01%
14.51%
13.60%
15.35%
15 - 15 3/4%
15 1/2%
Bankers' Acceptances
Propositions Accepted
15.00%
14.75
14.71
14.56
14.52
14.50
14.46
14.41
14.39
14.36
14.31
14.30
14.20
14.15
14.10
14.05
14.01
TOTAL
$181.6
69.5
25.3
19.2
21.0
7.6
19.4
34.7
28.1
33.4
36.1
16.2
47.9
86.1
34.0
29.8
28.4
$71571
Propositions Rejected
- 0 -
284
Daily Summary
(in millions of dollars)
Date - n/7/80
Type of Operation - Over-weekend Repurchase
Agreements
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Propositions Accepted
14.26% $40.0
14.25
35.0
14.13
19.0
14.125 113.0
14.10
76.0
14.06
60.0
14.05
30.9
14.03
35.0
14.02
25.0
74.0
14.01
14.00
569.0
13.97
6.0
13.96
28.0
13.93
19.6
13.91
143.9
13.90
145.0
TOTAL $1 ,41972*
Propositions Rejected
13.88% $110.0
13.875
757.0
26.6
13.81
13.80
142.0
13.76
55.0
131.8
13.75
40.0
13.70
13.69
30.0
15.0
13.67
13.65
5.0
13.63
5.0
13.625
25.0
10.0
13.60
13.55
10.0
84.0
13.51
83.0
13.38
10.0
13.25
TOTAL $l,5397"0~
Treasury & Agencies
Bankers' Acceptances
$2,958 .8
14.26 - 13.25%
$1,419 .4
14.26 - 13.90%
14.01%
$2,051 .9
$696 .2
14.71 - 13.92%
$628 .7
14.71 - 14.05%
14.37%
14.00%
15.01%
14 3/4%
Bankers'1 Acceptances
Propositions Accepted
14.71%
14.61
14.51
14.50
14.375
14.30
14.26
14.25
14.20
14.15
14.14
14.05
TOTAL
$26.0
31.3
20.4
186.1
41.0
96.2
61.4
87.0
31.8
10.7
26.8
10.0
$65577
Propositions Rejected
14.01%
13.92
TOTAL
$30.5
37.0
$373
285
Daily Summary
(in millions of do] lars)
Date - 11/10/80
Type of Operation - 3-day Repurchase Agreements
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Propositions Accepted
14.26% $141.5
14.20
94.0
14.18
32.0
14.15
89.3
14.13
64.2
14.125
201.0
14.11
24.0
14.10
403.0
14.09
15.0
14.07
73.1
14.06
50.0
14.05
318.0
14.03
22.0
14.02
40.0
14.01
155.0
14.00
52.0
13.95
25.0
13.91
99.0
13.90
40.0
13.875
415.0
TOTAL $2 ,35371
Treasury & Agencies
Bankers' Acceptances
$2,678.6
14.26 - 13.25%
$2,353.1
14.26 - 13.875%
14.05%
$2,187.7
$703.3
14.51 - 14.00%
$664.3
14.51 - 14.15%
14.37%
14.10%
14.57%
JJ 15fc
^4 3/4%
Bankers' Acceptances
Propositions Rejected
Propositions Accepted
13.87% $ 5.0
13.86
44.5
5.0
13.85
5.0
13.80
13.76
68.0
8.0
13.75
13.68
17.0
13.625
40.0
13.56
5.0
13.51
10.0
13.25
118.0
14.51%
14.50
14.41
14.40
14.39
14.375
14.33
14.32
14.31
14.30
14.26
14.20
14.15
TOTAL
$3233
TOTAL
$51.7
149.2
84.9
36.9
11.3
26.2
51.6
29.2
57.7
28.4
15.3
62.4
59.5
$6613
Propositions Rejected
14.01%
14.00
TOTAL
$28.0
11.0
$39.0
286
Daily Summary
(in millions of dollars)
Date - 1V12/80
Type of Operation -
1-day Matched Sales
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Propositions Accepted
12.86% $10.0
12.95
125.0
12.98
40.0
13.00
320.0
13.02
20.0
13.03 175.0
13.09
50.0
13.10 495.0
13.11
5.0
13.125
25.0
13.14
35.0
13.15 225.0
13.16
10.0
13.19
50.0
13.20 100.0
13.24
30.0
13.25 402.4
13.28
50.0
TOTAL $2,1
Propositions Rejected
13.35% $20.0
13.375
60.0
13.40
20.0
13.49
30.0
13.50
20.0
13.51
20.0
13.60
55.0
13.61
20.0
13.625
50.0
13.75
25.0
13.90
150.0
14.00
30.0
TOTAL
$2,667.4
12.86 - 14.00%
$2,167.4
12.86 - 13.28%
13.11%
$2,041.0
13.40%
13.01%
3 - 16%
12 3/4 - 13%
287
Daily Summary
(in millions of dollars)
Date - 11/13/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
Approximate Market RP Fate for Treasury
& Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
$2,563.6
13.40%
14.00%
13 1/2 - 14 3/4%
288
Daily Sunmary
(in millions of dollars)
Date - 11/14/80
Type of Operation - No Market Activity
Matched Sales with Foreign:
$2,158.0
Approximate Market KP Rate for Treasury
& Agency Securities:
13.40%
Effective Rate for Overnight Federal
Funds:
14.23%
Federal Funds Trading Range:
13 7/8 - 17%
289
Daily Summary
(in millions of dollars)
Date - H/17/80
Type of Operation - 3-day Repurchase Agreements
Total Propositions;
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Treasury & Agencies
$4,933.8
15.30 - 14.05%
$2,517.9
15.30 - 15.06%
15.16%
$2,430.5
Bankers' Acceptances
$528.6
15.61 - 15.10%
$460.6
15.61 - 15.25%
15.43%
14.55%
16.22%
15 - 19%
16.00%
Bankers' Acceptances
Propositions Accepted
Propositions Accepted
15.30% $145.0
15.28
95.0
15.27
170.0
15.26
130.0
15.25
47.0
15.20
20.0
15.18
10.0
15.17
50.0
15.16
115.9
15.15
297.0
15.14
50.0
15.13
300.0
15.125
742.0
15.09
100.0
15.06
246.0
Total $2,517.9
15.61%
15.51
15.45
15.41
15.40
15.375
15.36
15.27
15.26
15.25
Total
Propositions Rejected
15.10%
Total
Propositions Rejected
15.05 % $107.0
10.0
15.03
15.02
33.0
312.0
15.01
84.0
15.00
45.0
14.95
76.0
14.92
210.0
14.91
75.0
14.90
15.0
14.89
126.0
14.88
673.0
14.875
5.0
14.85
$101.2
16.7
48.2
53.4
42.7
102.4
13.7
45.7
23.0
13.6
$460.6
14.82%
$10.0
14.81
40.0
14.80
74.0
14.78
5.0
14.77
45.0
14.76
44.9
14.75
325.0
14.72
17.0
14.55
20.0
14.51
5.0
29.0
14.50
30.0
14.05
Total $2,4137?
$ 68.0
$ 5O"
290
Daily SuniTary
(in millions of do] lars)
Date - 11/18/80
Type of Operation - 1-day Repurchase Agreements
Treasury & Agencies
•total Propositions;
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$2,299.0
16.375 - 15.10%
$2,247.3
16.375 - 15.50%
15.90%
$2,185.3
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate: for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of ^5arket Entry:
Bankers' Acceptances
$113.0
16.25 - 15.75%
$113.0
16.25 - 15.75%
16.08%
15.50%
17.19%
16 1/4 - 18%
17 1/4%
Treasury s Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
16.375% $ 41.3
16.16
100.0
16.13
17.0
16.125
650.0
16.06
100.0
16.01
20.0
16.00
21.0
15.95
35.0
15.91
29.0
15.88
131.0
15.81
75.5
15.80
29.0
15.78
10.0
15.76
388.0
15.75
219.0
15.74
20.0
15.71
3.0
37.5
15.70
15.69
12.0
15.66
5.0
15.65
40.0
10.0
15.63
15.625
55.0
15.62
5.0
10.0
15.60
99.0
15.55
85.0
15.50
Total $2,247.3
15.41%
15.375
15.35
15.26
15.25
15.10
Total
16.25%
16.16
16.01
16.00
15.75
Total
$10.0
5.0
21.2
5.5
5.0
5.0
$5177
$ 61.6
1.0
20.9
2.0
27.5
$H3T0"
Propositions Rejected
- 0 -
291
Daily Surmary
(in millions of do] lars)
Date - 11A9/80
Type of Operation - 1-day Repurchase Agreements
Treasury & Agencies
Total Propositions:
Range of Kates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$1,447.6
16.00 - 14.875%
$1,288.3
16.00 - 15.15%
15.31%
$2,077.5
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
16.41%
1 2 - 1 7 1/4%
Treasury & Agencies
Bankers' Acceptances
$121.7
16.125 - 15.50%
$121.7
16.125 - 15.50%
15.81%
15.60%
16 3/4%
Bankers'1 Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
16.00% $ 2.0
15.76
10.0
15.66
131.0
15.60
10.0
10.0
15.56
15.53
15.0
15.51
59.8
15.50
36.0
10.0
15.47
41.0
15.45
10.0
15.40
5.0
15.39
15.375
37.0
23.0
15.35
15.31
28.0
210.0
15.30
15.27
4.0
15.26
5.0
161.5
15.25
15.18
80.0
15.15
400.0
Total $1,288.3
15.06% $65.0
15.01
4.3
15.00
85.0
14.875
5.0
Total
$159.3
16.125%
16.02
16.00
15.75
15.61
15.51
15.50
Total
$ 37.3
14.4
8.9
7.6
1.0
24.4
28.1
$12177"
Propositions Rejected
292
Daily Summary
(in millions of dollars)
Date - 11/20/80
Type of Operation - 1-day Repurchase Agreements Treasury & Agencies
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
Propositions Accepted
16.17% $100.0
16.07
50.0
15.92
48.0
15.91
111.3
15.86
10.0
15.82
26.0
15.81
86.0
15.78
12.0
15.77
35.0
15.76
55.0
15.75
825.1
15.70
30.0
15.67
328.9
15.66
80.0
15.65
196.0
15.63
30.0
15.625 906.0
15.61
105.0
15.60
200.0
15.59
200.0
15.57
220.0
15.56
64.0
15.55
5.0
15.53
200.0
15.52
40.8
15.51
63.8
15.50
40.0
TOTAL $/1,060"
$4,398.7
16.17 - 15.15%
$4,067.9
16.17 - 15.50%
15.68%
$2,329.0
Bankers' Acceptances
$412.8
16.25 - 15.61%
$380.5
16.25 - 15.66%
15.93%
15.30%
17.01%
163s - 17*5%
17%%
Bankers' Acceptances
Propositioas Accepted
15.42% $14.0
15.40
48.0
15.39
20.0
21.8
15.38
15.375 48.0
15.35
20.0
25.0
15.33
15.30
25.0
15.25
60.0
15.24
24.0
15.21
5.0
15.15
20.0
TOTAL $330.8
16.25% $18.5
16.05
18.5
16.01
83.0
16.00
94.5
15.91
43.0
15.86
48.6
15.76
37.6
15.75
8.7
15.66
28.1
TOTAL $3S0T5"
Propositions Rejected
15.61% $32.3
TOTAL $3777
293
Daily Surrmary
(in millions of doDlars)
Date - 11/21/80
Type of Operation - Over-weekend Repurchase
"
Agreements Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Acceptad:
Weighted Average Rate:
Matched Sales with Foreign:
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Pange:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
$3,639.1
16.85 - 15.70%
$3,188.1
16.85 - 16.05%
16.39%
$2,101.1
Bankers' Acceptances
$425.5
17.01 - 16.16%
$375.5
17.01 - 16.26%
16.67%
16.05%
17,63%
16 1/2 - 18 1/4%
17 3/4%
Treasury & Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
16.85%
16.60
16.55
16.54
16.53
16.52
16.51
16.50
16.42
16.41
16.40
16.38
16.375
16.35
16.31
16.30
16.29
16.27
16.26
16.25
16.23
16.21
16.17
16.13
16.13
16.125
16,10
16.06
16.05
TOTAL
16.01%
16.00
15.99
15.91
15.90
15.88
15.81
15.75
15.70
TOTAL
17.01%
16.80
16.76
16.75
16.625
16.51
16.41
16.375
16.26
TOTAL
$
35.0
80.0
860.0
35.0
219.0
10.0
31.0
87.6
52.0
30.0
10.0
20.0
165.7
35.0
316.5
435.0
33.0
139.0
166.0
38.0
37.0
48.0
9.4
65.0
10,0
45.0
12.0
30.9
133.0
$3,188.1
$ 40.0
360.0
24.0
4.0
5.0
3.0
5.0
5.0
5.0
$450"
$ 91.0
25.3
28.1
19.6
102.1
27.9
28.7
10.0
42.8
$375.5
Propositions Rejected
16.16%
TOTAL
$50.0
294
Daily Sun-nary
(in millions of do]lars)
Date - 11/24/80
Type of Operation - 1-day Repurchase Agreements Treasury & Agencies
Total Propositions:
Range of Fates Offered:
Amount Accepted:
Range of Pates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
$2,161.3
16.625 - 15.625%
$2,045.3
16.625 - 15.99%
16.20
$2,199.2
Approximate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Tradijng Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Bankers' Acceptances
$320.3
16.875 - 16.10%
$290.3
16.875 - 16.26%
16.59%
16.15%
17.11%
16 1/2 - 17 3/4%
17 1/4%
Treasury & Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
16.625% $ 54.0
16.31
195.0
16.30
40.0
16.27
26.0
16.26
129.0
16.25
554.0
16.21
98.3
16.20
70.0
16.18
68.0
16.17
25.0
16.15
101.0
16.14
35.0
16.13
40.0
16.125
31.0
16.12
21.0
16.10
335.0
16.06
35.0
16.05
92.0
16.01
2.0
16.00
70.0
15.99
24.0
TOTAL
:§2,045.3
15.81%
15.80
15.78
15.77
15.75
15.65
15.625
TOTAL
16.875%
16.65
16.625
16.60
16.51
16.50
16.36
16.30
16.26
TOTAL
$ 40.0
10.0
12.0
14.0
5.0
30.0
5.0
$L16.0
$ 37.8
33.9
120.4
21.5
5.3
25.0
8.6
3.8
34.0
$290.3
Propositions Rejected
16.10%
TOTAL
$30.0
$3oTo~
295
Daily Summary
(in millions of dollars)
Date - 11/25/80
Type of Operation - Ito Market Activity
Matched Sales with Foreign:
Approximate Market RP Rate for Treasury
& Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
$2,848.4
16.00%
16.69%
16 3/8 - 18%
296
Daily Sumrary
(in millions of do] lars)
Date - 11/26/80
Type of Operation - 2-day Repurchase Agreements
Treasurv & Aaencies
Total Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Katched Sales with Foreign:
$1,877.9
16.39 - 15.01%
$1,805.9
16.39 - 15.75%
16.00
$2,061.8
Approxiirate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate a t
Time of Market Entry:
Bankers' Acceptances
$387.1
17.08 - 15.90%
$387.1
17.08 - 15.90%
16.43%
16.00%
18.33%
17 - 27%
17 3/4%
Treasury & Agencies
Bankers' Acceptances
Propositions Accepted
Propositions Rejected
Propositions Accepted
16.39%
16.375
16.35
16.30
16.21
16.20
16.18
16.16
16.15
16.12
16.06
16.02
16.00
15.90
15.89
15.875
15.81
15.77
15.76
15.75
TOTAL
15.72%
15.60
15.52
15.50
15.01
TOTAL
17.08%
16.75
16.625
16.52
16.50
16.31
16.30
16.26
16.00
15.90
TOTAL
$ 216.0
25.0
10.0
30.0
15.0
171.0
20.0
34.5
7.0
46.0
60.0
20.0
173.3
397.0
15.0
85.0
12.0
25.0
58.0
386.1
$1,805.9
$ 5.0
10.0
2.0
20.0
35.0
$7270~
$ 5.8
53.9
70.1
23.3
46.1
43.7
9.9
97.9
30.5
5.9
$387.1
Propositions Rejected
0 -
297
Daily Summary
(in millions of do]lars)
Date - 11/28/80
Tyoe of Operation - over-weekend Repurchase
Agreements
Tbtal Propositions:
Range of Rates Offered:
Amount Accepted:
Range of Rates Accepted:
Weighted Average Rate:
Matched Sales with Foreign:
Approxiinate Market RP Rate
for Treasury & Agency Securities:
Effective Rate for Overnight Federal
Funds:
Federal Funds Trading Range:
Estimated Federal Funds Rate at
Time of Market Entry:
Treasury & Agencies
$2,371.4
16.75 - 15.625%
$2,279.7
16.75 - 15.80%
16.12
$2,286.3
16.75%
$16.0
100.0
16.51
160.0
16.50
90.0
16.36
121.0
16.32
35.0
16.31
33.0
16.28
160.0
16.27
83.1
16.26
25.0
16.25
16.16
45.0
16.14
27.0
50.0
16.13
20.0
16.125
32.6
16.10
80.0
16.07
57.0
16.06
94.0
16.05
175.0
16.02
16.01
266.5
16.00
167.0
15.0
15.90
15.88
35,a
15.86
22,5
15.80
370.0
TOTAL $2\,TJ9?T
16.00%
13.00 - 20 1/4%
Propositions Reiected
15.78% $10.0
15.77
6.7
15.76
35.0
15.75
20.0
15.625
20.0
TOTAL
$91.7
$525.3
17.08 - 15.90%
$523.3
17.08 - 16.25%
16.69%
18.56%
Treasury & Agencies
Propositions Accepted
Bankers' Acceptances
18 3/4
Bankers' Acceptances
Propositions Accepted
17,.08% $27.9
17,.01
80.7
17,.00
62.0
16,.80
116.9
16..51
20.0
16..50
89.1
16,.41
6.6
16..35
52.3
16.,31
53.1
16..25
14.7
TOTAL
$52X1
Propositions Reiected
15. 90% $ 2.0
$ 2.0
TOTAL
298
ARTICLES FROM VARIOUS PUBLICATIONS
(Wall Street Journal, July 30, 1981)
Canada Asks Banks
To Reduce Their Loans
Used for Takeovers
By a WALL STREET JOURNAL Staff Reporter
OTTAWA-In an unusual move designed
to aid the sagging Canadian dollar, Canada's finance minister, Allan J. MacEachen,
met with senior Canadian banking officials
to request a reduction in takeover loans,
particularly those converted into U.S. funds.
Emerging from a closed-door meeting
late yesterday, Mr. MacEachen said the
banking officials "responded to my view
quite well and felt that it was a timely action."
However, Mr. MacEachen didn't say
whether he had received firm assurances
from the banking officials, who weren't
identified, or what actions would be taken if
takeover loans weren't reduced.
Mr. MacEachen indicated that he had
made a broad appeal for reduced lending,
not only for take-overs outside Canada but
for domestic bids, too. It wasn't disclosed
whether specific limits were sought on
either the number or the amount of individual loans. Mr. MacEachen said he expected
that banks would meet existing commitments.
The Canadian official said he made the
unusual request for restraint because of
what he called "an epidemic quality" to current conditions. In the past two weeks, the
Canadian dollar has fallen almost 1.5 cents
(U.S.). On anticipation of a government
statement yesterday, the Canadian currency
gained 0.33 cents (U.S.) to close at 81.33
cents.
Recent months have marked a wave of
Canadian purchases of U.S. assets, in Canada and the U.S. One analysis by Pitfield
MacKay Ross Ltd., a Toronto-based broker
age firm, estimates that capital outflows
from Canada have totaled $10 billion (Canadian) versus an annual average of $2 billion during the 1970s.
Mr. MacEachen didn't specifically tie
such outflows to Canada's nationalist energy
policies, but he urged that the policies be applied more slowly. The energy program is
designed to encourage Canadian purchases
of U.S. assets and has sparked a number of
major takeovers, including the $1.46 billion
purchase by state-owned Petro-Canada of
the assets of Petrofina Canada Ltd., which
was controlled by Petrofina S.A.
Concern that these nationalist policies
may be extended to other industries isn't
merited, Mr. MacEachen said. In a clear
appeal to foreign investors, the finance minister said: "Obviously, we still want to encourage the in/low of capital."
"In that connection," he added, "I
wanted to assure the Canadian banking
community, as well as the population at
large, that it is not the intention of the government to extend the policies embodied in
the national energy policy to other sectors of
the Canadian economy."
299
(Newsweek magazine, July 27, 1981)
BUSINESS
Christoph Blumnch—Ntwsmu
Real-life gamesmanship played for superstakes: Almost every day another bid, and 'another company under the gun
The New Urge to Merge
O
ne prominent banker called it a "feeding frenzy," and last week, as the biggest takeover battle in American corporate
history gained momentum, the description
seemed right on the mark. Three giant companies—Du Pont, Seagram and Mobil—
were battling for control of Conoco, Inc.,
the nation's ninth largest oil concern, and
the bidding was fast approaching the S8
billion level. Meanwhile, other cash-rich
corporate giants were eying their own acquisition targets, and frightened companies
scrambled to protect themselves. By the end
of the week, the hunters and their prey had
stocked up war chests of bank credits worth
more than $25 billion—enough to buy Detroit's Big Three automakers with $10 billion to spare—and many analysts predicted
that the marauders were preparing for a
long-term merger binge of unprecedented
proportions. "Having had that first taste of
blood," said Larry Goldstein, chief economist for the Petroleum Industry Research
Foundation, "it is hard to believe they will
pull back."
The new merger fever owes much of its
fury to the current state of the oil industry.
Because of the recent worldwide surplus of
crude oil, many companies have watched
helplessly as their stock prices fell to levels
that did not reflect the true value of their
assets. Acquiring those stocks at depressed
prices amounts to buying oil at prices as low
as S5 a barrel—a bargain that is virtually
irresistible to companies that have amassed
huge hoards of cash. As a result, analysts
think half a dozen small to middle-size oil
companies are likely candidates for takeover (page 54), and even some of the giants'
may be vulnerable if world oil prices stay
Thefiercebidding
battle for Conoco
raises fears about
whether U.S. business
is getting too big.
soft. "People are looking at the oil companies and saying 'to hell with any short-term
problems'," says Elliott Fried, an executive
vice president at Shearson Loeb Rhoades.
"Assets in the ground will go nowhere but
up in price, and this might be the last golden
opportunity to buy oil cheaply."
But the war over Conoco, in particular,
has broader implications. Perhaps most important, it will provide the first niojor test of
Ronald Reagan's antitrust policies, which
are widely expected to be considerably more
lenient than those of his predecessors. If the
Justice Department approves the acquisition of Conoco by another big oil company,
many businessmen may feel free to pursue
mergers and acquisitions they would never
have attempted in stricter times—making
big consolidations more than ever a permanent part of the business scene and creating
still more revenue for the Wall Street firms
that specialize in putting the deals together
(page 52). Already, the prospect of the increasing concentration of big business has
raised squawks of protest in Congress. And
there are even some fears that a tidal wave of
mergers will do serious harm to the national
economy, as robust corporate demand for
merger loans renews upward pressure on
interest rates, swells the money supply and
fuels inflation.
Stampede:The seeds ofthecurrent merger craze were sown early last May, when
Canada's Dome Petroleum offered 565 a
sharefor 22 million Conoco shares. Much to
everyone's surprise, Conoco stockholders
stampeded to unload, offering Dome 55 million shares. Dome wanted only enough
shares to force Conoco to turn over its interest in a Canadian company, however, and it
stuck to its original terms. But other acqui-
300
ition-minded companies, excited by the vel discussions between Du Pont headquart- a new offer, hoping Mobil would move first,
tockholders' response, began poring over ers in Wilmington, Del., and Conoco front But they finally took another plunge. They
he public statistics on Conoco—and quick- offices in Stamford, Conn., the two compan- sweetened their offer to S95 a share for 40
y realized that they were looking at a bar- ies announced a deal. Du Pont would buy per cent of Conoco's stock and pledged 1.7
jain. Conoco's domestic reserves of400mil- Conoco fora total of $6.9 billion—$3 billion shares of Du Pont for each remainingg share,
e
ion barrels of oil, its strong position in in cash for the first 40 per cent of the oil Conoco's
C '
di
ikl approvedd the
h
directors
quickly
company's shares and 1.6 shares of Du Pont new deal.
; North Sea production and its Consolidation
Coal Co. subsidiary—the second largest for each ofthe remaining Conoco shares.
Insight: Just two days later, Mobil made
:oal producer in the United States—added
But the battle was far from over. Jefferson its move. It offered to buy 43.5 million
up to assets worth well over $ 140 per share of and his wife, Naomi, were on their way to a shares of Conoco—slightly more than half
Conoco stock. At the time, Conoco was golf game early last week when a Du Pont of those outstanding—for $90 a share, and
selling for about S50 on the New York Stock public-relations officer telephoned with dis- to trade Mobil securities for the rest of
' Exchange.
concerting news: Seagram had just boosted Conoco's stockk at a rate equal to $90 a share,
J: Seagram Co., Canada's huge distiller, its offer for Conoco, seeking about 51 per In announcing the bid, Mobil chairman
was next to make a run at the prize. Cono- cent of the stock for $85 a share in cash. Rawleigh Warner Jr. calculated that it beat
co's board of directors rejected a "friendly" Because investors—disturbed at the idea of Du Pont's second offer by $3.80 a share, and
offer from Seagram chairman Edgar Bronf- Du Pont's prospective transformation into topped Seagram's by $5. And Mobil vice
man to buy 25 per cent of the company's a giant oil company—had bid down the president Herbert Schmertz provided an
stock—and to refrain from acquiring more chemical company's stock after news of the intriguing insight into just how hot the confor at least fifteen years. But Seagram's Conoco deal, Seagram's new offer topped test for Conoco had become. Just hours
'move made Conoco nervous. To protect Du Pont's combined cash-and-stock bid by before Mobil made its offer, the oil company
;
themselves, the company's directors began more than $4 a share—though it was not for was approached by a representative of Seamerger negotiations with Cities Service, an- all of the stock. Once again, Jefferson con- gram who wanted to know whether Mobil
; other oil company ripe for takeover; by vened a round of emergency meetings. By would consider a joint bid with Seagram for
pooling their resources, Conoco and CS that time, rumors were mounting that Mo- Conoco. "We indicated that we would not,"
managers thought they would become too bil, the second biggest industrial company said Schmertz.
big for a potential buyer to swallow. But in the United States, was also considering a
Most analysts expected that Mobil's offer
Seagram did not give up. It offered to pay bid for Conoco. Du Pont's directors delayed would set off a new round of bidding for
S2.6 billion in cash for a 41 per
Conoco—and that it may well
cent interest in Conoco—and Mobil drilling site, Warner (inset below): Testing Washington
bring in some new players. Seawould make no friendly promgram itself may yet find a partises about future purchases.
ner for the higher-stakes game.
With that, Cities Service broke
Another frequently mentioned
off the merger talks.
contender is Standard Oil of
California, whose officials
Help: In desperation, Conowere sounded out by Conoco's
co chairman Ralph Bailey
investment bankers when the
turned to a "white knight" who
Connecticut company was
had already offered help: Edseeking a white knight. Last
ward G. Jefferson, chairman of
week, however, Socal spokesE.I. du Pont de Nemours & Co.
men denied any interest. But
After a frantic week of high-leDu Pont's Jefferson, Texas
chemical plant: How far can
Conoco's 'white knight'go?
Seagram's Bronfman and his
product: An unwelcome raider
from north of the border
301
First Boston's Wasserstein and Perella: A tense chess game
The Marriage Brokers
man Sachs. "It was the first blue-chip raid." There were many
more to follow, and today, says Martin Lipton of WachtelJ,
Lipton, "I doubt that there are very many companies in the
country that, if the opportunity presented itself and the target
looked attractive, would not attempt a hostile tender offer." As
the battle over Conoco indicates, money is becoming increasingly less of an object. "Eighteen months ago," says Lipton, "it
would have been customary to advise a client worth more than
$2 billion that it was virtually inconceivable that they would be
the target of a hostile takeover offer." But now "a market value
of $5 billion or $6 billion is not a deterrent."
Chess: Takeover battles are frequently fought like tense
games of chess. Last year, for example, when Pullman, Inc., was
threatened by a hostile bid from J. Ray McDermott & Co., First
Boston searched around and finally persuaded WheelabratorFrye, Inc., a New Hampshire engineering firm one-third Pullman's size, to serve as a friendly "white knight" acquisitor
instead. But in more human terms, the battles can exert a real toll
on the companies involved. First Boston's Joseph Perella and
Bruce Wasserstein directed the Bache Group's successful defense against the Canadian Belzberg brothers—who had gradually been acquiring an ever-greater share of Bache's stock. "It's
like slow death," says Perella, "when soraeone goes into the
market and buys 5, then 10 and 20 per cent of your company, and
inevitably you have to sell out [to a white knight] or else he's
going to buy it cheap." Eventually, First Boston induced Prudential Insurance Co. to step in with a friendlier offer.
As the takeover wave has accelerated, the hours spent on the
mergers and acquisitions trade become nearly unbearable.
"We're going crazy, and it's just like this everywhere else," says
Jay Higgins of Salomon Brothers. "The problem is that when
somebody's going to put his career on the line to make an
acquisition and pay a lot of money—he couldn't care less about
your personal life." With billion-dollar battles being fought
every day, says one top participant, "it's not a business in which
one'plans vacations, or even dinners." It is also not a game for
older players: the average age in First Boston's mergers and
acquisitions department is 31.
Yet the merger business also has its compensations. First
Boston, for example, charged Pullman $1,500 per man-hour to
engineeer its rescue, for a total cost of $6 million. "The fees are
gigantic," admits one investment banker. Those fees, of course,
are a function of thesize of the mergers they represent—and with
the Conoco takeover alone providing possible bounties of more
than $30 million, investment bankers will remain alert to opportunities to keep the boom in big mergers alive.
The director of mergers and acquisitions for a major Wall
Street investment house was chuckling last week over a phone
call he had received from the chief executive of a $7 billion
corporation. The headlines that day had been full of news of the
battle for control of Conoco, Inc., and the caller was worried that
hisfirmmight also be vulnerable to a hostile takeover bid. "I was
literally pinching myself," the banker recalled. "The chances
that that company will have any problems are infinitesimal."
But then the banker paused... and his voice took on a new note
of uncertainty: "I'll probably pick up the paper tomorrow and
something will have changed."
Until the current seizure ofmerger madness abates, about the
only thing that remains certain in the highest echelons of merger-making is that more and more fearful executives will be
placing similar calls to one of a small group of elite investment
bankers who are involved in nearly every large-scale contest for
corporate control. "We're members of a club," says Felix Rohatyn, partner of Lazard Freres and one of Wall Street's bestknown deal makers. And membership gives the major players
the inside track to some huge profits (table). First Boston Corp.,
for example, stands to gain as much as $ 15 million ifits client, Du
Pont, wins control of Conoco.
Newcomers: Merger counseling was for many years an almost incidental service provided by such old-linefirmsas Morgan Stanley, First Boston, Lehman Brothers, Lazard Freres and
Goldman Sachs—but as the trend toward takeovers
has intensified, they have expanded rapidly and been
joined by fast-rising newcomers to thefieldsuch as
Salomon Brothers, Kidder Peabody and Merrill
Lynch-White Weld. All the club members provide
the same range of services, from identifying merger
opportunities to directing all-out defensive battles.
They even use the same lawyers. Two firms—Wachtell, Lipton, Rosen & Katz and Skadden, Arps, Slate,
Investment Banker
Meagher & Flom—seem to be in on nearly every big
deal. While eachfirmhas its particular strengths and
Morgan Stanley
weaknesses, their differences are often as much in
Salomon Brothers
style as substance. "It's like choosing your doctor or
lawyer," says Rohatyn. "People will choose investment bankers very often on the basis of what particular person they happen to like to work with."
The turning point for the business came in 1974
when International Nickel Co. of Toronto staged a
successful attack on ESB, Inc., a stuffy battery maker
in Philadelphia. "In our little world of mergers, that
was a very big event," says Steve Friedman of Gold-
HARRY ANDERSON with CONNIE LESLIE in New York
A FRUITS OF MATCHMAKING
^
Wall Street* s merger experts often work on
their deals for days with little sleep—but a sampling of the fees they have earned recently
shows their efforts are handsomely rewarded.
Deal
Shell Oil/Belridge Oil
Elf-Aquitaine/Texasgulf
Wheelabrator-Frye/Puliman
Fluor/St. Jce Minerals
Kraft/Dart industries
Tenneco/Southwestern Life
Nabisco/Standard Brands
Cooper Industries/ Gardner-Denver
RCA/CIT Financial
6.5_
SJO
3.5
3.0
3.0
2.0
1.8
302
IUSINESS
srhaps the most likely entry in the Conp stakes is Texaco. It, too, was apjroached by Conoco in its flight from Searam, and sources close to the companies
Jeport that Texaco was the source of an
nonymous $85-a-share bid Conoco had
eported to the Securities and Exchange
Commission. Recently, Texaco lined up $6
million in credit in European markets—the
«ggest such credit arrangement in history—and oil-industry experts say the company needs to acquire domestic sources of
jil and natural gas.
; How far Du Pont could go in the bidding
is not clear. Last week the company announced that it had arranged for an extra $ 1
billion in loans—$700 million more than it
conoco
And just last week, in the midst of the
Conoco conflict, Treasury Secretary Donald Regan weighed in with an opinion. "Our
economy is growing, our nation is growing
and the world is growing," said Regan. "So
why shouldn't companies grow?"
Overlap: The issues before the antitrust
watchdogs are fairly clear. Seagram and
Conoco are simply not in competition with
each other in any area of their operations.
Du Pont and Conoco overlap only because
of a minor Conoco chemical division that
could easily be spun off as a condition for
government approval; otherwise, their
combination representsjust the sort of "vertical" merger—one company's acquisition
of another in its supply, production or distribution chain—that antitrust chief Baxter
thinks the government should approve.
Bailey briefs Conoco employees: Making light of uncertainty at 'Takeover Alley*
used to counter Seagram's latest offer. In
bidding against the likes of Mobil and Texaco, however, the company might find the
Federal government on its side. "I don't
think any oil company could do this deal,"
says one key insider. "The antitrust laws
would be a joke if that happened." Even if
Du Pont loses the Conoco battle, however,
not everyone will be sorry. According to
high-ranking company sources, some managers and members of the Du Pont family,
which still owns about 30 per cent of the
company's stock, are disgruntled because
the additional shares issued in a Conoco
acquisition would dilute their interest in the
company by about one-third.
The Ante: Just what Mobil's battle plans
might be was equally obscure. According
to the company's SEC filing last week,
Mobil's interest in Conoco preceded the
first Conoco-Du Pont deal—and Wall
Street experts say Mobil could up the ante
to $115 a share. But Mobil's motives may
be mixed. Some analysts think that in part,
at least, the company is playing spoiler,
hoping to blow Seagram, in particular, out
of the action.
Canada's National Energy Plan, which
was designed to give Canadian companies
more control of that country's energy resources, has severely cut the value of American companies' Canadian holdings. That, in
turn, has eroded the companies' stock values, making it even easier for an opportunistic Canadian company to try to gobble them
up. "Mobil and others have considerable
resentment," says Robert Morris of Drexel
Burnham Lambert. "There would be a lot of
quiet rejoicing in the U.S. oil community if
Seagram were defeated." But Mobil also
has more practical ends in mind. "Mobil's
primary objective is to win," says Sanford
Margoshes of Bache Halsey Stuart Shields.
"Its secondary objective is to test the political and legal climate."
The entire business community looks forward to that test. And Washington is taking
it very seriously, too. Last week the Justice
Department and the Federal Trade Commission were embroiled in an unusual intramural spat over which agency should have
antitrust jurisdiction over the Conoco
deals. FTC staffers had already started evaluating both the Seagram and Du Pont bids
when William F. Baxter, Assistant Attorney General for antitrust, demanded that
his forces take charge. Baxter's argument
was that Justice has more expertise on energy- and chemical-industry matters—and
would be able to act more quickly and decisively on the case. Then, having won his
way, Baxter turned supervision of the matter over to Justice's patent and copyright
lawyers—who have since had to ask the
FTC's oil and chemical experts for advice.
So far, the agencies have not determined
which will examine the Mobil bid, but given
Baxter's heavy-handed intervention, the
betting is that Justice will investigate that
one, too.
Ifso, all the deals on the table have a good
chance for government approval. Reagan's
Justice Department, with Baxter in the
lead, has made no secret of its belief that
bigness in business is not necessarily bad.
The Mobil bid is the trickiest. It represents a "horizontal" merger—an amalgamation of two companies in the same business—and even Baxter insists that such
combinations deserve close scrutiny to
guard against the concentration of too
much market power in one boardroom. But
Mobil and Conoco are not really direct
competitors in any significant markets,
even though they are, respectively, the second and ninth largest oil companies in the
country. In announcing Mobil's offer,
chairman Warner said that his own company's review of the relevant market shares
shows that a merger "should not violate the
antitrust laws." And Mobil executives express confidence that the Justice Department will concur.
Under 1968 guidelines, Mobil and Conoco may overlap unacceptably only in the
production of one chemical and in the sale
of gasoline in two states. "If there's no
problem under the old guidelines, there's
certainly not going to be a problem under
Baxter," says one top aide. "The law we've
got talks about competition, not size, and
that's just a fact."
Many economists agree. Particularly in
303
BUSINESS
the oil business, they argue, there is little
danger of too much concentration. Unlike
companies such as General Motors, IBM
and U.S. Steel, for instance, even the biggest
oil giants control relatively modest shares of
their complex market: although Exxon and
Mobil are the two largest American industrial corporations, their combined share of
total U.S. refining capacity is only 14 per
cent. Big Oil's power is also steadily eroding. "OPEC wrested away control at the
wellhead for much of the supply and is
now moving into refining," says Samuel
Hayes III, professor of investment banking
at Harvard. "The companies no longer have
the control they did ten years ago."
In view of the current economic climate,
oil acquisitions make particularly good
sense. Buying undervalued oil on the stock
market is far cheaper thanfindingit. According to Robert Stobaugh, co-author of
the Harvard Business School's best-selling
"Energy Future," drillers must count on
spending $10 a barrel in the search for oil.
Once oil is found, the reservoir must be
developed—a process that can add $3 a
barrel to the cost. Finally, the electricity to
run pumps, transportation costs and other
downstream expenses can add $3 more to
the total, making stock-market oil at $5 a
barrel and less an undeniably good buy.
Economists also dispute the conventional wisdom that plowing investment dollars
into acquisitions, instead of pumping them
l i r t ~ ~ ? ~ \ T * - r * ^.* 4.1.^ A U ^ ^
W H O S INCXt a t t U C A l t a r .
into existing operations, is necessarily an
"unproductive" use of assets. Prior to the
Conoco bidding war, thebiggest acquisition
in history was Shell Oil Co.'s $3.7 billion
purchase of Belridge Oil Co. in 1979. Using
new technology, Shell has boosted the production of its acquired fields from 42,000
barrels a day to 60,000.
Productivity: Even outside the oil industry, most economists think growing
concentration is fundamentally neutral.
Some worry that executives currently are
spending too much time on takeovers and
not enough on operating problems. Others
fear that as companies get bigger they may
become unmanageable. But some big
mergers result in economies of scale that
actually improve productivity and eventu-
lure ofa valuable energy alternative: coal. Mobil and other oil
giants havefledglingsynfuels operations that could draw on
Conoco's ample reserves, and Seagram could profit simply by
With the acquisition of Conoco, Inc., by somebody an almost mining the coal and selling it to an energy-hungry market.
certain event, the newest game being played in oil-company
Many experts say that the heavy bidding for oil-company
boardrooms and on Wall Street is "who's next?" Texaco is stocks may bejust beginning. And
d when the dealing is done, says
rumored to have its sights set on either Atlantic Richfield or one Washington-based energy consultant, "Five or six of the
Cities Service—and those two companies may be shopping smaller integrated domestic companies may have disappeared."
around for merger partners of their own as protection against a The losers in the battle over Conoco, for instance, might tackle
raid. Meanwhile, Pennzoil chairman J. Hugh Liedtke says that another oil company with large coal reserves, such as Pennsylvahis company has been approached to play the roles of both nia-based Sun Co. Smaller oil-production companies like Supe"white knight" and "black knight" in pursuit of other compa- nor Oil and Louisiana Land & Exploration may be hit next,
nies—but Pennzoil itself is reportedly a possible target for Although their stock prices are doing better than those of the
Standard Oil of California.
integrated companies, which also refine and market oil prodThe reasons for the sudden attraction to oil companies as ucts,
• their
•• • reserves will be bought at relatively higher prices.
acquisitions are clear enough. Measured by the stock-market "And if you can't steal the Conocos and the Marathons, you
prices for their shares, the major energy concerns have long might go after an even better deal on a natural-gas company,"
been depressed in relation to the underlying value of their predicts Barry Sahgal, senior energy analyst at Bache Halsey
assets. The current oil glut has depressed prices still more— Stuart Shields.
and now, analysts say, many companies have oil and naturalSome strategists suspect that more big foreign-oil companies
gas reserves that alone are worth three to four times their stock- may soon join in the bidding for American petroleum reserves—
market value (chart). Even at
and some even think that
Exxon, the largest oil company,
premiums well above their
HIDDEN ASSETS
may enter the takeover game.
stock-market prices, acquiring
The worldwide oil glut has depressed
Exxon, so far, has avoided the
companies can get real barthe stock prices of oil companies to the
purchaseofother oil companies
gains. If Seagram were to win
point where they fail to reflect fully the
on the theory that its sheer size
Conoco at its current bid, says
value of their reserves.
would void any deal on antiHarvard Business School protrust grounds. But if Mobil's
fessor Samuel Hayes III, in efV .J
Estimated
bid for Conoco gets a green
fect it wii! be buying oil at $3.50
Market
value of oil
light from Washington, Exxon
a barrel—a tidy discount from
price
and natural-gas
might well be in the market to
the world crude price of $34.
reserves per share
per share
buy up a competitor too.
Strategy: But more is inGetty Oil
$72.00
$250
For all the attractions, willyvolved than mere fire-sale
210
Marathon Oil
68.63
nilly purchases of oil compaprices; the current shoppers
205
60.25
Standard Oil (Ind.)
nies could cause indigestion for
are also seeking textbook-type
some buyers. Much of the inbusiness "fits." If Du Pont
Standard Oil (Calif.)
172
40.38
dustry's operations have been
wins Conoco, for example, the
Atlantic Richfield
170
50.50
reduced to marginal profitabilchemicals giant will have
147
87.25
Conoco
ity because of the oil glut. If the
bought a steady source of pe130"
Cities Service
56.50
trend continues, many raiders
troleum feedstocks for many of
45.50
may find they have bought
130
Phillips Petroleum
its chemical and plastic prodlines of business they can't
ucts. If crude-poor Mobil car40.75
130
Sun Co.
afford to keep. Many analysts
ries the day, it will get a massive
38.75
Union Oil
100
are already warning that toinflux of domestic reserves free
Amerada Hess
32.00
87
day's merger spree will lead to
from OPEC oil embargoes and
an equally intense divestiture
sudden price hikes. And for all
Louisiana Land &
38.25
55
binge in the months ahead.
the potential raiders, belea.Exploration
_
SUSAN DENTZER with bureau reports
guered Conoco provides the
Source: Donaldson, Lufkin & Jenrette Securities Corp.
304
we're going to move, now's the time'," says companies in recent weeks could put upBUSINESS
Metzenbaum. "William Baxter has the ward pressure on interest rates, he says, and
a!!y show up in lower consumer prices. wrong perspective, and he ought to go back make it difficult for other sectors of the
, "[It] really depends on the industry and to reading his law books."
business community to obtain credit. In a
I the managerial process itself," says NorthThe two liberal senators are urging Judi- letter to the Federal Reserve Board, St. Ger! western University management professor ciary Committee chairman Strom Thur- Xnain argjoedthat themexger acti v
mond to hold hearings on the Conoco situa- driven*bv a "mob psychology... fi
Albert Rappaport.
, Certainly not all mergers are made in tion before the August recess in the hope unlimited credit," and called on the Fed to
! heaven. Usually, the acquired company has that such hearings would postpone, if not curbit.Thelawmaker'sconcernissharedby
been in trouble of one sort or another that prevent, a Conoco merger. Thurmond i
some highly respected bankers. "I think the
made it vulnerable to takeover in the first expected to reject that request—on the Administration ought to ask for a moratoriplace. Especially in acquisitions that in- ground that he doesn't want to interfere in um on these takeovers until it develops a
volve diversification—a big corporation the free market's play.
clear antitrust policy and studies their imtrying to expand its horizons by absorbing
There is also considerable displeasure in pact on the financial markets," says Lacy H.
an entirely new kind of business—the trou- the House of Representatives. The Mines Hunt, chief economist at Philadelphia's Fibled target's difficulties sometimes get and Mining subcommittee headed by Ne- delity Bank.
worse under new management and are shel- vada Democrat James Santini last week
P i l one Federal Reserve official
Privately,
tered by the owner's ability to pay for mis- passed a bill that would knock Seagram out acknowledges that the enormous credit
takes. "Management of the new
caches could cause macroeconomic
subsidiary knows it is no longer out
trouble. Much of the money is apthere swimming by itself, that it will
parently being secured in European
be projected, and that they are such
credit markets, where some $735
a small part of such a big company
billion in greenbacks have piled up
that they will not have the sharesubject to no U.S. banking regulaholders breathing down their necks
tions. The unexpectedly massive inall the time," says Drexel Burnham
fusion of these funds into American
Lambert's Robert Morris. The most
financial markets could complicate
embarrassing failure of diversificathe Fed's efforts to control the U.S.
tion so far has been Mobil's own
money supply. If so, the central
1976 purchase of Marcor for $1.6
bank's only recourse would be to
billion. Marcor's Montgomery
put even stiffer brakes on domestic
Ward subsidiary has performed so
money growth. Over time, says the
badly that in the past year Mobil has
Fed official, the effects of this tembeen forced to bail it out with $355
porary jolt to the Reagan monetary
million in interest-free loans.
policy would be smoothed over—
but not without some sharp shortShrinking Profits; Despite such
term pressure on interest rates.
problems, almost everyone agrees
that the bitter combination of inflaOneWinner:In testimony before
tion and slow economic growth has
the Joint Economic Committee late
fueled the urge to merge among corlast week, Fed chairman Paul A.
porate executives. The reai rate of
Volcker tried to calm those fears.
return on the value of company asHe pointed out that much of the
sets has dropped significantly in remore than $25 billion in credit lines
cent years—from 15.8 per cent in
arranged in recent weeks have been
1965 to 9 per cent in 1979—and
lined up by companies that want to
B*ttmann Archivt
profits are whittled down by the
bid for Conoco—and since only one
ever-rising cost of maintaining and Bigness in McKinley 's era: How permissive will Reagan be? o f the Conoco suitors can win in the
bui!ding plan ts and equipment. As a
end, not all the credit commitments
result, companies seek higher returns by of the Conoco game. The measure would will necessarily be drawn down.
investing in other corporations—and they impose a nine-month freeze on foreign purBut that assumes that after Conoco the
willingly bid high for what they want. Before chases of more than 5 per cent of U.S. losers will stop their prowling—something
the merger binge that began in the late companies with mineral rights on Federal that is by no means certain. So far, for
1960s, companies typically paid 28 per cent lands. Santini's freeze would be retroactive example, Texaco has remained absolutely
above market value fora controlling interest to July 15 and is aimed at retaliating broadly silent on its own plans for using about S3
in acquisition targets. Today, says Harvard against Canada's energy policies. A second billion in ready cash and its historic $6
business professor Malcolm S. Salter, they subcommittee has approved a bill that billion line of credit. Although Bache's
would force foreign companies to play by Margoshes, among other analysts, thinks
pay 50 per cent or more.
If economists are not particularly dis- the same credit rules that constrain Ameri- there is a "50-50 chance" that Texaco will
turbed by the merger wave, plenty of politi can companies. By prohibiting them from move in on Conoco, it is just as possible that
cians are. Democrats Edward Kennedy of borrowing more than 50 per cent of an the company will take a run at another
Massachusetts and Howard Metzenbaum • acquisition sum, it would remove a distinct undervalued property. The same holds true
of Ohio are raising alarms in the Senate advantage foreign corporations have en- for the other bidders in the Conoco stakes,
about the implications of the Conoco deal joyed in the American merger sweepstakes.
Perhaps sensing the growing danger,
and the dangers of the Reagan Administra- It would not affect Seagram, whose borrow- Gulf Oil—the nation's fifth largest oil
tion's permissiveness on antitrust matters, ing is not even close to the limit.
company—announced last week that it
As they see it, the current war is just the
JMot^Psycholo^y': One influential con- was purchasing 5.1 per cent of its own
start of a dangerous trend toward consoli- pressman,
HousejBanking^FinanceAQdJJx^. outstanding shares. Company spokesmen
dation that could destroy small business hfw A ffai ^^mi^'^.fA i liHn nn . Fernnnri explained that Gulfs stock prices, which
and hurt consumers. "Every corporate ^ j . S.tT.Germajaof Rhode Island, worries that have been hovering around $35 a share,
boardroom and every lawyer representing a the huge mergers may unsettle the financial reflect less than one-third the value of its
corporation in this country is saying, *If ever markets. Themassivecreditlinessecuredby assets. This meant that buying its own
305
stock was a good investment, but the $350
million purchase should also shore up the
stock price—and help prevent Gulf from
falling prey to a Conoco-like raid.
While it seems likely that the company in
the eye of the storm—Conoco—will end up
being acquired by someone, it is still far
from clear just who that will be. Although
Mobil's offer appears to be the most attractive on the table so far, the other competitors have certain advantages. Du Pont, for
instance, has the full support of Conoco's
management, which has put together $3
billion in credit lines of its own, presumably
in order to buy some of its own stock to stave
off an undesirable coup.
Du Pont also has an ace up its sleeve in the
form of an option to buy millions of unissued shares of Conoco, thereby frustrating
Seagram and Mobil efforts to gain majority
control. For its part, Seagram is offering to
pay entirely in cash for the 51 per cent of
Ccnoco stock it seeks—and to some shareholders, the promise of an immediate payoff
may outweigh a long-range gamble on a
higher price.
Nervous Wait: Not surprisingly, the
siege of Conoco has thrown the company's
employees into a state of high uncertainty.
The company's top officials protected
themselves well before the latest bidding
round took off: the board of directors gave
Bailey and eight others new employment
agreements guaranteeing their salaries
through mid-1984—no matter what. Lower-level employees have no such protection,
although it is unlikely that either Du Pont
or Seagram, which are involved in such
drastically different primary businesses,
would have much cause to interfere or chop
heads. Mobil is another matter. One big oil
company swallowing another might well
decide, for efficiency's sake, to consolidate
certain operations. While they await the
outcome, Conoco employees are trying to
make the best of things. They have renamed
the bar at Brock's, a local restaurant near
headquarters, "Takeover Alley."
Almost all observers predict that the bidding for Conoco will go much higher—
perhaps to as much as S115 a share—before
a winner emerges. If so, some losers could
still claim a victory: if they succeed in
buying big blocks of stock from the shareholders during the auction, they may be able
to sell them at a hefty profit to whomever
wins the prize. But there is at least one group
of sure winners on the sidelines. Conoco's
70,000 stockholders have already watched
the value of their shares soar from less than
$50 last spring to $87 last week. By almost
every estimate, the stock will be worth
much more by the time any deal is consummated. In the meantime, all they have to do
is sit back and enjoy the cutthroat fun.
gton. RICHA
SA
Francisco, DAN SHAPIRO
306
(Economist magazine, July 25, 1981)
Poor little rich banks
America's banks can raise $38 billion overnight, but in some ways
they are now unhealthily weak
The huge loans mobilised in America's latest takeover
battles—$38 billion promised at last count—may seem
to be a tribute to the enormous financial power of
America's big commercial banks. Actually, the way in
which those lending consortia are organised is a worrying sign of the extent to which big American banks have
seen their power eroded by their largest customers.
Big corporate borrowers with good credit ratings
rarely have any difficulty in raising such loans. The
bank organising the finance phones up its sister banks
and ropes them in ("We've put you down for $200m for
Megalopolis Oil. All right?"). Some of the big borrowers are now flatly refusing even to tell the providing
banks what their money is to be used for. When the
details of the lending consortia and takeover bids were
announced, at least one big bank discovered that it had
financed an attempt to do down one of its best
customers. "We won't be getting much business from
them for the next few months", wailed its spokesman.
That experience was not unique. In the bidding war a
number of banks have found themselves—by accident
or design—on both sides of the fight.
Gilded cage
These banks appear in different consortia because, says
one corporate banker, "in this business, you no longer
have clients, just customers." American banks—forbidden to become investment bankers, cut off from
expanding their business with personal customers by
the ban on interstate banking, trapped by usury laws
and nagged by competition from such new rivals as
money-market funds—are fighting fiercely for corporate business. America's biggest firms have not been
slow to take advantage.
Despite this tough competition, the big New York,
Chicago and San Francisco banks have held on to their
pre-eminent positions as corporate bankers. They say
this is because of their expertise. It is also because of
the magical qualities of their names. A takeover
bidder, or a potential victim rounding up funds for
defence, wants to have his lending consortium headed
by Chase Manhattan, Citicorp, Manufacturers Hanover, Morgan Guaranty or whomever. A consortium
headed by a regional bank or a foreign bank might be
able to raise just as much money, but it would not strike
the same chill of fear into the beholder. Corporate
America, now run predominantly by colourless business school graduates, likes its bankers to possess the
inherited trappings of the great barons of finance.
These barons, though imprisoned by their customers,
find that the cage in which they are trapped is a gilded
one. The $38 billion of potential loans arranged by the
takeover participants in the past few weeks have'
yielded the banks some $150m in commitment fees,
before a penny actually changes hands.
Once any of that potential money is turned into real
loans, the banks will get their usual spread on the
money they lend. Some banks are cross that the very
biggest corporate customers have asked for a discount
from prime rates, to match the finer distinctions of
company credit-worthiness made by the commercial
paper market. But the banks have duly if reluctantly
offered such discounts, and have undermined their
bargaining position further by agreeing to lines of credit
to back up a company's commercial paper operations,
should the market prove temporarily difficult. With
margins on corporate lending shrinking, commitment
fees have come to play an increasingly important part in
the banks' profits.
In all these ways, America's fragmented banking
system now suffers from comparative weakness when
dealing with the great corporations who are its principal
customers. That is one reason why bank shares languish
on Wall Street. The top ten biggest American banks
have a stock market capitalisation of $17 billion, while
America's 10 biggest industrial firms have a capitalisation of $154 billion. Outside America, the banks are
stronger. But even in countries where banks have been
able to retain higher levels of profitability, to keep their
retail networks growing, and to remain financial equals
of the companies they deal with, competition (sometimes from American banks hoping to escape from
their crowded domestic market) is beginning to reduce
the banks' relative clout.
Elephants aren't controllable
Is this bad news? In many ways, no. Some analysts are
saying that the $38 billion so easily raised for takeover
finance could threaten America's control over its
money supply or prevent a repetition of (eg) the $40
billion lent by the commercial banks to poorer countries last year. Since only a portion of the takeover
bidders' new $38 billion—perhaps a quarter—will be
turned from commitment into loan, these arguments
are at present being exaggerated. But if the American
antitrust authorities allow a merger between two giant
oil companies, the stage will be set for a rapid burst of
307
industrial concentration. In such a merger wave, the
bidders will finance much of their acquisition with bank
loans rather than bonds (too weak a market at present)
or equity (too expensive, since oil firms believe their
shares are undervalued, and dividends must be paid out
of post-tax income while interest payments qualify for
tax relief). A series of mergers between very big
companies might make some of the worries about
inadequate control of money supply come true.
Even a monetary control system as mechanical and
legalistic as America's present one relies on the assumption that commercial banks act independently, in
their own interests, responding to internal pressures of
profit and loss. In the long term, this assumption must
be true, or the banks would collapse one by one. But in
a fierce competition for corporate customers, in which
they deal from weakness with their giant customers, the
banks are quite capable of acting perversely for short
periods, to oblige arm-twisting customers or fight for
market share. And the markets increasingly judge the
success or failure of monetary policy in the shortest of
short terms. The shifts of power in America's financial
system provide yet another reason for questioning
whether Mr Paul Volcker, who is concentrating the
Federal Reserve's policy more and more intensely on
the control of short-term monetary movements, can be
confident that his aims are very clear.
308
(Business Week magazine, August 10, 1981)
Editorials
Mergers are not growth
There is nothing inherently wrong with mergers, even
the giant combinations that have been proposed in the
U. S. over the past month. But mergers that size contain the seeds of giant risks, too. Pan Am's merger with
National Airlines has not only failed to produce the
synergism that was expected, it has brought the resultant airline to the brink of financial disaster.
Even worse from the standpoint of promoting the
growth of the economy, when Seagram, or Du Pont,
buys Conoco, and when Penn Central buys Colt Industries, not a single new job will be created in the U. S. If
Mobil Oil buys Conoco, not a single new barrel of oil
will be discovered.
What is hard to understand is why these companies
with huge cash or borrowing resources and unrestrainable urges to grow cannot or will not grow their
businesses internally, developing new products and
upgrading manufacturing facilities. Last year, for
example, RCA—once a premier high-technology company—explained to BUSINESS WEEK that it did not have the
$200 million necessary to develop a videocassette
recorder of its own, even though recorders have turned
out to be the fastest-growing appliances of the decade.
But RCA had no difficulty borrowing $1.2 billion to buy a
lackluster finance company.
The rationale for some of today's giant mergers
becomes even less clear when the buyer is using borrowed money, raised at today's record-high interest
rates. When Fluor Corp., with a net worth of about $500
million, paid $2.7 billion for St. Joe Minerals, it had to
borrow $1 billion. Because it bought 45% of the company for cash, paying $80 a share, it is forking over $12 a
share to the banks, just for interest on the loans until
the merger is consummated. That interest is hardly
offset by the 90<f-a-share dividend it received. Fluor
ended up pouring virtually all its cash flow in the first
half of 1981 into interest payments.
Although there is nothing illegal about such mergers—in fact, an attempt to bar them would only be
institutionalizing bad management at some companies—the U. S. will never solve its difficult economic
problems by following this kind of pattern. What U. S.
industry needs is giant investment in new products and
modern manufacturing processes. It needs to shed its
preoccupation with short-term earnings and be concerned with growth that also helps the economy to
grow.
309
(Wall Street Journal)
Overlapping Shareholdings Pervade
Competition for Control of Conoco
By CHARLES J. ELIA
funds, also are among the 34 largest owners tutions have sole discretion but aren't the
staff Reporter of THE WALL STREKT JOURNAL of Mobil stock, controlling nearly 17%.
beneficial owners.
If anybody wins the bidding battle for
Rep. Bedell has asked the Federal Trade
In the case of Bankers Trust, all but a
control of Conoco Inc., some people won't Commission to investigate the role of institu- fraction of the holdings of Mobil, Conoco and
wind up losers-the shareholders of Conoco, tional investors in the current wave of merg- Du Pont stocks are employe plans that give
By sheer coincidence, perhaps, many of era among major corporations. In a letter to beneficiaries first rights to voting the shares
the biggest of those shareholders are also the FTC, he expressed concern that "in the on corporate proposals, Mr. Locker says,
among the biggest shareholders of Du Pont case of some of the largest banks, the ques- Those shares haven't been included in the
Co., which is bidding big dollars against tion is compounded by the fact that some of total percentages listed as held by instituSeagram Co. and Mobil Corp. for Conoco.
the same institutions are deeply involved in tions with crossholdings.
Many of the big Conoco-Du Pont share- the financial arrangements attendant to
The 13.3 million Mobil shares managed
holders are also among the biggest share- pending mergers."
by Bankers Trust include about 12 million
holders of Mobil. In fact, through instituMobil, Gulf Oil Co., Texaco Inc., Du Pont shares owned by two employe plans. Three
tions such as banks' trust departments, in- and other would-be acquirers have raised Conoco employe plans account for more
surance, pension and public retirement billions of dollars in bank credit lines re- than five million Conoco shares under Bankfunds, at least partial control of all the com- cently to pursue takeover plans. But the ers Trust management,
panies involved, is concentrated.
banks insist that normal lending relationParadoxically, although Mobil and Du
The battle for Conoco is putting all those ships with customers exist completely unin- Pont, along with Seagram, are slugging it
big shareholders into the glare
out for Conoco, CDE finds that
of a spotlight they'd probably
Du Pont owned 744,000 of MoInterested Parties
rather avoid. It again raises
bil's 212 million shares outstandStock Ownership (Shares)
questions about the concentraing at last count.
OU PONT
CONOCO
MOBIL
tion of stock ownership in relaCDE's Mr. Locker says new
2,144,900
762,800 2,060,000
tively few hands, and about Prudential Insurance
data on crossholdings reflect a
2,005,478 1,512,616 1,389,397
whether the price of oil-com- Manufacturers Hanover
higher
degree of concentration
Morgan 4 Co.
1,765,000
424,000 4,864.000
pany control reflects rational J.P.
of stock ownership across the
Insurance Annuity economics, or the self-interest of Teachers
College Equities Retirement Fund _1,454,087 1,187,700 1,450,000 board than was reported in
a few rich shareholders.
CDE's earlier listings.
Citicorp
> _ 1,341,253 2,390.000 1,393,014
"In effect," says Michael N.Y. State Teachers Retirement Fund 1.163,000 871.000 522,200
In the 50 largest U.S. compaLocker, president of Corporate
Cafifornia Public Employes £
nies, for example, an average of
Data Exchange, New York, a reTeachers Retirement System
„ 992,700 1,051,300
430,000 49 stockholders control 41% of
Girard
Trust
_
847,264
377,320 728,379 the stock, with an average of
search concern, "the same
- 762,500 636,385 1,267,296 30% of the stock concentrated in
shareholders will be deciding Wells Fargo
-741,585 473,038 616,162 the hands of the top 20 holders.
.
the fate of this merger on both Provident National
_
627,508
Chase
Manhattan
Bank
_
501,859
2,450,438
sides of the transaction." Mr.
Rosenberg, staff direc_ 624,906 917.760 544,410 t o rMarc
Locker's firm has just published US. Steel Pension Trust _
of R e p Bedell's subcommit_
578,748
First Union Bancorp
398,289
638,711 tee, says the pattern of crossa stock-ownership directory listBankers Trust*
610,314
5,629,206
13,337,329
holdings found in the Conoco-Du
ing the largest holders of stocks
504.456 283,601
739.083 Pont-Mobil triad "applies in
Fidelcpr _
in 456 of the Fortune list of the Walter
E Heller International _
-496,449
414.707
741,770 nearly all cases throughout the
500 largest industrial companies. Batterymarch
_ 427,500
225,100 536,368 energy sector." That is one reaFinancial
In Washington, Rep. Berkley US. Trust Co. _
-422,701
785,589
616.204
Bedell, an Iowa Democrat and Texas Teachers Retirement System
556,884 son, he says, that Mr. Bedell in
385,200
233.700
letter to the FTC, also raised
chairman of the House Small Metropolitan Life
229.250 432,500 his
:
347,775
Business subcommittee on en- Ameritrust
862.525 the broader issue of the institu394,822
-J
338,082
ergy, says the Conoco bidding First Pennsylvania
797,981 tions' role in other mergers.
227,841
.
324,613
Mr. Locker's research firm
816,563
"illustrates how incestuous the Bank of N.Y.
729,291
318,541
relationships' have become" N.Y. City Teachers Retirement System - 2 5 6 , 2 0 0 222,800 466,632 didn't include Seagram in its
among big companies. "Thirty- * mostly employe plan holdings
Source COB Stock Ownership Directory largest-holders directory, but
other data, from Computer Di
six of thetop65 holders of Conoco stock also are listed among the biggest fluenced by the trust or investment-manage- rections Advisors, Silver Spring, Md., show
investors in Mobil or Du Pont," he says.
ment departments that oversee the same a number of institutional owners of Conoco,
Mobil and Du Pont also had holding on
"The problem is a situation where share- banks' investment operations,
holders are abletosit on both sides to vote
The accompanying table listing large in- March 31 of Seagram.
on purchases at higher than market prices stitutional owners of Du Pont, Conoco and
For example, client assets managed at
to benefit themselves," Rep. Bedell says. Mobil, is drawn from data compiled by Cor- Citicorp included 348,800 shares of Seagram;
"I'm greatly concerned about what appears porate Data Exchange, whose listings go be- at J.P. Morgan 177,000 shares, at U.S. Trust
to metobe a significant drain of capital re- yond the ownership information filed by fi- Co. 107,275 shares and at Wells Fargo 129,sources away from more productive uses, nancial institutions with the Securities and 800 shares. Harris Trust, which was listed
It's raising interest rates and it impinges on Exchange Commission,
by Mr. Locker's firm as owning 742,000
the small-business segment of society."
It draws, as well, on corporate disclo- shares of Conoco and 915,000 Mobil shares,
The most recent available figures show sures in insider reports, proxy statements, had 662,000 shares of Seagram on March 31.
that the 34 largest holders of Du Pont hold registration statements and other public
Aside from.the matter of crossholdings,
nearly 23% of Conoco's outstanding shares, documents, institutional holdings in the ta- the Corporate Data Exchange listing show
Of those 34 holders. 24, mostly bank-trust, We are as of last Dec. 31 and for the most
insurance, pension and public retirement part, are managed assets in which the insti-
310
that the 20 largest holders of Conoco control
27.5% of the stock. In all, CDE found 74
holders, each with more than 0.2% of the
stock, and these 74 held about 46% of all of
Conoco's 108 million shares.
One of the largest is Newmont Mining
with 3.5 million shares. Another is Capital
Guardian Group, a Los Angeles bank and investment-management concern, with nearly
3.5 million shares. Capital Guardian also
showed up as one of the largest holders of
Du Pont, with 2.6 million shares. Du Pont's
largest holder, by far, is the Du Pont family, with 35% of its 148 million shares.
Similarly, the Rockefeller family interests remain among the major owners of Mobil, accounting for 4.2 million of its 212 million shares. CDE also lists Internorth Inc.
with three million shares of Mobil, BaneOklahoma with 2.6 million, Payez Sarofim &
Co., an investment management firm in
Houston, with 2.2 million shares, and National Detroit Corp. with nearly 2.1 million
shares.
Among other large oil companies, concentration of stock varies. The 20 largest
stockholders account for 16.9% of Exxon
shares, 23.7% of Mobil. 17.1% of Texaco.
24.8% of Standard Oil of California, 27% of
Gulf Oil, 25.3% of Standard OU (Indiana),
20.9% of Atlantic Richfield, 49.6% of Sun
Co, 26.4% of Phillips Petroleum.
311
(Wall Street Journal)
Huge Credit Lines May
Presage Acquisitions
By P A U L B L U S T E I N and STEVE M U F S O N
Staff Reporters of THE WALL STREKT JOURNAL
NEW YORK - During the two-month
chase for Conoco Inc., five major oil companies arranged lines of credit totaling $24.7
billion.
The money i s still available. It could still
be used to buy other companies. Analysts
and merger specialists on Wall Street suspect what i s past m a y be prologue: The $7.5
billion acquisition of Conoco could be just
the beginning of an extensive takeover
spree.
"I've talked to the chief executives of
1
four or five of these big oil companies,"
says an investment banker. "They're saying, 'If assets can be bought, I want to be
ready. I don't want to be left behind.' "
Constanttne Fliakos, an oil-industry analyst for Merrill Lynch, Pierce, Fenner &
Smith Inc., s a y s h e believes merger activity
will continue, particularly in the energy
field. "Nothing h a s changed," he says. "The
oil stocks are still undervalued." Merger
specialists at investment-banking firms on
Wall Street s a y several major transactions
are being discussed, "especially," says a
veteran dealmaker, "in the natural-resource
business, including oil and g a s . "
Among the companies that have arranged big lines of credit are Texaco Inc.,
Gulf Oil Corp., Marathon Oil Co. and Cities
Service Co. Of course, Mobil Corp. still has
available several billion dollars of credit
that it didn't get to spend for Conoco. In addition, other oil. companies are understood to
have arranged large credit lines, but with
less fanfare.
"Everyone i s squaring off," says an investment banker with years of experience
making petroleum-industry deals. Merrill
Lynch's Mr. Fliakos predicts "more testing
of the waters" b y companies that want to
find out how much oil-industry consolidation
the Reagan administration will allow.
In Wall Street takeover rumors, oil companies often mentioned a s possible targets
are "second tier" companies with market
values of a s much a s $7.3 billion ( s e e accompanying chart.)
But tile chances that one oil company
would suddenly m a k e a hostile takeover bid
for another s e e m remote. Wall Street specialists s a y top executives in the energy
business simply aren't so inclined, although
the situation could change quickly if a company in another industry were to.make an
unwelcome bid for an oil company.
its intentions. Asked what the company expects to do with the $6 billion of credit
raised for the Conoco battle, a Mobil spokesman says, "we're counting it."
Such a spark could come, merger specialists say, from an attempt by a relatively
small company to buy a minority interest in
one of the medium-sized oil companies that
are considered vulnerable. After all, Conoco
didn't become a plausible takeover target
until Dome Petroleum Ltd. made a tender
offer for part of Conoco shares. Similarly,
Cities Service h a s been a subject of takeover
speculation ever since Nu-West Development Corp. Ltd. started trying to buy a
stake in it.
Cities Service president Charles Waidelich has been trying to dispel the speculation. "Cities Service i s not a merger candidate," he recently told securities analysts.
"We are not planning any mergers. No discussions are being held with anyone, and we
will resist with every m e a n s at our disposal
any attempt at a raid."
'Second Tier' Oil Companies
Company
Annual Salesi
1980
Common Stock
Market Value
Aua 5,1981
(Billions)
Phillips
$13.38
Sun
12.96
Occidental
12.48
Getty
10.15
Union
9.98
8.18
Marathon
Amerada H e s» 7.87
Cities Service 7.79
Kerr-McGee
3.48
Pennzoil
2.48
1.50
Superior
Louisiana Land 1.04
$6.85
5.48
2.25
6.36
7.31
4.39
2.82
4.79
2.18
2.78
6.10
1.54
Oil and Gas
Reserves*
1980
(Millions of
barrels)
2,143**
1,499
913**
2,391
1,922
1,796
1,190**
845
306
294
973
177
•'Natural
gas converted to oil equivalent
"Ma/orify of reserves outside U.S.
In Pittsburgh, Gulf s a y s the outcome of
the Conoco contest doesn't..change its acquisition strategy. Gulf, which recently negotiated a $5 billion credit line for acquisition financing, has narrowed its list, says James
E. Lee, president, without homing in on
"any one company" a s a candidate. Gulf
chairman Jerry McAfee adds that his company "isn't interested in being a party to an
unfriendly takeover" or to "an acquisition
for acquisition's s a k e . "
Of course, Wall Street speculation about
takeovers has to be viewed warily, because
some of the people spreading the word are
also the stock-speculators and deal-makers
Mobil, for example, apparently h a s de- who stand to benefit if the rumors come
cided that "if someone else starts a takeover true. And there a r e other factors that could
for an oil-and-gas company, Mobil i s free to slow things down.
come in and bid, on the theory that the comTheodore Eck, chief economist for Stanpany will be sold anyway," s a y s an invest- dard Oil Co. (Indiana), considers the Conoco
ment banker. Gulf, Marathon, Texaco and fight the result of "a temporary situation"
other potentially acquisitive concerns aren't in which oil shares have been depressed in
likely to make unfriendly bids for their oil- relation to exploration costs. As oil-company
industry competitors, either, he says, "but stock prices rise again in recognition of the
they're willing to be white knights. The ques- value of underlying assets, Mr. Eck argues,
tion is whether a spark will s e t things the stock-market bargains won't last. "The
mere fact that one deal succeeds makes the
off."
Mobil, however, i s keeping mum about *ext one more difficult."
312
QUESTIONS SUBMITTED TO MR. VOLCKER BY COMMITTEE MEMBERS
QUESTION SUBMITTED BY CONGRESSWOMAN ROUKEMA
Question. On page 11 and 12 of your statement, you make clear the importance of
"greater caution and restraint in both wage and price behavior." This point is
emphasized by your further comments about a "crucially important round of union
wage bargaining (which) begins next January, potentially setting a pattern for
several years ahead."
Are you suggesting that we institute an incomes policy? If so, what kind of
incomes policy would you suggest?
Can you envision a carrot and/or stick approach which efficiently accomplishes
your goal of "greater caution and restraint?"
What is the proper role of government, if any, in such a policy?
What suggestions do you have for both labor and management as they enter this
round of union wage bargaining? Please be specific.
Answer. I do think that it is critically important for labor and management alike
to exercise restraint in their wage settlements and pricing decisions in the months
and quarters ahead. So far the encouraging signs have been mainly on the price
side, although fairly recently there have been some tentative indications of easing
in wage pressures in some sectors of the economy. I am hopeful that as time passes
the collective bargaining process—left to its own devices—will confirm these indications, and I consequently do not endorse an incomes policy at this time.
The plain fact is that incomes policies have never worked very well during
peacetime in this country, in contrast to most European countries where they have
been tried much more frequently and with somewhat more success in some instances. I think there are basic reasons for this difference in experience: Ours is a
more heterogeneous workforce, and the wage-setting process in the United States is
much more decentralized. Moreover, the tradition of private decisionmaking on
economic matters, including wage determination, is more deeply entrenched here
than it is in Europe. And, the approaches we have tried in incomes policy have
tended to be less comprehensive.
It seems to me that any policy that is successful must take account of these
differences. This means, for one thing, that the role of government should not be
one of direct involvement and intervention in private decisionmaking. This is one
reason why I have long been intrigued by the so-called carrot-and-stick approach, as
illustrated by the tax-based incomes policy (TIP) proposals, which reward and penalize decisions on the basis of how they are made in the private sector. However, such
policies entail significant administrative complexities, and I have yet to see an
imaginative plan that also is workable.
Absent such a solution, I believe we have little choice but to point out the
consequences of inflationary behavior by wage and price setters and encourage the
forces of competition bearing on price and wage decisions. The impact of import
controls, regulation, and such legislation as Davis-Bacon are all relevant in that
connection. The heavy calendar of collective bargaining now slated for 1982 will
constitute a litmus test for national economic policy. By that time the parties sitting
down to the negotiating table will have witnessed more than two years of systematic
efforts to slow monetary growth, and quite possibly a significant improvement in
general price trends. If you ask me what specific advice I would have for them, I
would suggest that they look hard at that evidence, assess realistically the determination of national policy in unwinding inflation and then adjust their expectations
accordingly. We at the Federal Reserve have repeatedly indicated that we will not
supply enough money to finance both high inflation and strong economic growth;
firms or groups of workers that attempt price or wage increases inconsistent with
that fact will be acting in a way that is contrary to both their own and the national
interest.
QUESTIONS SUBMITTED BY CONGRESSMAN LOWERY
Question 1. For the past year inflation has been declining from double-digit rates,
yet interest rates remain at unprecedented high levels. There are several theories as
to why this is happening. What circumstances do you feel are responsible? How long
do you expect this situation to exist, assuming a scenario in which other economic
factors remain essentially the same?
Answer. Despite favorable signs on the inflation front, interest rates, particularly
long-term rates, remain at high levels. One reason is that market participants have
partly discounted recent easing of price pressures as reflecting some reversal of the
"special factors" in the energy, food and commodities sectors that had raised inflation rates in 1979 and 1980. Thus, recent easing in the underlying rate of inflation is
313
viewed as being less pronounced than the moderation of increases in the various
price indexes. In addition, market concerns about the prospective size of the federal
deficit may be contributing to high interest rates. Even so, as the next several
answers indicate, when inflationary expectations begin to respond to the more
permanent lessening of inflationary pressures that I believe is in train, interest
rates will begin to move down.
Question 2. One of the theories used to explain the inflation/interest rate relationship that we are presently experiencing is that of "inflationary expectations." If this
is in fact the cause of our current interest rates, how can we best turn around the
psychology of inflationary expectations?
Answer. One element in turning around inflationary expectations is public recognition that a commitment to monetary and fiscal restrain underlies governmental
policies. Another element involves a response to such policies in private sector wage
and price decisions that shows through in sustained declines in the observed rate of
inflation. As actual price behavior provides a confirmation of the government's
commitment to long-run price stability, a reduction of inflationary expectations will
naturally tend to occur.
The fundamental prerequisite for this process to unfold is having governmental
policies in place that in fact resist inflationary pressures. In this regard, the Federal
Reserve is pursuing growth rate ranges for the monetary and bank credit aggregates this year—and has announced ranges for next year—that we believe are
consistent with a deceleration of inflation over time. Of course, a wide range of
fiscal and regulatory policies also have important roles to play in an overall antiinflationary strategy.
Question 3. Besides having a significant impact at home, interest rates have a
great impact abroad. How do high interest rates here affect the economic policies of
our principal trading partners? Of the international economy as a whole?
Answer. Because the economy of the United States is so large, high interest rates
in this country have important effects on other countries. The basic thrust of our
policy—to achieve a lasting reduction in our inflation rate—is widely appreciated
abroad. However, the short-run effects of this policy, in terms of output and employment, are transmitted to other countries and, in some cases, exacerbate an alreadyweak demand situation. Efforts by foreign authorities to support the value of their
currencies in the face of a strong dollar intensify these effects. Moreover, high U.S.
interest rates impose financial burdens on countries, including some hard-pressed
developing countries, who are borrowing in international markets.
However, the level of U.S. interest rates is not the only factor putting downward
pressure on the currencies of our trading partners of imposing burdens on developing countries. All countries—including the United States—must guard against a
temptation to assign undue responsibility for economic problems to external forces.
On July 16, I presented my views on this subject in more detail, before the Joint
Economic Committee. A copy of that statement follows:
314
For release on delivery
9;00 A.M., E.D.T.
Statement by
Paul A. Volcker
Chairman, Board of Governors! of the Federal Reserve System
before the
Joint Economic Committee
July 16, 1981
315
I appreciate the opportunity to appear before this
Committee to present the Federal Reserve's views on the
international implications of U.S. macro-economic policies,
and particularly monetary policy.
Inevitably questions arise abroad, as they do in this
country, about particular techniques and implications of U.S.
ecomomic policies.
After all, nearly all of the nations
represented at the Ottawa Summit, and most others, are faced
with difficult problems and choices in developing economic
policy, and external influences on their interest rates and
exchange rate^ inevitably raise new complications for some
just as at times external developments
own policy-making.
—
complicate our
However, the expression of such concerns
should not be taken as disagreement with'the basic intent or
thrust of our policies, certainly not among those most closely
concerned with financial policy.
I base that judgment -on my
own discussions with central bankers and finance ministers
abroad as well as on the conclusions reached in May at the
meeting of the IMF's Interim Committee in Gabon and more
recently at the OECD Ministerial meeting.
Accordingly, I expect that the President will hear a
general endorsement of the broad purposes and objectives of
U.S. ecqnomic policies when he meets next week with other
heads ,b£ state and governments.
Specifically, I believe that
the priority the United States has attached to the fight against
316
inflation is widely appreciated.
Indeed, the leaders of_
these very nations, along with many others, have long urged
us to adopt rigorous and convincing anti-inflation policies,
and I do not believe they will change that attitude now.
Foreign officials do rightly stress that, in our interdependent world, U.S. economic developments and policies have
ramifications for the policies and performance of other economies.
Our weight in the world economy, while relatively smaller than
in the early postwar years, is still very significant, and
leaders abroad have to take U.S. economic policies into account
when they formulate their own programs.
They do want us to be
aware of the external implications of high dollar interest rates
and a rising dollar, as we should be.
abroad as well as at hpme —
The short-run effects
can indeed be discomforting.
—
But
\je should also have a sense of proportion about those* effects.
The United States 'should not and can not assume the
responsibility for- all the economic difficulties of particular
countries.
In some instances -- for example, countries with
sizable balance -of-payments deficits —
some depreciation of
their currencies relative to the dollar may have been natural,
and a number of countries have internal reasons for following
firm monetary policies.
Changes in exchange rate relationships
within .Europe have been relatively small recently, and most of
the trade of those countries is not:* affected by the substantial
appreciation of the dollar.
The point is often made in the
context of the dollar's appreciation that oil and other
317
commodities are priced in dollars, but it should also be
pointed out that monetary restraint in the United States has
contributed importantly to squeezing out inflationary excesses
in those markets.
In general, it is rarely easy to trace through the
relative weight of different forces impacting on the economic
policy problems of different countries.
including the United States —
We all —
certainly
must guard against a temptation
to assign undue responsibility to external forces.
I would
remind you that any exchange rate involves two national currencies;
a change in that exchange rate may reflect policies or developments in either country, or more likely both at the same time.
The recent ' "strength" of the dollar vis-a-vis some currencies
headlined in the press has been relative; it may be —
indeed
has been -- influenced by conditions abroad, as well as in the
United States.
I would note that short-term interest'-rates in
the United States are a bit lower today than at the- turn or the
year, and interest rate differentials are narrower with respect
to continental European currencies.
Yet the dollar has appre-
ciated substantially against those currencies over the past six
months.
Because of the potential for misunderstanding, and because
developments and policies here do have effects on other countries
whose leaders face difficult economic problems and choices, we
have a clear responsibility to listen closely to their views,
to explain our policies carefully, and to respond to constructive,
318
substantive criticism.
Prolonged misunderstanding is always
dangerous,for economic and political friction could impair
the fabric of the open international economy that serves us
all.
My perception is that, fortunately, there is broad
understanding of our objectives and policies —
combined, of
course, with a good deal of impatience in awaiting results,
just as is sometimes the case at home.
The essential point about U.S. economic policies
monetary, fiscal and other —
—
is our commitment to reducing
inflation. Most of the foreign leaders with whom I have talked
readily agree that it is in their countries' fundamental interest,
as well as oursj, that the United States make significant progress
against inflation.
Because of the dollar's role in world
financial markets and because of the U.S. prominence in the/
world economy, a necessary condition for the restoration .of
stability in currency markets and for the resumption of sustained,
worldwide economic growth is the restoration of greater price
stability in the United States.
Obviously, they,as we, would like to see* lower and more
stable U.S. interest rates and less variation in exchange rates.
Everyone would agree that reduced inflation and a clear sense
of movement toward price stability must be the basis for maintaining such stability over time.
Against that background,
international discussions raise questions of means, not ends.
As you know, Federal Reserve monetary policy has been
directed at restraint in the rate of growth of the monetary
319
aggregates. _Some observers —
those, outside our borders —
and they are not confined to
believe we are following a policy
deliberately directed at achieving high interest rates and
dollar appreciation.
Such views are mistaken; the Federal
Reserve has neither an interest rate nor an exchange rate
objective.
We do take the view that persistent restraint
in the growth rates of the monetary aggregates is necessary
to ensure lower inflation —
rates —
over time.
and therefore lower interest
I find no disposition among my colleagues
abroad to question that necessity.
In the short run, interest rates are a function of the
many factors!that influence the demand for money and credit,
including the budgetary position of the government, the strength
of business activity, and the inflationary momentum.
So long
as actual and expected inflation and nominal demand remain
strong, high interest rates should not be surprising.- Only
i
*• •
when inflation slackens significantly, and marketsfcjeliev.ethe
slowdown will be sustained, can we look forward to meaningful,
sustained declines in dollar interest rates, consistent with
growth in real activity.
i
Relative interest rates can and do influence exchange
markets. " But that influence has to be judged in the context
of other influences working at the same time.
As I have
already suggested, it would be a mistake to attribute the
roughl^ 20 percent weighted-average appreciation of the dollar
since December of last year primarily to the behavior-of nominal
320
interest rates on dollar assets.
The differential between
U.S. interest rates and short-term interest rates on average
in foreign industrial countries has declined about 2-1/2 percentage points since the end of 1980.
U.S. short-term interest
rates are now about 1 percentage point less than their December
average.
Interest rates on the continent of Europe are appreciabl;
higher, yet their currencies have depreciated substantially
relative to. the dollar.
countries —
Interest rates in two of the Summit
Japan and the United Kingdom —
have declined so
far "this year, and in one of those countries -- Japan —
the
depreciation of its currency relative to the dollar has been
smaller than that of the continental European currencies.
The yen, as well as the Canadian dollar, has experienced a
weighted-average appreciation so far this year.
Obviously, one must look beyond absolute or relative
interest rates to explain the dollar's appreciation this year.
Among the other relevant factors in the United States have been
the first signs of some! improvement in our relative inflation
performance, a continuation of a relatively favorable U.S.
current-account position, and favorable assessments of the
potential of the new Administration's economic program.
On
the other side of the Atlantic, balance-of-payments deficits
have been large, and there has been a sense of greater political
change and uncertainty.
number of foreign observers, while not questioning
the need for monetary restraint in the United States have
321
suggested that monetary policy should not carry so much of
the burden of the stabilization effort either here or in their
own countries.
As you know, I have also often emphasized the
importance of fiscal restraint and regulatory and other policies,
alongside firm restraint on the moneys supply, in a comprehensive
program to reduce U.S. inflation.
At the same time, we all have
to recognize the difficulties in changing these policies dramatically and quickly.
We are in fact making progress in reducing
the strong upward trend in government expenditures -- and I
would remind you that the Administration has emphasized that
more will need to be done in future years, particularly if we
are to reap the benefits of tax reduction in a context of
reduced budget deficits.
The closer the budget is to balance,
all else equal, the less pressure will be felt in financial
markets, the lower interest rates will be, and the danger of
abnormal exchange rate pressures will be lessened.
But it would
be unreasonable to expeqt a balanced budget overnight', and I
believe there is a growing understanding abroad, as at home,
that fiscal policy cannot easily be shifted in the short run.
After all, most other governments are grappling with fiscal
problems at least as difficult as our own.
It is equally important to recognize that there are no
"quick.fixes" available through monetary policy to lower or fine
tune interest rates.
If the Federal Reserve, for example, were
to deviate from its policy of monetary restraint in an effort
322
to lower interest rates, any seeming short-run relief would
have to be balanced against the substantial risk —
United States and the rest of the world —
for the
of excessive credit
growth, a further hardening of inflationary expectations, and
still greater interest rate pressures in the future.
"Like others, I shall applaud lower interest rates in
the United States any day if they signal success in the battle
against inflation.
But I would look upon lower rates with
mixed feelings if they promised more inflation and hence
higher interest rates for the future."
Those words are not
mine, but those of a central bank colleague in Europe.*
It
seems to me they capture the essence of our policy problem.
Of course, as I suggested earlier, there is impatience
for results.
Monetary restraint is painful,, and it cuts unevenl
at home as well as abroad.
Moreover, the burdens are-not
restricted to the industrial economies; developing countries
are affected as well.
s|ome are experiencing slower growth in
their exports because of slack demand in the industrial world.
They are all facing much stiffer borrowing terms in internationa
markets than those to which they have been accustomed.
It may
be of little comfort to suggest that, in some cases, those terms
may well have been too easy in the past —
internationally as
well as domestically nominal interest rates have frequently
•Remarks by Karl Otto Pohl, President of the Deutsche Bundesh
June 12, 1981, before the Roundtable of the International Be
Institute in Cannes.
323
been exceeded by actual inflation rates, encouraging excessive
indebtedness and the postponement of needed adjustments.
What
we would all like to see is a reasonable middle ground, and
more stability and predictability; we will not succeed unless
we keep at it.
If we cannot promise instantaneous and easy results
—
the answers do not lie in "fine tuning" fiscal or monetary
policies —
we can and must make the effort necessary to
explain our policies, formally and informally, in all the
forums available to us, and to consider carefully the views
of others.
In that connection, I have long felt that the
economic summits can help assure that our mutual economic
concerns are fully discussed and addressed at the highest
level, and the success of those meetings over time can be
measured less by any concrete agreements than by the decree
of understanding reached about our mutual problems an'd purposes.
Certainly we1 must all avoid the temptation to be'come
inward looking during this difficult period.
Intensification
of trade restrictions would be damaging to the interest of
all countries.
Together we must seek effective ways to help
developing countries cope with their own serious adjustment
problems, not the least by maintaining and strengthening our
commitment to cooperation and dialogue in the IMF and World
Bank.
Most of all, it is crucial that we not fail in our
basic purpose of restoring stability and laying the base for
324
sustained growth.
One wise foreign official, widely-
experienced in international affairs, recently put i t to
me roughly as follows:
You cannot expect us to be enthusiastic
about the effects of your policies; we will a l l have different
opinions about just how you are going about i t ; but the fact
is we have no agreed better alternatives to offer you. We
can only wish you success.
I would only add that with success the present international concerns will fade in memory.
We would do no one a
service, at home or abroad, if we were to take actions that
would jeopardize the prospects for that success.
Question 4. What is the impact of monetary policy on GNP?
Answer. Economists generally believe that a policy of monetary restraint places
broad limits on the growth of nominal GNP—that is, the combined result of changes
in real output and the price level. The Federal Reserve's policy of monetary restraint is directed toward reducing inflation. But unfortunately, this policy does not
work directly on prices, and its initial effects often fall on real output and employment. So long as inflation continues near its current rate and inflationary expectations remain imbedded in economic decisions and institutions, pressures on interest
rates will be intense and real activity is likely to be constrained, particularly in
credit-sensitive sectors such as housing and automobiles. Over the longer run,
however, the gradual reduction in the expansion of money and credit will lead to an
easing of inflation and inflationary expectations. This will set the stage for stronger—and sustained—real growth, lower interest rates, and reduced unemployment.
Question 5. What is the impact of federal budget deficits on monetary policy?
Answer. In an environment of restrained monetary growth, the size of the federal
budget deficit is an important determinant of credit market conditions and interest
rates. New borrowing by the federal government, whether to finance budget deficits
or off-budget programs, competes with private demands for a limited supply of
credit and inevitably aggravates interest rate pressures. The demands of the government are insensitive to interest rates and thus will always be met. However, if
private demands for credit are strong, rates for other borrowers often will be pushed
up in the process. Thus, it is essential that fiscal policy and monetary policy work
together in the effort to achieve noninflationary economic growth.
Question 6. There are several important wage contract negotiations coming up
next year. What are the implications for inflation? What role, if any, should the
government play in this process?
Answer. In 1982, collective bargaining negotiations will take place in major industries including petroleum refining, trucking, rubber, electrical equipment, automobiles, and agricultural equipment. Altogether, about SV2 million workers will
negotiate major new settlements. However, to the extent that these highly visible
settlements are reflected in other wage decisions, their eventual importance in the
overall inflation picture looms much larger than the number of workers involved
might suggest. Negotiations in 1982 are important for another reason. Over the past
decade, wages in many of these industries have been rising more rapidly than
productivity. Consequently, rising labor costs have put upward pressure on prices. A
fundamental issue that must be faced by both labor and management is whether
325
workers can continue to receive real wage gains in excess of productivity growth
without adverse consequences to firms, industries, and the nation as a whole.
With regard to the role of the government, I believe it is fundamentally to foster
and maintain a competitive economic environment. Regulatory policies affecting
wage- and price-setting should be critically reviewed. These and other governmental
policies aimed at protecting incomes and insulating markets from competitive pressures merely will delay tough decisions that need to be made at the bargaining
table. To the extent that these decisions ease pressures on costs and prices, the
result will be greater economic growth, more jobs for American workers, and a
speedier return to stable prices and lower interest rates.
QUESTIONS SUBMITTED BY CONGRESSMAN BEREUTER
Question 1. Commerce Department figures indicate that the ratio of fixed capital
to output in the farm sector is three times that in manufacturing. The ratio of
inventory to output also is approximately three times that in manufacturing. Of
course, this means a heavy reliance on credit in the agricultural sector.
Vice Chairman Frederick Schultz, of the Federal Reserve Board of Governors,
recently told the House Agriculture Committee that a change in resources of agricultural banks (i.e., a shift from heavy reliance on passbook and low-cost savings
instruments to money market certificates) is tying formerly local agricultural banks
into national credit markets and therefore into higher national rates.
What answer does the Federal Reserve have for my farm constituents who fear
that high interest rates will bankrupt them any day now?
Answer. High interest rates have unquestionably had an adverse effect on farmers, as indeed they have on other credit-sensitive sectors such as housing, automobiles, and small business, But, it is important to bear in mind that interest rates
are high because inflation and the demand for credit have remained high. The
Federal Reserve would do the agricultural community no service in loosening its
resolve to slow monetary growth; in all probability interest rates would soar to new
highs as inflation worsened. As current efforts by the Federal Reserve to control the
money supply and by the Administration and Congress to cut Federal spending and
reduce the Federal deficit take hold, we should be able to look forward to sustained
reduction in interest rates.
As discouraging as the current situation may seem, there are some reassuring
aspects to the condition in which farmers find themselves. For example, while the
Commerce Department figures you cite on capital and inventories relative to output
are correct, it may surprise many to find that farmers' debt relative to total assets—
somewhat less than 20 percent—is much lower than for the manufacturing sector.
This is because farmers hold a lot of land, which has appreciated greatly in value
over the years. Although appreciation hasn't alleviated the squeeze that inflation
has put on cash flow, it certainly provides a somewhat different picture of their
overall financial position.
Perhaps because of this, farmers have not, in general, experienced difficulty in
obtaining credit over the last year or two. Indeed, as Vice Chairman Schultz pointed
out in his testimony, loan deposit ratios at rural banks are currently in a comfortable range, indicating reasonable credit availability and the rates paid on loans at
these banks, while high, are somewhat under the national average.
Question 2. A recent study released by the International Monetary Fund urges
use of an "incomes policy" as well as monetary and fiscal policy to fight inflation.
The Reagan Administration opposes such a suggestion. Do you have any views on
an appropriate incomes policy, if any, which we should pursue? Please elaborate.
Answer. I do not support an incomes policy to supplement current monetary and
fiscal policy, as explained more fully in my response to Representative Roukema's
question. As also indicated in that response, if any incomes policy were implemented, I would favor a carrot-and-stick type of approach, like TIP, presuming that
administrative complexities could be ironed out.
Question 3. A June 29 BusinessWeek article suggested that the government should
shift to short-term debt to take the pressure off long-term markets in the private
sector. Do you agree? Please explain.
Answer. There is a presumption underlying this question that relative supplies of
securities, particularly Treasury debt, are the principal determinants of the shape of
the yield curve. While I do not dispute the notion that a significant shift towards
shorter-term Treasury financing would influence rate relationships, I think that
other fundamental factors are at work holding long-term rates high. The chief one,
in my view, is that the evidence of progress in controlling inflation is as yet
inconclusive; market participants thus expect interest rates in general to remain
326
quite high for some time to come. I think also that the prospect of heavy Treasury
financing needs in coming quarters, regardless of the form of this borrowing, has
taken its toll all along the maturity spectrum. Besides, to the extent that a shift
towards shorter-term borrowing did relieve pressures in long-term markets, it would
merely shift these pressures into shorter-term markets which already are under
considerable strain.
CONDUCT OF MONETARY POLICY
WEDNESDAY, JULY 22, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 10:10 a.m. in room 2128 of the Rayburn
House Office Building; Hon. Fernand J. St Germain (chairman of
the committee) presiding.
Present: Representatives St Germain, Reuss, Gonzalez, Minish,
Annunzio, Mitchell, Neal, LaFalce, Evans (Ind.), D'Amours, Oakar,
Vento, Lowry, Schumer, Frank, Patman, W. Coyne, Hoyer, Stanton, Leach, Weber, McCollum, Carman, Wortley, and J. Coyne.
The CHAIRMAN. The committee will come to order.
Yesterday the Chairman of the Federal Reserve Board presented
his report on the conduct of monetary policy and the targets being
set for the growth of money and credit for 1982.
We all know what the Chairman said. He said that we can look
forward to even tighter money in the upcoming year, which I
believe will result in continued high and volatile interest rates. I
will use Mr. Volcker's own words to describe the impact of that
policy:
High interest rates undeniably place a heavy burden on housing, the auto industry, small business, and other sectors especially dependent upon credit. The thrift
industry, in particular, has come under heavy stress as its costs of funds exceed
returns on fixed-rate assets acquired when interest rates were much lower. The high
level of U.S. interest rates also has repercussions internationally, complicating
already difficult economic policy decisions of some of our major economic partners.
He is right. His policies are placing an unbelievable burden on
housing, the auto industry, farmers, small businessmen, and consumers.
Yet the large oil companies and other giant corporations barely
notice what he is doing: $40 billion worth of takeover lines of credit
to Gulf, DuPont, Mobil, and Pennzoil can be granted in days to
allow them to engage in bidding wars—$40 billion. Think what
that amount of credit could do for home building, for our farmers,
for the people of this country.
Despite all of this, the administration and the Federal Reserve
remain wedded to policies which do not spread the burden of our
fight against inflation equally. Whenever banking legislation comes
before this committee, we all hear a lot about the "level playing
field."
Unfortunately, when it comes to people, to farmers, to small
businessmen, and to workers, there is no level playing field. With
us today are representatives of some of these sectors to tell us
about their experiences under current monetary policy.
(327)
328
You may have seen some of the press this morning. Yesterday's
hearing was unbelievably well attended. The participation by the
membership on both sides of the aisle was most gratifying, and I
think most indicative of the concern that each and every one of us
on this committee has about the effect of monetary policy and
resultant high interest rates that have been failing for such a long
sustained period of time.
So, you should take heart in the fact that the membership is
responding.
Mr. Turner, we will ask you to begin. We will put your full
statements in the record. You may now proceed.
STATEMENT OF J. C. TURNER, INTERNATIONAL UNION OF OPERATING ENGINEERS, AFL-CIO; ACCOMPANIED BY CARL
COAN, LEGISLATIVE COUNSEL, NATIONAL HOUSING CONFERENCE; ROBERT MULLINS, DIRECTOR OF LEGISLATION, NATIONAL FARMERS UNION; PAUL FRY, EXECUTIVE ASSISTANT
DIRECTOR OF FINANCE AND ADMINISTRATION, AMERICAN
PUBLIC POWER ASSOCIATION; WILLIAM STAFFORD, EXECUTIVE ASSISTANT TO THE MAYOR OF SEATTLE, U.S. CONFERENCE OF MAYORS; AND HOWARD SAMUEL, PRESIDENT, INDUSTRIAL UNION DEPARTMENT, AFL-CIO
STATEMENT OF J. C. TURNER, INTERNATIONAL UNION OF
OPERATING ENGINEERS, AFL-CIO
Mr. TURNER. Thank you, Mr. Chairman.
We are all very grateful to you, Mr. Chairman, and to your
committee, that you have seen fit to give us this opportunity to
appear.
We were greatly encouraged a few weeks ago when you were
kind enough to come over and address our group at a breakfast.
The things you said were pretty much the things that we believe.
And we, of course, read about what happened yesterday, and that,
too, is very encouraging—that is the reaction of your honorable
committee.
We also were very pleased that Chairman Reuss of the Joint
Economic Committee has been moving ahead, I understand, with
the joint resolution of the House and Senate, going into this very
important matter. And we do hope that the resolution will get a lot
of attention, and certainly it will have the support, I think, of most
of the American labor movement, if not all of it.
Today we have several groups, all of whom have their own views
perhaps as to what ought to be done in terms of solving the
problem. But what we are going to try to do is to tell you the way
looks from our point of view.
And we have with us Carl Coan, the legislative counsel for the
National Housing Conference. And we have Robert Mullins, director of legislation, for the National Farmers Union; Paul Fry, executive assistant director of finance and administration for the American Public Power Association, William Stafford, executive assistant
to the mayor of Seattle, representing the U.S. Conference of
Mayors, and Howard Samuel, president of the AFL-CIO Industrial
Union Department.
329
I would like to read to the committee the opening paragraphs of
our statement. And then we will go on to the other speakers, who
will each present their point of view, Mr. Chairman.
We would like to thank the chairman, as I said, and the members of the committee for this opportunity. We represent a broad
range of organizations, including the Industrial Union Department,
AFL-CIO; the American Public Power Association; and the various
other organizations, whose names I read.
[The joint prepared statement of J. C. Turner on behalf of the
International Union of Operating Engineers; Carl Coan on behalf
of the National Housing Conference; Robert Mullins on behalf of
the National Farmers Union; Paul Fry on behalf of the American
Public Power Association; William Stafford on behalf of the U.S.
Conference of Mayors; and Howard Samuel on behalf of the Industrial Union Department of the AFL-CIO, follows:]
330
STATEMENT OF
3.C. Turner, International Union of Operating Engineers, AFL-CIO
C a r l Coan, L e g i s l a t i v e C o u n s e l , National Housing Conference
Robert Mullins, Director of Legislation, National Farmers Union
Paul Fry, Executive Assistant Director of Finance and Administration,
American Public Power Association
William Stafford, Executive Assistant to the Mayor of Seattle,
U.S. Conference of Mayors
Howard Samuel, President, Industrial Union Department, AFL-CIO
before
COMMITTEE ON BANKING, FINANCE & URBAN AFFAIRS,
U-S. HOUSE OF REPRESENTATIVES
July 22, 1981
331
We would like to thank the Chairman and members of the committee for
this opportunity today to discuss a very important issue. We represent a broad
range of organizations including the Industrial Union Department, AFL-CIO,
American Public Power Association, International Union of Operating Engineers,
U.S. Conference of Mayors, National Farmers Union and the National Housing
Conference. We have come together today out of a common concern about the
ravaging effects of high interest rates.
While the country's attention in recent months has been directed toward
the budget and tax proposals being debated in Congress, interest rates in our
nation's financial markets have once again approached unprecedented levels.
It is our belief that, if unchecked over time, the current tight money policy of
the Federal Reserve will result in continued high and volatile interest rates, and
wreak havoc on the nation's economy.
As you well kno v, in October of 1979, the Fed embarked upon a new experiment
in monetary policy that marked an historic change in the object and method of
open market operations. Under Paul Volcker's leadership, the Fed was to begin
concentrating strictly on controlling the money supply rather than controlling
for interest rate targets. This new approach to monetary policy, although begun
under the Carter Administration, is still being followed today. By clamping down
hard on the money supply, the Fed hopes to rid the economy of rapidly rising
prices by restricting demand and dampening people's expectations of future inflation.
This so-called monetarist approach, we believe, is an ineffective remedy
for the disease of inflation. It is also destructive to our economy, with a debilitating
impact on capital spending, productivity, economic growth and our ability to
compete in the international marketplace. In addition, high interest rates have
a disproportionate impact on certain key sectors of the American economy, including
the automobile and auto parts industry, all kinds of small business, construction,
332
utilities, state and local government, and agriculture—industries and sectors
that, by and large, form the backbone of economic life in the United States.
We would like to outline in greater detail these damaging effects that the Fed's
tight money policy has had—and the effects that it is likely to have in the future.
The first and most apparent effect of extremely high interest rates is to
choke off demand for goods and services. As money becomes increasingly expensive,
businesses and consumers in general tighten their belts and reduce borrowing
and consumption. In addition, high interest rates artificially inflate the international value of the dollar, thus further eroding the demand for American goods
in foreign as well as domestic markets. The end result is idle productive capacity
which exacts a high cost in lost output and increased unemployment. Certain
interest-sensitive sectors of our economy bear an exceptional burden of high
interest rates. Such basic American industries as automobiles, construction,
and agriculture as well as small businesses, utilities and governments at all levels
are buckling under the pressures of rising interest costs. A brief description
of some of the damage follows:
HOUSING & CONSTRUCTION
High interest rates have all but knocked the foundation out from under
the housing industry. Although the industry needs to produce roughly 2.5 million
units per year to satisfy underlying housing demands and replacements, the average
annual production of new housing units during the last three calender years was
under 2 million, including regular new housing units and mobile home shipments.
With mortage rates now above 16 percent, the outlook for the housing industry
is extremely bleak. New housing starts in June registered a meager annual rate
of 1.0 million units. Unemployment in the construction industry is running at
16.6 percent.
333
As we well know, high interest rates have also had a severe impact on savings
and loan associations—the institution that has provided the bulk of home financing
in this country. With portfolios dominated by long-term, low yielding asse.ts,
thrift institutions have been squeezed by having to pay high market rates of interest
to stem the outflow of deposits. In 1980, for example, survey data from the
U.S. League of Savings Associations indicate that the S<5cL business had more
than 65 percent of its mortgage portfolio in loans at interest rates of less than
10 percent. Yet new mortage rates during the year never fell below 12 percent
—and were usually much higher. Severely weakened balance sheets will likely make
affordable mortage money harder to come by in the future—especially if the S&Ls
place more of their deposits in short-term investments to take advantage of high
short-term interest rates.
Shortages of mortgage money and housing, brought on by high interest rates,
fuel inflation and deprive many people of an affordable and adequate home. The
median prices of existing homes sold increased by 12 to 14 percent in each of the
past three years. The prices of new homes during this period increased by comparable
percentages. Thus, not only do high interest rates in themselves cause housing
inflation, but they also contribute to housing shortages which fuel inflation even
more.
The construction and construction-related industries are obviously hard hit
by rising interest costs. Because of their major role in our economy, these industries
have traditionally played an important part in leading the rest of the economy into
both recessions and recoveries. For this reason, it is unlikely that we will see a
significant economic recovery as long as high interest rates keep the housing and
construction industries in a state of virtual paralysis.
334
SMALL BUSINESS
High interest rates are dealing America's small businesses a heavy—and
often fatal—blow. Because smaller firms are more dependent on short-term
debt than are large corporations, the unusually high short-term interest rates
are creating a great deal of stress among small and medium-sized businesses.
The number of small business bankruptcies is soaring. Small firms, because they
are considered to be higher risk borrowers, must pay higher rates of interest
than larger corporations. And because these firms operate within a more competitive
environment, they are less able to pass on higher interest costs. Some analysts
suggest that it is not so much the cost of capital that prevents small businesses
from obtaining the financing they need, but rather the availability of capital.
When credit is tight—and particularly when local banking markets are highly
concentrated—banks become more risk-averse and avoid making loans to small
firms altogether. Instead, they tend to favor doing business with larger corporations
which are easier and less costly to deal with.
AGRICULTURE
Record high interest rates are also having a severe impact on American
agriculture, and in particular on family farmers. Because farmers shoulder a
very heavy burden of debt, any rise in interest rates squeezes farm profits more.
Debt has soared from 6 percent of overall farm cash-flow in 1970 to 19 percent
today. And farmers' debt-to-asset ratio has doubled since 1950 from 8.5 percent
to 17 percent in 1980. As of January 1, 1981, the outstanding debt of American
farmers stood at a staggering $180.5 billion. And in 1981 alone, farmers will have
to pay out more than $20 billion just to service this mountain of debt.
The financial vise in which farmers find themselves is especially alarming
in light of the role that agriculture plays in boosting our sagging economy. Last
year, for example, the United States ran a $23 billion agricultural trade surplus,
helping to offset the massive $51 billion deficit inccured in our international trade
in other merchandise. Blessed with a temperate climate and rich soil, and
335
buttressed with advanced farm technologies, U.S. agriculture occupies a premier
position in the international marketplace. The strength of it is not only felt in
a reduced deficit and more farm jobs, but also in ancillary industries such as
transportation and commodity processing and trading.
Although the future demand for American agricultural products is expected
to expand rapidly, farmers will have to make huge new investments to expand
and modernize their productive capacity. Farm profits, from which these new
investments must be financed, are being severely squeezed by the increasing
costs of all inputs—especially energy and money. Last year, net farm income
plunged nearly 30 percent. The less capital that farmers are able to generate
internally, the more they must depend on debt to finance their operations. Tight
money and high interest rates may prove to be one of the primary factors that
leads to the loss of yet one more market for American goods.
AUTOMOBILES
The U.S. automobile and auto-related industries are in a crisis. Fierce
competition from abroad and rising energy prices have exacted a heavy toll.
The Big Three have begun to re-position themselves by introducing new lines
of fuel efficient cars in an attempt—albeit a belated one—to meet the challenges
of their foreign competitors.
High interest rates, however, have stifled their efforts. Because most people
finance the purchase of a car with short-term loans, fluctuations in interest rates
have a major impact on auto sales. This fact is borne out by monthly domestic
auto sales figures. Auto sales began to recover from the recession last summer
when they increased from an annual rate of 6 million units in May to 8 million
units in September. This recovery was aborted, however, by a resumption of
the climb in interest rates. The prime rate rose from about 12 percent in September
to more than 20 percent in December. And auto sales quickly plunged in January
to 5.6 million units.
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The high price of credit has not only kept customers away from the showrooms;
dealers have become overstocked and some have gone under due to the increasing financial
pressures, as they have had to pay more than 20 percent per annum to finance their
unsold floor inventory. The auto industry's problems are, to be sure, the result of many
factors. High interest rates, though, have further compounded the difficulties facing
the industry and will continue to hamper their efforts to regain the market position
lost in recent years.
UTILITIES
The electric utility industry is our economy's most capital intensive industry.
It requires three to four dollars of investment for each dollar of revenue. The current
total capitalization of the electric utility industry including the investment of the federal
government is in the neighborhood of $300 billion. The annual new money requirements
of the industry are in the range of $15-20 billion.
Unstable financial markets and high interest rates are particularly disruptive for
electric utilities and impose very heavy cost burdens on their customers. The local,
publicly-owned sector (utilities owned by municipalities or other political subdivisions
of states) of the electric utility industry accounts for about $35 billion, or 12 percent
of the industry's total capitalization. As public entities, these utilities raise capital
in the tax-exempt municipal bond market. Interest rates in the municipal bond market
have literally doubled in the past 3ft years. Although the bond market was quite stable
over the 30-year period following World War II, it has become extremely volatile in
recent years. The Bond Buyer 20-Bond Index varied only 48 basis points between its
1977 high and low. In 1978, however, the variation between high and low was 109 basis
points; in 1979, 130 basis points; and in 1980, a volatile 345 basis points. For the first
time, informed observers are beginning to doubt that local, publicly-owned electric
utilities will be able to issue long-term bonds at affordable rates with which to finance
the necessary expansion of their facilities.
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The additional costs imposed on these utilities, and hence on their consumers,
have already been substantial. The doubling of interest rates since 1977, for example, will add approximately $250 million to the costs of local publicly-owned
electric utilities this year.
GOVERNMENT
High interest rates also have a deleterious impact on government at all
levels. The net interest paid by the federal government is estimated to be more
than $80 billion in Fiscal Year 1981, or over 12 percent of total federal outlays.
The interest paid on the public debt has far outstripped the growth in the debt
itself. Between 1954 and 1980, the public debt tripled while the interest paid
on it increased twelve times. As high interest rates are sustained, interest outlays
will continue to escalate.
Rising debt service costs will frustrate efforts to hold down federal expenditures and reach President Reagan's goal of balancing the budget. In fact, Treasury
Secretary Reagan has recently revised the projected budget deficit for FY 1981
upwards to take into account rising debt service costs. An Administration that
is committed to reducing non-defense spending and balancing the budget will
find itself forced to make additional cuts in non-defense programs to move toward
budgetary balance, as federal revenues are used to pay ever-increasing interest
payments.
Although state and local government can raise capital in the tax-exempt
bond market, rising interest rates have also squeezed their operating budgets.
Interest costs for the average state and local security have risen 450 basis points
since 1977—or almost doubled in dollar amount in the last four years. Even this
dramatic growth underestimates the magnitude of the problem as interest rates
have skyrocketed in recent months. Current rates on municipal bonds have been
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above 11 percent recently, compared to near 8.5 percent only one year ago. In
addition, federal spending cuts will add to the fiscal woes of state and local governments
and force their bond ratings still lower, making it more expensive to borrow money.
As the public infrastructure of our cities deteriorates, the efficiency of private
sector economic operations will also decline.
PRODUCTIVITY
Faced with declining real wages, increasingly scarce natural resources and
fierce international competition, the United States desperately needs to restore
its sagging productivity. Between 1965 and 1973, productivity in manufacturing
industries increased by 2A percent a year; from 1973 to 1980 the rate of gain
fell to a scant 1.2 percent. And for the economy as a whole, the figures are worse
because productivity gains in the labor-intensive service industries are hard to
achieve.
High and volatile interest rates have a debilitating impact on productivity.
To begin with, by restricting demand and creating idle capacity, high interest
rates exact a stiff price in slower productivity growth—whatever the merits of
idle capacity in fighting inflation. Plants are designed to operate most efficiently
at full capacity. Yet during the last decade, our economy was operating at an
average capacity utilization rate of 82 percent—far below the 90 percent rate
considered to be the approximate point at which resources are most efficiently
utilized. One economist suggests that nearly one-third of our productivity slowdown can in fact be attributed to idle capacity.* This decline in productivity
can only be abated by monetary and fiscal policies that move our economy toward
full utilization of the nation's resources.
•Lester Thurow, The Zero-Sum Society.
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Over the last few years, a near-consensus has emerged that the United
States must increase the level of productive investment if it is to revitalize the
flagging American economy. Accordingly, there is a lot of talk about the need
to provide the appropriate incentives to stimulate business investment. The Congress
is now in the process of deliberating on the various proposals that have been put
forward to achieve these ends.
High and volatile interest rates, however, impede productive investment.
To begin with, by creating idle capacity high interest rates actually weaken the
incentives for business to invest. With existing idle capacity and uncertainty
about future demand for their product, business people are understandably reluctant
to commit funds for the expansion or modernization of their facilities.
High interest rates in themselves are also a powerful investment disincentive. A recent Business Week article cited the fact that "many corporate officers
say they are waiting for assurance that there will actually be demand for their
products as well as a significant drop in the cost of money before they make
their move (to increase capital spending]."
The dangerous structure of interest rates today affects the composition
of investment. Usually, at this phase in the business cycle, yields on long-term
securities are high relative to the yields on short-term securities. This encourages
investors to commit their funds for long periods of time. However, what we
find today is that the yield curve is "negatively sloped," i.e., the yield on shortterm securities is higher than on long-term securities. With an interest rate
structure like this, why should an investor or a corporate treasurer put his funds
into projects that might pay, say, an 18 percent return when he can get a guaranteed
18 percent—or more—return in short-term, highly liquid, financial instruments?
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INFLATION
Although the Fed's tight money policy is being pursued with the intent to
restrict the demand for credit and thus dampen down inflation, the money supply
today is, at best, difficult to control. Large corporations now turn with ease
to overseas credit markets such as the Eurodollar system or to the U.S. commercial
paper market. Additionally, the spectacular growth of money market funds is
making it increasingly difficult for the Federal Reserve to regulate the supply
of money flowing through the economy. Only a long-term major recession or
depression would slow the economy down to the point at which prices would
begin to fall, and the economic and social costs of such a policy would be traumatic.
Although high interest rates are supposed indirectly to bring inflation down,
they in fact contribute directly to inflation. High interest rates become wrapped
up in the costs of all industrial and consumer goods and services. In 1980, the
interest expense of America's corporations totaled a record high 45 percent of
net profits before taxes, compared with only 14 percent during the 1960s. Additionally,
as mentioned before, interest payments add a heavy burden to the federal budget.
In 1981, federal outlays for debt service costs are expected to top $80 billion,
or 12 percent of total government expenditures.
By creating idle capacity, high interest rates further exacerbate inflation.
As plants move away from operating at full capacity, unit costs rise and profit
margins are squeezed. To the extent that companies are able to pass higher costs
on to consumers, high interest rates, albeit indirectly, cause prices to rise.
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FOREIGN EXPERIENCE
Margaret Thatcher's Britain has pursued a tight money policy similar to
that of the Fed in this country. And if the British experience is any indication
of what we can expect, the United States has little to look forward to. Unemployment in England has risen to more than 10 percent, its highest rate since the depths
of the Great Depression. In the construction industry alone, more than 300,000
workers are unemployed, despite the fact that the waiting list for public housing
has grown to more than 1 million people. High interest rates have crippled industry
and played an important role in slowing the British economy down to a virtual
standstill. Yet they have not brought inflation under control; figures for June
indicate that British prices are still rising at an annual rate of 11.3 percent.
The recent riots that have raged on throughout England are no doubt a somber
reflection of the country's sour economic performance.
CONCLUSION
This inventory of damage wrought domestically by excessive interest rates
for productive investment matches the chronicle of international repercussions
expressed at the Ottawa summit meeting. Leaving for another day any comments
on the international side, the inescapable conclusion of our stories is that the
vital sectors of our society which we represent cannot endure a protracted experience of these crushing levels of interest rates. Yet independent economists of
all inclinations seem agreed—uniquely and disturbingly so—-that high and volatile
interest rates will be a burden on our economy for the forseeable future. The
signals from the independent Federal Reserve Board, to the extent they can be
deciphered, seem to indicate yet a further tightening in the growth of the money
supply—and that means a further tightening of the noose of high interest rates
around the interest-sensitive productive sectors of our economy.
Mr. Chairman, we will be working to frame solutions to this challenge. We
know that calling for lower interest rates alone is not enough. But describing
the damage caused by the current destructive practices of our monetary authorities
is a vital step in beginning that process.
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Mr. TURNER. We have come together today out of a common
concern about the ravaging effects of high interest rates. While the
country's attention in recent months has been directed toward the
budget and tax proposals being debated in Congress, interest rates
in our Nation's financial markets have, once again, approached
unprecedented levels.
It is our belief that, if unchecked over time, the current tight
money policy of the Federal Reserve will result in continued high
and volatile interest rates and wreak havoc on the Nation's economy.
As you well know, in October 1979, the Fed embarked upon a
new experiment in monetary policy that marked an historic
change in the object and method of open market operations.
Under Paul Volcker's leadership, the Fed was to begin concentrating strictly on controlling the money supply, rather than controlling for interest rate targets. This new approach to monetary
policy, although begun under the Carter administration, is still
being followed today.
By clamping down hard on the money supply, the Fed hopes to
rid the economy of the rapidly rising prices by restricting demand
and dampening people's expectations of future inflation. This socalled monetarist approach we believe is an ineffective remedy for
the disease of inflation. It is also destructive to our own economy,
with a debilitating impact on capital spending, productivity, economic growth, and our ability to compete in the international
marketplace.
In addition, high interest rates have a disproportionate impact
on certain key sectors of the American economy, including the
automobile and auto parts industry, all kinds of small business,
construction, utilities, State and local governments, and agriculture, industries, and sectors that by and large form the backbone of
economic life in the United States.
We would like to outline in greater detail these damaging effects
that the Fed's tight money policy has had and the effects that it is
likely to have in the future.
The first and most apparent effect of extremely high interest
rates is to choke off demand for goods and services. As money
becomes increasingly expensive, businesses and consumers in general tighten their belts and reduce borrowing and consumption. In
addition, high interest rates artificially inflate the international
value of the dollar, thus further eroding the demand for American
goods in foreign as well as domestic markets.
The end result is idle productive capacity, which exacts a high
cost in lost output and increased unemployment. Certain interestsensitive sectors of our economy bear an exceptional high burden
of high interest rates. Such basic American industries as automobiles, construction, and agriculture, as well as small businesses,
utilities, and governments at all levels, are buckling under the
pressures of rising interest costs.
Now, we also know that in addition to the domestic impact in the
area of foreign affairs, we find that our usual allies, normal allies,
are very critical of our high interest rates, claiming that it is
helping to upset their economies.
343
I must say that I was over in England 2 weeks ago for a week,
attending some conferences, and under the so-called supply side or
monetarist approach of economics, we find that the entire construction industry is down over 300,000 people.
We find 2,600,000 people out of work. I think over 11 percent is
out of work over in England. Despite all of the promises, by cutting
taxes and going to the other monetarist approaches, that investment was going to follow, and high levels of employment, growth,
et cetera, just hasn't happened over there. And God forbid that the
same results occur here.
So, Mr. Chairman, we will now turn to our next speaker, which
is Mr. Carl Coan, from the National Housing Conference.
STATEMENT OF CARL COAN, LEGISLATIVE COUNSEL,
NATIONAL HOUSING CONFERENCE
Mr. COAN. Thank you.
My name is Carl Coan, and I am here on behalf of the National
Housing Conference. Leon Weiner, its president, wasn't able to
attend today.
It is almost like carrying coals to Newscastle to tell you what the
housing situation is. You are very aware of it. I have been sitting
in your conference on the housing legislation for the last 2 days for
this year.
As part of that consideration, you are confronted with a result—
the result of the high interest rate situation, and that is a very
sharp decrease in the amount of section 8 and public housing funds
that will be available next year, as mandated by the various actions of the House and Senate, on the budget resolution and the
reconcilation bill.
I believe that interest rates are one of the prime causes of this.
They have driven up the cost of housing, all housing—subsidized,
as well as unsubsidized—to the point we are now confronted with
cries that it is just too expensive to provide housing for the poor,
for the low income, for the moderate income. That is just one
indication of what has happened.
Housing starts and permits for new buildings, new housing, interestingly enough, I notice—I checked it on the way up here this
morning in the cab—started dropping in October or November
1979, which is the time that the present policy of the Federal
Reserve was put into place. And they have been down ever since.
There have been a few occasional blips upward, but we have
never reached the level of housing production at which we were in
September 1979. That is almost 2 years now.
That effect has been felt throughout the economy. It is not only
new housing, it is the sale of existing homes. All you have to do is
try to sell a house today to see what you're confronted with. Much
of the market for new homes comes from people upgrading themselves either because they would like a little better house and they
can now afford it in normal times, or they've got more children or
other needs that they have to meet. And when they are looking for
a new home, they can't sell their existing home—if they can't sell
their existing home, they're not going to buy a new home.
In the rental area, there is practically no new apartment construction going on today for rental purposes, unless it is under
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some subsidized program, tandem, or section 8 with or without
tandem.
We have a high need for additional housing in this decade. And
we are producing at a level in June of just barely over 1 million
units on an annualized basis. That is at best one-half what we
need.
The low-income programs are being destroyed, I'm afraid, as
rents go up, as the cost of construction goes up, playing into the
hands of those who don't want to spend Government money and
who tend to say, "Let's hold these programs down". They are just
in serious, serious trouble.
Another problem area is that of the thrift institutions, which
have been the prime supporter of the single-family home market
for the last 40 years. You read some of the stories. One-third of
them are going down the tube. I don't suspect it's quite so bad that
they're going down the tube, but people are scared.
My wife says:
Tell me when you think there is trouble in one of those Maryland state insured
associations so I can get my $900, or whatever it is, out of that savings account
which is paying me such good interest.
I suspect there are those kinds of concerns all over the country.
At the same time, people are going for the maximum dollar for
the moment. The maximum dollar for the moment is not helpful to
housing. It is good at the moment, but what does it mean for your
children and for yourselves when you go to find a house or your
children need a house?
I have children in their early twenties who are at that stage of
life now where they will soon be out looking for homes. I don't see
them being able to buy a house as I was able to at their age, 20some years ago.
It has not only affected housing, it has affected all construction.
Unemployment is at 16 to 17 percent in the construction trades—a
totally unacceptable situation.
We are, once again, confronted with a problem of workers leaving or intending to leave or having to leave the construction area.
And once again, when we start building again, we're going to find
that the supply of skilled workers—both union and nonunion—are
going to be down, because people are going to have to go out and
find other jobs if they can't get jobs in that area in which they're
used to working.
I think there is another area which has not really been thought
about too much in the housing area. There is a large industry
which produces materials for housing and nonresidential construction—concrete, lumber, gypsum board, steel, brick, and all of those
materials that are essential to building and construction. These
industries are operating at a very reduced capacity or a very low
percentage of their potential capacity now. And yet if we were to
turn around and get back to, in the housing area, a construction
level, or a starts level, of 2 or 2.1 million units, many of these
manufacturers would have inadequate capacity. This is a problem
that occurs time and time again as we go through these housing
recessions. They have that inadequate capacity, and they recognize
it. But they don't feel that it makes sense to invest the money to
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increase that capacity because of the slumps that have incurred
time and time again, every 2, 3, or 4 years.
As a result, when we reach a housing construction level which
comes near to what we need, we find that we have inflation occurring because prices get very high. If the demand is for a million
bricks a week and the industry can only produce 500,000 or 700,000
or 800,000 bricks a week, then there is going to be price bidding
and more costly houses being built, more costly office buildings
being built, more costly stores and warehouses and industrial
plants being built.
It seems strange to me that the only way in which we can
control inflation is by causing more inflation. And yet I feel—and I
have felt for many years—that is what we're doing.
The high interest rates have to go throughout the economy. The
effect in the area in which I'm familiar—and that is the construction and housing area—is that we have more inflation because of
the big swings in production levels. And yet we are saying we are
curing a problem. I think we are making the problem worse.
Thank you, Mr. Chairman.
Mr. TURNER. NOW, Mr. Chairman, we would like to hear from
Robert Mullins, director of legislation for the National Farmers
Union.
STATEMENT OF ROBERT MULLINS, DIRECTOR OF
LEGISLATION, NATIONAL FARMERS UNION
Mr. MULLINS. Thank you, Mr. Chairman.
I appreciate the opportunity to appear before this committee
with this panel.
As you may know, the National Farmers Union is an organization representing independent family farmer and ranchers
throughout the United States.
I would like to very briefly outline several points of concern that
we have and the impact of these record interest rates on the family
farm economy.
First of all, farmers will pay more than $20 billion in interest in
1981 on their current debt of $180.5 billion, compared with outlays
in 1980 of $16.5 billion. The current Commodity Credit Corporation
interest rates on commodity loans is at 14 V2 percent, almost double
what it was 2 years ago.
At the existing 1981 rates, it is going to cost farmers 46.4 cents a
bushel to put wheat in the loan. It's going to cost almost 35 cents a
bushel to put corn in the loan. On top of this, with the waiver of
interest being terminated on the farmer-held reserves, it's going to
cost farmers almost 51 cents a bushel to put wheat into the reserve
program and 37 cents a bushel to put corn in the reserve.
The effect of this is going to be to discourage use of the reserve
program. And that will impact next year and the year after, both
on producers and consumers, particularly if we move into a tight
supply situation.
At the start of this year, it was predicted that farm exports
would set a new record value of about $48 ¥2 billion. Now, because
of the high interest rates affect the cost of handling grain inventories, we are already projecting that that record will be reduced
by at least $2Vfe billion, to $46 V2 billion.
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As far as farmers are concerned, high interest rates are a crude
and very ineffective way of discouraging credit use. At the end of
March of this year, farm borrowings from commercial banks was
running 10 percent above a year ago. At that time, farmers were
borrowing at the rate of $5.4 billion a week, compared to $4.9
billion the year before.
Interest rates are also affecting the ability of farmers to generate
capital internally. In 1970, U.S. farmers relied on loans, or a net
increase in loans, for only 5 percent of their cash sources of
income. This year they are substituting credit for income at what
we consider a rather alarming rate, with borrowing accounting for
23 percent of their cash sources of operating funds.
We feel that the tripling of effective interest rates since 1977 on
consumer loans has diverted about $30 billion in purchasing power
from food, housing, and other necessities and indirectly, therefore,
lowering the demand for American agricultural products.
With these high interest rates have also come a proliferation of
money market funds and other investment opportunities which
have severely drained funds from country banks. We are feeling
the impact of that in the availability of loanable funds out in the
country. Such record interest rates coming at a time when farm
debt is also ballooning to record levels, it is just extracting a
fearful price from farmers. We maintain that had the basic interest
rate remained at reasonable levels, the net income of U.S. farmers
would have been substantially higher over the past several years.
According to our calculations, about $12 billion has been diverted
from the income side to the cost side because of these interest
rates. If this diversion of income continues, we maintain that the
future for many of our family farms is bleak indeed, and if that
happens, Mr. Chairman, the food supply of this Nation and consumer costs are going to continue to increase.
Thank you.
[Mr. Mullins' prepared statement, on behalf of the National
Farmers Union, follows:]
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STATEMENT OF
ROBERT J. MULL1NS
DIRECTOR OF LEGISLATIVE SERVICES
NATIONAL FARMERS UNION
PRESENTED TO THE
BANKING, FINANCE S URBAN AFFAIRS COMMITTEE
U. S. HOUSE OF REPRESENTATIVES
CONCERNING
"THE IMPACT OF CREDIT POLICIES ON
AMERICAN AGRICULTURE"
WASHINGTON, D. C.
July 22, 1981
Mr. Chairman and Members of the Committee:
I am Robert J. Mullins, Director of Legislative Services for the
National Farmers Union. I appreciate the opportunity to appear before
the Committee today on behalf of the members of the National Farmers
Union and commend the Chairman for holding this hearing on a subject
which is of immediate concern to the farmers and ranchers of this
country.
Credit availability, federal credit policy and record high interest
rates are having a severe impact on America's farmers.
The high cost of farm borrowings is the most obvious and
staggering of the effects of the extraordinarily high interest rates being
maintained by the Federal Reserve Banking system despite a lack of
apparent beneficial effects. But the direct cost to farmers is only
one of the many damaging impacts of the high interest levels which have
bounced around between 17% and 21% for most of this year. The latest
reports average interest rate paid by farmers for such things as livestock, feed, farm operations, machinery, etc., is 17.92%, almost four
points higher than a year earlier, an increase of 27% in the going interest
rate. The net effect is that as farmers borrow more, they have less
ability to repay the loans.
348
- - FARM INTEREST OUTLAYS. Farmers will pay more than $20
billion in interest in 1981 on their current debt of $180.5 billion cdmpared
with their outlays of $16.5 billion in 1980.
— CCC LOAN RATE COSTS. The current CCC interest rate on
commodity loans is 14?%. At the existing 1981 crop loan rates, that is a
cost to farmers of 46.40C a bushel on wheat and 34.80C a bushel on corn
for 1981 regular loans. If the first year waiver of interest is terminated
on farmer-held reserve loans, it will cost farmers 50.75C a bushel on wheat
and 36.98C a bushel on corn.
— REDUCED PROSPECTS FOR GRAIN EXPORTS. At the start of
this year, it was predicted that U.S. farm exports would set a new record
value of $48.5 billion in 1981. Now, because high interest rates affect
the cost of handling grain inventories and due to other factors, predictions are that exports will have a value of only about $46 billion.
— NO REDUCTION IN CREDIT USE. High interest rates are a
crude and ineffective way of discouraging credit use, at least as far as
farmers are concerned. At the end of March this year, farmer borrowings
from major commercial banks was running 10% higher than a year ago, at
a rate of $5.4 billion in loans per week, compared to $4.9 billion a year
earlier.
— INFLATION RATE IS ACCELERATED BY HIGH INTEREST RATES.
Since high interest rates become wrapped up into costs of ail industrial
and consumer goods and services, they tend to aggravate inflationary
pressures, rather than reduce them.
— COST OF GOVERNMENT SHARPLY INCREASED. High interest
rates inflate the cost of government at all levels. For the federal government alone, interest outlays for fiscal year 1982 will be $106.5 billion,
up from $94 billion. The interest outlays in fiscal 1982 will be $65 billion
higher than in 1977 when the basic cost of money was about 6%.
— GOVERNMENTAL DEFICITS ARE AGGRAVATED. The $65 billion
cited above would be enough by itself to bring the fiscal 1982 federal
budget into balance. It is a waste which should no longer be tolerated.
— ABILITY OF FARMERS TO GENERATE CAPITAL INTERNALLY
IS REDUCED. In the year of 1970, U.S. farmers relied on new loans,
or a net increase in loans, for only 5% of the cash sources of funds for
their operations. In 1981, farmers are substituting credit for income at
an alarming rate, with borrowing accounting for 2 3% of their cash sources
of operating funds.
— PURCHASING POWER OF CONSUMERS DIVERTED FROM FOOD,
OTHER NECESSITIES. The tripling of effective interest rates since 1977
on consumer loans has diverted $30 billion of purchasing power from food,
housing and other necessities. Indirectly, therefore, high interest rates
depress the effective demand for products of American farms.
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— COMPETITION FOR FUNDS SIPHONS MONEY AWAY FROM THE
FARM SECTOR. With the advent of high interest rates has come a proliferation of money market funds and other investment opportunities which
are drawing several billion in loanable funds from agricultural purposes.
The adverse effect upon country banks, which normally service farm borrowers, has been particularly notable.
Early in 1977 — about four years ago — the prime interest rate
was at 6.25 percent. The prime rate, which is the pace-setter for
interest rates generally, advanced to 11.75 percent by the opening of
1979, and since then we have seen the prime rate rise to as high as
21 £ percent.
Such record interest rates, coming at a time when farm debt is also
ballooning to record levels, is extracting a fearful price from farmers.
We maintain that had the basic interest rate remained at reasonable levels,
the net income of U. S. farmers would have been substantially higher
the last several years.
According to our calculations, about $12 billion in income has been
diverted from the income side to the cost side of farm balance sheets due
to the impact of the higher interest rates.
As we attempt a general overview of the money and credit crisis,
we recognize that as important as these overall statistics and trends may
be, there is always the possibility that we may lose sight of the human
element — the farmers and the farm wives and family members and the
manner in which they feel the effects of the debt burden and the high
interest rates.
We call your attention to the dimensions of the credit crisis in
ATTACHMENT "A".
On January 1, 1981, the outstanding debt of U. S. farmers was
$180.5 billion — an increase of $23 billion or 15 percent in a yearrs
time. That is twice what it was five years ago and more than seven
times what it wa* in 1960.
In ATTACHMENT "B", we show the annual average prime rate for
the past 31 years together with the monthly figures for the past five years.
The prime rate is now almost ten times higher than it was in
1949 and about three times what it was early in 1977.
In ATTACHMENT "C", we show the interest outlays by farmers
over the past 20 years, from a grand total of $1,269 million in 1960 to
$16.5 billion for 1980. That is more than a 12-fold increase from 1960
and more than a doubling in just four years.
It is sometimes maintained that the changes in interest rates do
not make themselves immediately felt. The interest rates in some mortgages and many promissory notes are fixed, and so the new rates do
350
not become an immediate problem.
misleading.
However, that assumption can be
In referring to ATTACHMENT "D", we show that only about 36 percent of real estate debt and only 12 percent of short-term debt is not
immediately affected by interest rate changes.
About 31 percent of the outstanding real estate debt each year is
new borrowing — so that will be affected by the new rate. The Federal
Land Bank system, which accounts for one-third of the real estate lending,
is now largely on a variable interest rate basis. The rates float according
to prevailing market conditions and so these loans are affected soon, if
not immediately, by the new rates.
On the short-term loan side, almost all of the debt on many farms
is rotated every year. It is paid off and new loans are drawn. There
are some loans, for example, on farm machinery purchases, which may
run three to five years in duration. But, as best as we can calculate,
these longer-term "short-term" loans make up only about one-eighth of
the non-real estate debt burden.
In ATTACHMENT "E", we show the farm debt-to-asset ratio over
the past forty years.
While the ratio looks modest — about one dollar of debt for each
six dollars of assets — the figure is still on the high side.
The January 1, 1980, ratio of 18.1 is the most unfavorable since
1941.
A more meaningful measurement is the rate of substitution of credit
for income which we show in ATTACHMENT "F" relating to the cash sources
of funds of farm operators.
What this shows is that farm operations are not generating internal
capital as they have or as they should but instead are increasingly dependent on borrowed funds for cash operating money.
In 1970, new loans — or the net increase in loans — represented
only five percent of the cash sources of funds of farmers.
By 1975, this figure had risen to 12 percent, and in 1978 and
1979, it has amounted to more than 17 percent. In 1980, farmers were
borrowing money for 20 percent of their cash sources of operating funds.
In ATTACHMENT "G", we look at several measures of the ability
of farmers to handle their debt burdens.
The first of these is the U. S. parity ratio — currently at 63
percent of parity. What it means is that farms are able to pass through
only 63 percent of their operating costs (including interest) in the price
of their products.
The second item shows the per capita income of farmers from farming compared to the per capita income of non-farmers. The ratio of
351
62 percent is not a good omen of the viability of farming as an economic
enterprise.
In the third item, we show the return to farm equity compared to
the rates of profits in selected manufacturing industries. Again, the
3.6 percent farm rate in 1978 does not compare well with the 24 percent
rate in all manufacturing enterprises. A rate of 4.1 indicated only slight
improvement in 1979.
It is sometimes contended that the growth of farm debt and the
high interest rates are offset by the spectacular growth of the value of
farm assets.
However, item four is worth some study. It shows that from 1975
to 1979, if inflation is deleted, farm real estate values have actually declined.
Now, of course, the higher land values do make it possible to
incur larger debts.
But what it does is increase farmers1 ability to borrow, without
increasing their ability to repay.
Repayment depends on income — and we should never lose sight
of that.
It is important to understand that the Nation's farmers are also
affected by what high interest rates do to the remainder of the national
economy. Obviously, the higher interest rates are diverting consumer
purchasing power which could be used for food, for housing, for automobiles and other manufactured goods.
Should anyone be surprised that the housing construction industry is ailing with housing mortgages at interest rates of 16 percent and
more?
Should anyone be surprised that American cars are not selling
with car finance costs where they now are?
You have all been told many times that these tight-money, highinterest-rate policies are justified on the basis that they will reverse
inflationary pressures and save the value of the dollar.
Perhaps farmers would be willing to go through the wringer,
workers to be unemployed, and other citizens to forego purchases of a
house, a car or other major items, and our whole society to accept a
lower standard of living, if it achieved anything in the war on inflation.
But that policy is not succeeding - - it never has without precipitating depression — and it probably never will.
A BETTER ANTI-INFLATION STRATEGY IS AVAILABLE
In the Emergency Credit Control Act of 1969
(Title II of Public Law 91-151)
In early 1980, the Carter Administration attempted half-heartedly
and largely ineffectively to use the credit restraint provisions of
352
P.L. 91-151 to help curb inflationary pressures.
The effort was abandoned a brief two months later without ever
making use of some of the very significant tools which were available.
Later, the Congress voted to terminate the Emergency Credit
Control Act of 1969, but made the termination effective June 30, 1982.
Therefore, the authority still is available to the President and could be
used by the President to direct the Federal Reserve Bank board to take
certain constructive actions in the campaign against inflation.
We acknowledge that credit controls and credit allocation are
drastic tools, but conditions are desperate and the strateaies of the
Federal Reserve under the Carter Administration and under the Reagan
Administration, up to this time, have been entirely ineffective in curbing
inflation.
We see no prospect that the super-tight money policies of the
Federal Reserve system will bring about the needed economic cure.
One may not like the prospects of credit controls or credit allocation, but the alternatives are absolutely intolerable —
— Runaway inflation is worse,
— Recession is worse,
— High unemployment is worse, and
-- Hardship for those at the dawn of life, or those at the
twilight of life, or those in the shadows of life (the disadvantaged, the handicapped and the poor) is worse.
These alternatives are not viable alternatives for the American society
and they should make way for an effective, though stern, medicine of
credit controls and allocation.
The language of Title II of the 1969 Act deserves close reading
since it provides broad powers for the President:
Section 205 of the law provides that:
"Whenever the President determines that such action is
necessary or appropriate for the purpose of preventing
or controlling inflation generated by the extension of
credit in an excessive volume, the President may
authorize the Board to regulate and control any or ail
extensions of credit."
Section 206 lists the actions which the President may direct
the Federal Reserve Board to take, including:
"Prescribe the maximum amount of credit which may be
extended,
"Prescribe the maximum rate of interest, maximum
maturity, minimum periodic payment, maximum period
between payments, and any other specification or
353
limitation of the terms and conditions of any extension
of credit.
"Prohibit or limit any extensions of credit under any
circumstances the Board deems appropriate."
As we read this statute, we believe it contains authority for a
roll-back of interest rates to any level which the President may direct.
It contains authority to allocate credit to productive uses such as farming
and food distribution, to housing, to basic industries and to small business.
It contains the authority to prevent the flight of capital to foreign
countries to avoid the effects of the domestic credit controls.
If the White House would use this authority to roll back the cost
of money even to the then relatively-high level of 6£% which prevailed in
April, 1977, it would result in these savings to the American people:
— A $12 to $14 billion reduction in annual interest rate
outlays for American farmers;
— A $60 to $65 billion reduction in annual interest outlays by
the federal government (enough alone to balance the fiscal 1982 budget);
— A $200 billion reduction in interest outlays by American households, individual consumers, and other borrowers.
THE NEED TO EXTEND THE ECONOMIC EMERGENCY LOAN PROGRAM
Authorized in the
EMERGENCY CREDIT ADJUSTMENT ACT OF 1978
Public Law 95-334
On many American farms in 1981V interest outlays will be the
single largest expense item, exceeding even the cost of feed purchases
and the cost of purchased livestock.
The outstanding debt of U.S. farmers (which began this year at
$82.5 billion) is now thought to be approaching $200 billion. Farmers
depend on commercial or independent financial sources, such as commercial banks, life insurance companies, federal land banks and individuals
for 91% of their real estate loans. They depend on commercial or independent sources such as banks, Production Credit Associations (PCArs)
and individuals for 77% of their short-term borrowing (non-real estate).
About 15.4% of the non-real estate borrowing is from the Farmers
Home Administration (FmHA) and 3.3% from the Small Business Administration.
Yet for farmers, who cannot get financing from other sources,
the 9% of the real estate loans and the 18% of the short-term loans
which they get from federal government sources, are vital to their survival in farming. Disaster loans are such last resort loans.
Responding to a severe crisis in 1978, Congress and the President
approved the "Emergency Agricultural Credit Adjustment Act of 1978",
Public Law 95-334, which included a new economic emergency loan program.
354
Under this section, USDA is authorized to insure and guarantee
loans to family-scale farmers not able to obtain sufficient credit from
normal sources to finance actual needs at reasonable rates and terms
due "to national or areawide economic stresses, such as the general
tightening of agricultural credit or an unfavorable relationship between
production costs and prices received for agricultural commodities."
P.L. 95-334 authorized up to $4 billion in such economic emergency
loan programs through May 15, 1980. Subsequently, in March, 1980, the
law was extended with another $2 billion in loan authority through
September 30, 1981.
From early 1979 through June 10, 1981, some 115,823 economic
emergency loans have been made, totalling $6.3 billion. Since some repayments have already been made, a total of $404 million in unobligated funds
are available for loans in the remainder of the year ending September 30th.
In view of the current projection that total net income of U.S.
farmers may be as poor as the disaster year of 1980 and because of the
huge debt load of farmers and the extraordinary interest rates, it is
important that the Congress act to extend the economic emergency loan
program for at least two years beyond the scheduled expiration on
September 30th.
The House Agriculture Committee has recommended a one-year
extension of the economic emergency loan program, but without any
additional loan authority.
We think that the extension should be for two years with at least
another $4 billion in loan authority.
Neither the Reagan Administration nor the preceding Carter Administration recommended a continuation of this program, but we regard
that position as
short-sighted and mistaken.
The economic emergency loan program has helped 115,000 farmers
stay in farming. Without such a program, the end of the road could
come in late 1981 or early 1982 for many thousands of efficient and
productive farm operators, who are in economic difficulty through no
fault of their own.
Since the program functions through the insuring or guaranteeing
of loans by the FmHA, the net costs of the program to the U.S. Treasury (and to taxpayers) will be negligible. But to the farm operators
who are helped, it will mean survival.
355
ATTACHMENT
"A"
OUSTANDING FARM D E B T , ANNUAL CHANGE I N DEBT AND THE
COMPOSITION OF FARM DEBT
Annual Change in Farm Debt
S
Outstanding Farm Debt
As of January 1
Debt.in Increase Increase
Year Bil. ?
in. Btl. $ in %
1960
1970
1971
1972
1973
1974
197 5
1976
1977
1978
1979
1980
1981
24.8
53.0
54.5
59.1
65.3
74.1
81.8
90.8
102.7
119.3
137.5
157.8
28.2
1.5
4.6
6.2
8.8
7.7
9.0
12.1
16.6
18.2
20.3
A*. 7
113.0%
2.8%
3.4%
10,4%
13,4%
10.3%
11.0%
13.3%
16.1%
15.2%
14.8%
REAL ESTATE, NON-REAL ESTATE AND OTHER FARM DEBT
356
ATTACHMENT "B"
THE PRIME INTEREST RATE
Year
Rate '
1949
1950
1951
1952
1953
1954
.07
.56
.00
.17
.05
1955
1956
1957
1958
1959
.32
.50
.50
.50
.50
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
.61
.30
.96
1970
1971
1972
1973
1974
.91
i.72
i.25
1.03
10.31
O
H
CT>
C
a>t
Year &
Month
Year &
Month
Jan.
Feb.
Mar.
Apr.
May
June
% - 6 3/4
3/4
3/4
3/4
3/4
- 7%
Aug.
Sept.
Oct.
Nov.
Dec.
% - 7
1977
Jan.
Feb.
Mar.
Apr.
May
June
ai
m
<n
1978
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
- 6 3/4
>%
i% - 6%
>%
6%
i%
>%
i% - 6 3/4
3/4
July
Aug.
Sept.
Oct.
Nov.
Dec.
N
NOW ALMOST 8 TIMES HIGHER THAN IN 1949
>o r m m
1979
Jan.
Feb.
Mar.
Apr.
May
3/4
3/4 - 7
- 7%
% - 7 3/4
3/4
3/4
a «
u-iio
o
r-i CN
v o v o ^ o
July
Aug.
Sept.
Oct.
Nov.
- 8*5
1*5-9
- 9%
i% - 9 3/4
3/4 - 10*i
10% - 11«|
11% - 11 3/4
11
11
11
11
11
3/4
3/4
3/4
3/4
3/4
11*1 - 11 3/4
11 3/4 - 12%
12% - 13%
13% - 15
15 - 15 3/4
Apr.
May
June
July
Aug.
Sept.
Oct.
Vov.
Apr.
May
15%
,5%-16 3/4
6 3/4-191}
.9*5
.8*5-14
.4-1:
.2-1:
.1-1.
14-
21*5-20
20-19
19-174
17*5-18
18-20*5
clo:
357
ATTACHMENT " C "
Year
Million $
1960
1961
1962
1963
1964
1,269
1,344
1,478
1,655
1,804
1965
1966
1967
1968
1969
1,986
2,213
2,458
2,641
2,898
1970
1971
1972
1973
1974
3,213
3,372
3,701
4,476
5,496
1975
1976
1977
1978
1979
1980 ."
1981 (Est.)
6,066
6,687
7,565
9,300
11,900
16,500'
20,000
. . . .
3S
% Of 1967
500
S
2:
INTEREST PAID BY FARMERS
ON REAL ESTATE AND
NON-REAL ESTATE DEBT
S
~
£
~
£1
^ £
^
2
^
^.
c^
FARM INTEREST OUTLAYS
UP 5 TIMES
SINCE 1967
UP 11 TIMES OVER 1960
Prices Farmers Pay
1975
1976 1977 1978 1979'
Percentage of 1967
182
262
166
192
193
299
178
210
'January-May average. 'Interest on
'Taxes on farm real estate.
200
339
195
226
216
396
207
242
240
487
221
262
I estate debt.
358
ATTACHMENT "D"
ESTIMATED SHARE OF FARM DEBT BURDEN EXPOSED TO CHANGES
IN EFFECTIVE INTEREST RATES
REAL ESTATE DEBT
MONTREAL ESTATE DE3T
64%
ImmediaJ. el
,rf acted - 12%
Not Immediately
Affected - 36%
Sew
Borrowing-31%
ATTACHMENT "S"
Year
1940
1941
1942
1943
1944
%
13 .9
19 ,1
16 .6
13 .4
10 .6
1945
1946
1947
1948
1949
8 .9
7 .6
7 .2
7 «2
3 ,4
FARM DEBT TO ASSET
1940 - 1979
Year
%
1950
9 ,3
1951
8 ,5
1952
3 .6
1953
9 .6
1954
10 .3
1955
1956
1957
1958
1959
10 • 5
10 ,8
10 ,6
10 ,7
11.3
RATIO
Year
1960
1961
1962
1963
1964
11. 3
12. 4
13. 0
13, 3
14. 6
Year
1970
1971
1972
1973
1974
16 .3
16 ,7
16 .3
16 .6
15 .5
1965
1966
1967
1968
1969
15, 1
15. 6
16. 0
16. 5
16. 7
1975
1976
1977
1978
1979
15 .8
15 ,7
15 .7
16 ,7
16 ,8
3/
.I
ATTACHMENT "F"
INCREASE IN BORROWING BY FARMERS AS SOURCE OF CASH FUNDS
s and U S M of Funds in th« F?rm Sector 1970-1979
I »»l
aiilion dollan
n Sou css af f-j
1
M « cam meamt 'ram fjrtn jna noi
»ourc«s
2
3
4
N«t Mow of r«ai 4«ac« loans
N«t l o w of nonr«ai «sxat« :oans
Totat casn sourcss of 'unaa
?rocojr:icn of Cash ?*jnds
.
4C3
5.2
43.3
9.3
4.3
75.0
12.1
?n.n
3.4
50.3
54.3
3.1
71.3
4.2
59.3
S.7
73.4
5.3
7S.3
3.9 10.2
95.7 US.o
10.7
U.2
14.0
18.3
17.3
<^. f
\\Q.£>
17.0 3 ^ %
359
ATTACHMENT "G"
MEASURES OF ABILITY TO REPAY FARM INDEBTEDNESS
Item I
U.S. FARM PARITY RATIO
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
Item II
CCMSASISOH OF ?5S CAJTSt Z3CCMZ OP TZ&OSaS ?"RCM
VTSSL ?S^ CA2ITA I2SCCM2 CP aOS-?
iTcn-?araera ?rca A i l
Scurcss
?*r Capita : - c c a « cf ?ar=«ra ircm ?araiii? u
i ". : i
Sen-Sara
360
ATTACHMENT "G"
Item
(Continued)
MEASURES OF ABILITY TO REPAY
III
Return to Farm Equities and*Annual Rates oi Profits
on Stockholders Equities for Manufacturing Industries
C3 ?«rtnioq
a AU manufoctunnq aoroormon*
3 roaa and torwrwj atoauea
!975
1377
KTUtjf TO nuui EQUITIES AMO A.iNUAi. TATS of "fonrs ON sracxHoujew -iquina -o«
MAAUFAC7Ult)Na I M O U O T I E S ; IVtUtt
INCQMC -JUES
X4
3.J
3.3
U.S
3.7
ZX2
lfi.5
13
it
t M4
?ttre<«ini
a22.J
2
U.3
1<3
22.4
17. i
a j
13.9
19.3
23.1
24.3
21.3
2.9
U.Z
a'.5.s i
'A*
J.3
IS- i
ILi
21.3
kt
Item IV
VALUE OF FARM ASSETS IN 1967 DOLLARS
1975-1979
(Jan, 1)
Physical assets:
3eat sstats. . . .
N on real « t a t « :
1^4 JC^intffy jnd f^toCOr* vefiiC'^S • < * •
Coos stored on and off farms3
Housenoid souioment and turmsninqi.
Ffnanclal assets:
OeoosUs and currency
U.S. «xwin«o Bonds
!nv«stm«r»ts in ccoo«rativ«s
Xotar ,
Billion dollar*
197.7
197.A
197.3
197.2
197.2
22.2
30.9
9.5
9.9
11.*
30.9
20.3
21.1
HA
9.3
19.9
31.1
l-i.5
10.9
19.2
31.3
15.5
12.3
3.0
2.2
7.2
7.3
2.1
7.2
2.1
7.3
3.5
2.3
i.3
2.2
7.0
361
Mr. TURNER. Thank you, Mr. Chairman. Now we have Mr. Paul
Fry, the executive assistant director of finance and administration
for the American Public Power Association.
STATEMENT OF PAUL FRY, EXECUTIVE ASSISTANT DIRECTOR
OF FINANCE AND ADMINISTRATION, AMERICAN PUBLIC
POWER ASSOCIATION
Mr. FRY. Thank you, Mr. Chairman. We appreciate the opportunity to appear with the panel this morning.
The American Public Power Association represents about 1,750
local publicly owned electric utilities throughout the United States,
principally in small communities. The electric utility industry is
our economy's most capital-intensive industry. It requires between
$3 and $4 investment to generate $1 of revenue. The current total
capitalization of the electric utility industry, including the investment of the Federal Government, is in the neighborhood of $300
billion, and the annual new money requirements of the industry
are in the range of $15 to $20 billion.
Unstable financial markets and high interest rates are particularly disruptive for this industry, and impose very heavy burdens
on the electric utility industry's customers. The local publicly
owned sector of the industry, those utilities owned by municipalities and other political subdivisions of States, service about 14
percent of the industry't customers and has about $35 billion of net
electric plant, or ab.--ut V? percent of the industry's total capitalization. As public entii r: these utilities raise capital in the taxexempt municipal bun*s market. Interest rates in the municipal
bond market have J'iteral?y doubled in the past 3V2 years. This is
illustrated by the Bond Buyer 20-Bond Index, which stood at 4.45
percent in November 1977 and last week reached 11.09 percent.
Not only have interest rates doubled in a very short period of
time, but the market has become highly volatile as well. The
municipal bond market was quite stable over a 30-year period
following World War II, and investors were quite willing to commit
funds at fixed rates for long terms. This situation has now changed.
The Bond Buyer 20-Bond Index varied only 48 basis points between
its 1977 high of 5.93 percent and its low of 5.45 percent. In 1978
that variation between high and low was 109 basis points; in 1979,
130 basis points; and in 1980, 345 basis points. Already this year
the variation has reached 310 basis points.
The annual municipal electric utility debt financing is going
from about $750 million in 1970 to over $5 billion in the late 1970's
and about $4.7 billion last year. This represents about a threefold
increase in its share of the total tax-exempt bond market since
1970. It is clearly the fastest growing sector of the tax-exempt bond
market. Local public power systems plan about $5.5 billion in
capital expenditures this year, much of it to be financed with longterm debt.
The cost of money has simply overwhelmed all other factors
which collectively determine the retail price of electricity. This
causes many deferrals and cancellations of powerplants and much
higher electric rates to consumers. Interest costs today, in some
cases, represent nearly 50 percent of wholesale power costs and as
much as 20 to 25 percent of retail consumers' bills. It would appear
362
that inflation's intended remedy, tight money, is seriously aggravating the inflation of electric power costs.
Thank you, Mr. Chairman.
Mr. TURNER. Next, Mr. Chairman, we have with us the executive
assistant to the mayor of Seattle, from the U.S. Conference of
Mayors, William Stafford.
STATEMENT OF WILLIAM STAFFORD, EXECUTIVE ASSISTANT
TO THE MAYOR OF SEATTLE, REPRESENTING THE U.S. CONFERENCE OF MAYORS
Mr. STAFFORD. Thank you, and I represent the U.S. Conference of
Mayors here today.
I think we are all aware that for the cities of this country these
are very complex times, and it is very difficult for management of
city governments to plan, to decide what we should do for the
future, in terms of many of the kinds of capital, particularly capital projects which we are facing to get through the 1980's. The
budget cuts, the uncertainty in terms of how programs will come
out, the questions of funding level of the programs and then the
secondary decisions that will have to be made by State governments, leave the management of our cities in a virtual chaos which
would seemingly continue for the next at least 12 to 24 months.
We seem to be moving toward a period where we are going
toward local self-help, where the local governments will have to
make your own plans, do your own investments, and make your
own local decisions using more and more local funds. Therefore,
the discussions today in this committee fit right into the question
of if we are no longer going to have Federal moneys to make and
do certain capital projects in terms of sewers and water systems
and roads, that what we can borrow money for, borrow money
locally gives us what our—the amount of risk that people want to
take in their borrowing, lets us know what we can do in terms of
the future.
Let me take just the impact of interest rates on cities, which fall
in two different ways. One, on the corporate community. The city
of Seattle, as a government, as a corporation measured by employees or measured by sales versus the size of our municipal budget,
would be listed in Fortune's 500 if it were a private corporation.
Now, just to give you a good few examples of the impact of the
interest rates on the city, the high interest rates, the interest rates
for municipal bonds have doubled in the past 3% years. The Bond
Buyers Index has risen from 5.45 percent in November 1977 to 11
percent in July. Moreover, the municipal bond market is extremely
volatile, further complicating borrowing by State and local government.
Since 1979 the State and local government bond market has been
under severe pressures and many borrowing plans have been sidetracked. We, in Seattle for example, have just had to put off
decisions in our Metropolitan Sewer and Transit Agency, where in
the spring we were going to adopt our plans through the eighties,
because of the zeroing out of the program for the coming year and
the calculations that the sewer plan for 1990 would have required a
tripling of the sewer rates. Local officials decided for the county
and the suburban cities to put off the decision until later this year.
363
The same thing happened with our capital program for 1990,
which was to be adopted in the spring. Again, those decisions have
been deferred until the fall and next spring, until we get more
certainty in terms of what Federal moneys will be available for the
capital program and how that mixes with the interest rates and
with our inability to bond locally. It has thrown our entire planning for the next 10 years almost out the window.
About one-third of local capital projects are financed by longterm, and to a lesser extent short-term borrowing. According to a
recent survey of the Joint Economic Committee, long-term borrowing will rise as a source of financing for cities making capital
investments, especially given the decline I just mentioned in local
assistance. Now, this gets to other uncertainties which are in the
local markets, and one example of this which, just to quote a
paragraph in a letter to Congressman Rostenkowski on the All
Savers Certificates, a recent study by the Municipal Finance Officer Association shows that All Savers Certificates could draw away
$10 billion investment from local bond markets and drive up borrowing costs for States and local governments from $620 million to
$1.1 billion in the first year. One reason is because individuals now
buying 55 percent of new issues, historically they have comprised
only 20 percent of the bond buyers and the interest rates on the
All Savers Certificates would be nearly 2.5 to 3 percentage points
higher than the short-term tax-exempt rates, and about equal to
the long-term rates. In addition, the savers certificates would be
federally insured, and consequently a more secure investment than
State and local notes or bonds.
The new tax-exempt federally insured investment given to a
nongovernment entity, besides being unprecedented, could not
come at a worse time for the bond market. The tax-exempt rates
are already at alltime highs, and only 80 percent of taxable rates,
far above the historical average of 67 percent. Cities can ill afford
these high interest costs at a time when they are being hit with the
severe cutbacks in Federal and other local aid.
I think some of the major questions, if in fact—and the theory is,
to let local bonding take care of some of the infrastructure. We just
had another case in our State where Fairchild and Hewlett-Packard companies both wanted to locate not in the city but outside the
city limits. In both cases, the small communities could not afford
the infrastructure cost that accompanied two major plant investments. Luckily, we have our legislature meet 2 months out of the
year. They were in session and they rushed through an emergency
package to try to cover some of the costs of these two small communities.
That is the impact on the corporate city. The impacts of the high
interest rates on the border city are a summation of a lot of the
things youVe heard today. Housing, we're involved in some of the
higher risk housing like 312 loan program. If that moves through
to extinction, the ability of the city to, working with high risk parts
of the city to get local funds at any kind of a rate that would
cancel out. We just did close an SBA deal, our development director told me this week, for a little tortilla factory and it closed at
$500,000, central part of our city, a minority area. And it closed at
18-percent average between the SBA loan and the local financing.
364
The cities have—the country, in David Bureh's study done over a
year ago, showed that the birth of small businesses is very critical
to a city; that you have the birth and you have the death of
businesses. And in a growing city, a healthy city, the small businesses that come in offset those businesses which die. Presently, we
are seeing the death rate of small businesses being pressured by
their inability to borrow going up, and at the same time it is more
and more difficult for small businesses, particularly in high-risk
parts of the city, to get funds, particularly with the Federal programs now being pulled out.
I think that as cities—that these are times in which we aren't
going to be able to, and have to do more things locally, then the
Congress is going to have to look at the fact of things like the high
interest rates make it very difficult for the cities to do that.
Thank you.
Mr. TURNER. Mr. Chairman, next we have the president of the
Industrial Union Department, AFL-CIO, the department which
represents approximately 6 million members of the AFL-CIO,
Howard Samuel.
STATEMENT OF HOWARD SAMUEL, PRESIDENT, INDUSTRIAL
UNION DEPARTMENT, AFL-CIO
Mr. SAMUEL. Thank you.
Mr. Chairman, I have been asked to say a few words first about
the automobile industry, which is a well-recognized victim of the
current program of high interest rates. May I add that I say these
words with the endorsement of the United Automobile Workers,
the union which represents workers in the automobile industry,
and also of a number of unions which represent workers and
industries that make components and parts for the automobile
industry.
This industry, in total, is one of our most important and employs
about one out of six of all our manufacturing workers in this
country. Obviously, its problems have been caused not only by high
interest rates, but at least earlier by the pressure of competition
from abroad. The fact is, though, that a couple of years ago the
automobile industry began to pull itself by its own bootstraps out
of the situation. There are small-model cars now available—made
in this country—for domestic purchasers. But it hasn't accomplished its goal of bringing the automobile industry back to its
previous highs of employment and profitablity.
The cause, of course, has been high interest rates. They have
been seen very visibly, during the course of 1980 when sales in this
industry, sales and productivity began to rise early in the year
throughout May. Then, as interest rates began to accelerate during
that period there was a direct, almost one-to-one relationship to
sales and productivity of the automobile industry, until sales have
gone down, and as you know, they have stayed down. And that
industry still represents a very serious problem for this country. It
has caused unemployment probably involving several hundred
thousand workers in a wide spectrum of industries, not only in
automobile assembly but in steel, glass, rubber, chemicals, textiles,
and a number of others.
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Let me also take a moment to discuss with you two other principles regarding interest rates, and one has to do with productivity
and one inflation. All of you are aware that this country faces
somewhat of a crisis with respect to our productivity. The figures
are quite clear. Through about 1973 our productivity improvement
rates were climbing quite satisfactorily, and we led the world. And
the payoff was a dominant position in the world market, as well as
domestic growth.
Starting around 1973, those increases began to go down. They are
still down. Let me talk only about the productivity rates, incidentally, of the manufacturing industries which are relatively easier to
measure. Productivity rates in the service industries seem to be
worse, but are much more difficult to measure, to quantify satisfactorily. But the fact is that in the manufacturing industries, productivity has not kept up and represents a substantial problem now
for us.
The Congress has taken recognition of this and all of you have
spent a good deal of time, recently, trying to develop a tax bill, one
of whose purposes would be to provide investment for a new technology to improve productivity. And so the problem of productivity
is one that is well recognized.
There are a number of causes. I am not here to give a lecture,
nor could I, on the causes of low productivity growth, but there is
no question that high interest rates are a major cause. Professor
Lester Thurow, one of our most distinguished economists, claims
that high interest rates cause as much as a third of the failure of
productivity rates to go up; really, in effect, almost the major
factor. The reason, of course, is that high interest rates bring down
our capacity utilization and when a factory does not have full
capacity utilization, no manufacturer or very few manufacturers
are going to invest money in new machinery. It is far more sensible
to try and bring up capacity utilization using existing machinery,
existing capital equipment, and not try and invest in new machinery against an unknown future.
I might add, by the way, that the effect of high interest rates is
particularly felt, as all of you know, on long-term investment, longterm bonds. What has happened in the bond market is too wellknown to reiterate here, but obviously that has a major effect on
investment for new technology and for productivity.
Now, what is the effect of high interest rates on inflation? We
are told by Mr. Volcker, among others, that without high interest
rates we will not be able to defeat inflation. I would like to suggest
to the members of this committee that with high interest rates, we
will not be able to defeat inflation. In effect, high interest rates are
a major component of our inflationary problems. If we have had
any easing at all in inflation recently, certainly I think it is sheer
folly to give any of the credit to high interest rates. I would turn,
rather, to OPEC and to the declining cost of energy, which could
well be temporary.
Interest rates, we believe, have very little effect on inflation
except to make it worse, and I think this has been too well proven
to require very much emphasis, except simply to realize, as you all
do, the effect of interest rates on our Federal budget. You and
others are making a valiant effort to bring down our Federal
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budget, to make it a more reasonable reflection of our national
growth; and yet you are dealing with something like 12 percent of
our national budget are interest payments, and that figure is going
up. It is not going down.
Finally, in conclusion, this inventory of damage wrought domestically by excessive interest rates for productive investment matches the chronicle of international repercussions expressed at the
Ottowa summit meeting. Leaving for another day any further comments on the international side, the inescapable conclusion of our
discussion this morning is that the vital sectors of our society
which we represent cannot endure a protracted experience of these
crushing levels of interest rates. Yet independent economists of all
inclinations seem agreed, uniquely and disturbingly so, that high
and volatile interest rates will be a burden on us and our economy
for the foreseeable future. The signals from the independent Federal Reserve Board, to the extent they can be deciphered, seem to
indicate yet further tightening in the growth of the money supply,
and that means a further tightening of the noose of high interest
rates about the interest-sensitive productive sectors of our economy.
You heard about it yesterday, Mr. Chairman. We will be working
to frame solutions to this challenge. We know that calling simply
for lower interest rates alone is not enough, but describing the
damage caused by the destructive practices of our monetary authorities is a vital step in beginning that process and we are
exceedingly grateful to you, Mr. Chairman, and the members of
this committee for giving us this opportunity to do so.
Thank you.
The CHAIRMAN. Thank you, gentlemen. I want to commend you
not only for your statements but for the fact that on the one hand
you tell us about the problems that are created by the high interest
rates, yet you also very responsibly recognize that the solution to
the problem is a multifaceted one with no one magic solution.
Mr. Turner, as we have been reading in the press the past week
or so, enormous lines of credit are being granted to some of the
major corporations of this country for corporate takeovers. In some
instances, those obtaining the lines of credit don't even really know
what they want to take over, but they figure they want to play in
the ballgame. They want to be part of the act; they want to be
ready. Of course, this is tying up a great deal of money once these
lines of credit are granted.
The Chairman of the Federal Reserve Board yesterday indicated
that he is concerned about what is occurring in this takeover
situation. Do you believe, Mr. Turner, that we should attempt to
develop a policy that directs the scarce credit resources that are
available into productive investment and away from this game of
big time monopoly that is being participated in by so many of our
major corporations? And if you do feel that way, how do you think
the Federal Reserve Board and the administration could effectuate
such a program to insure that those resources go into productive
investment?
Mr. TURNER. Well, Mr. Chairman, I certainly believe that we
need to see to it that the Fed and the President activate the powers
that they have under the 1969 act which allowed them to allocate
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credit and to give favorable treatment to different sectors of the
economy. I think in particular, they were looking at these problems
of corporate takeovers where people have funds available or they
are able to get funds much more easily than people at a lower level
in the economy. Of course, there are some things in the economy
such as housing and the financing of activities in cities and a lot of
other activities which are much more important to the economy
and will do more for full employment and also for fighting inflation than these uses that are being put to it.
The law is there and the Fed can do it, with the approval of the
President. I would think that the initiative should come from the
President. I think you ought to ask the Fed to move ahead with
this sort of thing. I believe the idea of trying to pass a joint
resolution of the House and Senate on this whole matter, which I
think you and Mr. Reuss have been working on, I think that could
be very helpful, but the law is there.
You will recall that in March 1980 the Carter administration
applied some parts of that law, and right away the interest rate
went down, I think, to around 11 or 12 percent. And then for some
reason, it was never quite clear to me, they withdrew the credit
restraints. I think it had something to do with fear of recession, or
something, and they withdrew the credit restraints. And, if you
will recall, then, the interest rates began to move rapidly up again.
Now I am interested in low-cost electric power. Five years ago or
4 years ago—nuclear power, I think, is the cheapest power that is
available—3 or 4 years ago, the first 5 years of a nuclear plant,
there was a cost of—50 percent of the total cost was for interest
rates.
I think today that if you try to build a nuclear plant, you're
talking about 60 to 70 percent of the cost for the first 5 years as
being interest. Now how are we going to meet these power needs?
So I would hope, Mr. Chairman, through some kind of a joint
resolution or through some way of prodding the White House,
something could be done.
It is unfortunate, of course, that the Fed is so independent. I
don't know of any other modern industrial society where the monetary authority has such independence as we have in this country.
Now, you know, you elect someone President, and you elect a
Congress. The Congress and the President both are somewhatwell, I would say hog-tied, perhaps, in terms of acting because the
Fed has so much independence. And you can talk to them, you
know—here is on television last night, I saw Mr. Volcker, and here
is—a big part of this committee was certainly in complete disagreement with what Volcker was doing, and someone even threatened
to impeach him. And he said, "Well, somebody else will be there
anyway."
Well, here is an organization—when you are elected to Congress,
you are elected to the Presidency, you wanted to do something to
maintain a full-employment economy. You want to have an economy with low rates of interest. You want to have an economy with
low rates of inflation. But here is a man in a tremendously important position. You can do something about your fiscal policy, but
your monetary policy is in the hands of something—of an organiza-
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tion which in effect flaunts your authority, and which is what
happened yesterday.
So, Mr. Chairman, I would hope that we would do something to
get the 1969 act extended.
The CHAIRMAN. That's what I thought. You know, you were
almost as good as Paul Volcker and Arthur Burns and Bill Miller,
because our time has expired. I asked you one question, and there
goes the time. [Laughter.]
Maybe someday you will be the man, because that is a sine qua
non—to take one question.
Mr. ANNUNZIO. Mr. Chairman, will you yield? When you say that
someday Mr. Turner will be the man, at least he will have to run
for office and get elected. He's not looking for an appointed job.
[Laughter.]
The CHAIRMAN. Mr. Leach?
Mr. LEACH. Thank you, Mr. Chairman.
I think interestingly a good deal of what I think the whole panel
has said is in conformance with what Republicans and Democrats
alike think in terms of the effect of interest rates, and I was
particularly appreciative of your comments, Mr. Samuel, that you
appreciated our valiant effort to reduce the budget, and you pointed out what a high percentage of the budget our deficit financing
has determined.
Does that indicate that the AFL-CIO is moving in the Republican direction?
Mr. SAMUEL. I don't think that is a conclusion that is warranted
by anything I said.
Mr. LEACH. Fair enough.
One of the things I would like to ask, because it wasn't covered
much, and that is, when we look at society, we all know there are
different pushes to costs. Republicans sometimes like to dwell upon
the labor cost, and everyone dwells upon interest cost, and other
people dwell upon other types of cost.
But to put this all in perspective, could you provide for us the
relative position of labor, let's say over the last 3 or 4 years, in
relation to inflation and particularly the relationship of labor not
only to inflation but with the higher tax brackets that the average
person is being put into? Has labor gone forward or backward as a
general rule?
Mr. SAMUEL. The level of average wages has gone down; real
wages have gone down. It has gone down for almost 10 years. Most
of that loss has been in the last 2 or 3 years. Workers now—the
average worker has less disposable income in real dollars than he
did in the early 1970's. This is hardly true, of course, of interest
rates.
Mr. LEACH. Well, then would you say that—I mean, just as a
general rule, that Government policies of the status quo would
seem relatively unacceptable for labor and that we ought to be
changing direction in one fashion or another?
Mr. SAMUEL. I think that is the gist of the comments that were
made by all of us here today, that we have only approached the
subject of interest rates, and probably it wouldn't be appropriate
for me to discuss other activities and the other range of activities
that I think would be called for. But certainly one of the things
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that we feel most strongly about is to do something about high
interest rates which are such a major contributor to inflation.
Mr. LEACH. Fine. Thank you very much, Mr. Chairman.
The CHAIRMAN. Mr. Reuss?
Mr. REUSS. Thank you, Mr. Chairman. And I heartily congratulate this panel for the very, very able job they've done and their
addressing what is the primary economic problem right now, the
murderously high interest rates.
I note that your panel consists of leaders of labor and small
business and housing and farmers and utilities and the mayors of
our great cities, and that is a very impressive coalition.
I might point out that there are several other groups which
really ought to be included in your panel, and I am sure before
very long, they will be. One is American industry as such. Nothing
could be more destructive for the goal of investment in plant and
equipment, which everybody concedes is needed, than these murderously high interest rates. Also at your table should be American
exporters. The tremendously high interest rate policy of the Fed
and the administration means that the international dollar is inordinately high, and I am very much afraid that very shortly, if this
keeps up, those American industries which have been able to compete worldwide in the export field will find themselves priced out
of the market by a hyped-up, overvalued dollar. And that means
more losses of jobs and more misery for your industrial workers,
Mr. Samuel and Mr. Turner, and your farmers, Mr. Mullins.
Then there is still another group that in essence ought to be on
your panel, too. The great organizations that you represent—labor
and the farmers and the mayors and civic organizations, for example—have always taken what I think is a good world view, the view
of world brotherhood, that in our economic policy we have got to
look at what happens to our friends.
And it is significant that even though they were somewhat cowed
into obsequious silence yesterday at Ottawa, the leaders of Germany and France and Japan and Italy and Canada and all of the
other industrialized democracies are deeply upset at our wholly
unnecessary high interest rate policies. There are a few who do
speak out, and in that connection, I commend to you the New York
Times story of this morning, setting forth what Otto von Lumsdorf,
the German Minister of Economics, had to say at Ottawa.
He said—I'm quoting from this story—that "overloading monetary policy was driving interest rates in the United States and
Europe higher than needed." And he said "the United States was
conducting its monetary policy in too rigid and doctrinaire a way."
And he very clearly made the same point that you are making. So
that while you have got a marvelous pantheon of injured interests
at your table, I am suggesting that there are several others who
ought to be there, too.
Reference was made to the joint resolution, H. Con. Res. 160,
introduced earlier this week by Chairman St Germain and Chairman Fauntroy and myself, and shortly numerous others. In that
resolution, we suggest that there is a way out of the high interest
rate morass that we are in that doesn't involve turning on the
printing press and doing foolish things, that that way out consists
first, of the Federal Reserve not overdoing tight money. After all,
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last year's targets produced 20-percent interest rates. There's no
point in turning the screws even tighter, as Mr. Volcker and his
associates now threaten to do.
Second, the resolution points out that as long as you give out
huge tax bonanzas to people that don't need them, you are going to
have the Treasury driving up the price of money and further
adding to the misery, and that that isn't a necessary act of Government at all to make for future budget deficits.
And, finally, we make the point that has been made numerous
times this morning that monetary policy doesn't just involve dribbling out a supply of new money. It also involves attention to
demand. It is demand for new money which is produced by the
commodity speculators, the Bunker Hunts of this world, by the
corporate takeover artists, and by the foreign lending experts, that
drives up interest rates.
The Federal Reserve and the administration have all sorts of
existing powers by which they could dampen that demand, and
thus see that money available for farmers and small businessmen
and the housing industry and utilities and consumers and construction was available.
Other countries do it. Other countries are pointing the way. I
don't see why we can't. And it is good to have you here.
I haven't gotten around to asking my question yet, but let me
thus spend my 5 minutes in grateful appreciation of your testimony. My time has expired, Mr. Chairman.
The CHAIRMAN. Mr. Weber?
Mr. WEBER. Thank you, Mr. Chairman.
Gentlemen, the most important part of your presentation, to me,
is on page 13 where you say, "We will be working to frame solutions. We are all concerned about high interest rates." The problem, of course, is how do we get interest rates down in the best
way. I am extremely interested in the solutions that you men are
able to frame for us.
As I understand it, interest rates contain a time discount factor
and an inflation factor. If people are going to be paid back in cheap
dollars, then they're going to charge a premium as part of that
interest.
Do you believe that inflationary expectations will be raised or
lowered by yet another tightening of the money supply?
Mr. TURNER. In my opinion, there would not be as much inflation if we were to loosen up the money supply, particularly if we
were to allocate it to those areas which are most in need and which
are, I would say—have a greater right to lower interest rates. I
think that farming, I think that new types of utilities, I think a lot
of areas—housing, that sort of thing—I think they all require a lot
more attention and better credit rates in accordance with the 1969
act than, say, the money that might be required by a corporation to
take over another corporation.
Now that legislation is on the books. It simply is not being
implemented. As I mentioned in my earlier statement, it was implemented briefly in the Carter administration. Exactly why it was
dropped, I'm not clear. But I think in the whole approach of the
Fed, I think the fact that we don't have farmers on the Open
Market Committee, the fact that we don't have any businessmen
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on the committee except some bankers—I mean, by the banking
industry—is completely overweighting the Open Market Committee. And I think that the 14-year term that the members of the
Board have, I think that is entirely too long. I think the Chairman's tenure—the Chairman of the Fed—should be completely in
conformity with the term of the President, so that there would be,
perhaps, greater rapport. I think that generally it ought to be more
open in terms of what it is doing, and I think in terms of the
methods of selecting the Chairmen of the various Federal Reserve
banks that those boards ought to be opened up to more people.
It seems to me that so many times when bankers say, "Well"—
you know, it reminds me of putting the fox in charge of the
henhouse—when bankers with a great air of unctuousness say,
"Well, unfortunately we have to raise interest rates again", as the
thing goes in the beginning, it's not a bad game for the bankers,
but as time goes by the whole economy gets out of kilter, and they
find that they are not in such good shape.
Mr. WEBER. But I want to get back to the problem of expanding
the money supply, which we would all love to do if that was going
to cure the situation. But every time in the past when we have
expanded the money supply, we have had inflation increase, resulting in higher interest rates. Last week M1B grew by $6.9 billion;
short-term interest rates increased on Monday and the stock
market fell.
Given those kinds of facts, how is faster growth of the money
supply going to help to bring down interest rates?
Mr. SAMUEL. Congressman, if I may respond to that, if I can, we
are not here to suggest that the money supply be expanded, certainly in a major way. I'm not here either to defend the particular
level which the Chairman of the Federal Reserve Board discussed
yesterday. But I'm not sure that is really what the key issue is.
Interest rates can be dealt with in a way apart somewhat from
the money supply. We're suggesting that the allocation of credit
can make a major contribution to reducing the level of interest for
those areas that need it.
Let me point out to you, we are all being subject now to the very
unedifying spectacle, the spectacle which I think is of absolutely no
benefit to any possible area of our country, of some major corporations in a rather grotesque competition for credit in order to buy
Conoco. I have no idea what possible benefit, as I say, this is giving
to any of us—Dupont and Mobil and the rest of them forcing up
the price of interest rates so that we don't have enough credit for
utilities, for farms, for construction, for the purchase of automobiles, but instead, so that one company can gobble up another. It
doesn't help productivity; it doesn't help inflation; it doesn't help
the United States.
But until we do something about the allocation of credit, which is
the real answer, not the money supply, you're not going to be able
to cure it.
Mr. WEBER. Thank you. My time has expired.
The CHAIRMAN. Mr Gonzalez?
Mr. GONZALEZ. Thank you, Mr. Chairman.
Yesterday, Mr. Volcker in his statement again went back to this
old litany about the fact that labor, most labor was responsible for
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the high cost factors, and he said so specifically on page 3 of his
testimony. And I guess that was what kind of made me irk more
than anything else, because he went back to the same old thing,
and that is the corporate blames the victim. And it's just that I
have, through 28 years, watched this—the argument that is advanced, Very seldom have I seen it very positively rebutted officially.
Now, especially Mr Turner, I would like to know what, if anything, in the way of studies, other than at one time when we had
hearings on housing, has been conducted. Naturally, labor is a
factor, but the insinuation is that it is a disproportionate factor
because it is unrestrained in its wage demands and has been,
according to Mr. Volcker's testimony.
Is that the record actually?
Mr. TURNER. The record is just the opposite, Mr. Congressman.
All through the 1970's, I don't know of an economist who is worth
his salt who has said that this was a wage-push inflation. The
wages have followed the price increases. They have lagged behind
the price increases right along. And, certainly, it is true today, it
has been true for the last 10 years, and as a matter of fact in the
area of housing, whereas you go back to, say, 1949, my recollection
is that the cost of labor at that time might have been running in
the maybe 20, 25, 28 percent—something like that. Today it is
down to 17 percent. That is the cost of onsite labor.
Now some of that is due to work that has been done, putting the
elements together before they arrive on the job, prefab and so
forth. But still there has been a tremendous drop.
There have been any number of studies made on this, and I'll be
happy to have some copies sent over to you for your to peruse.
Mr. GONZALEZ. I would be most grateful to you, because there is
a lot of linkage here. You have the Bacon-Davis issue pending and
which, of course, I might point out that critically—and I don't
mean to be embarrassing or anything, and it is certainly not personal, any more than I meant it to be yesterday with the Chairman
of the Board, because it is really not a one-man corporate thing.
Mr. TURNER. I thought you were very good with him.
Mr. GONZALEZ. Well, I did restrain myself. [Laughter.]
I must say that really sincerely. But you know, it was the hardhats, the industrial construction unions, that went for Mr. Reagan.
I am very intrigued by the approach Mr. Reagan has taken to his
commitment with respect to Bacon-Davis in which he really returns to the Nixon dictum: "Don't listen to what we say; just watch
what we do." And what he is doing is saying, "Well, we're not
going to fight the congressional attempts to do away with BaconDavis; we will just remain neutral there. But in the meanwhile, we
will give positive instructions through the administrative branch
for rules and regulations through the Labor Department that in
effect will vitiate Bacon-Davis." So there is a linkage there. There
is a linkage between productivity, as Mr. Volcker was bringing out
and did bring out in his statement yesterday.
Now everything that I see and read in the international financial
journals—for instance, the reports from Germany, France, England—especially England with your Thatcher Toryism which is
converted into Reaganomics Toryism in this country, because what
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we have is not conservatism, it is Toryism—and they show that
their productivity is not as high as the American labor productivity. Their restrictive economic policies in England and in some of
those adopted previously in Germany did not address themselves
nor did they even partially solve the problem which we are confronted with, the worldwide problem. And it just seems to me that,
given those facts, we in the Congress have been derelict in not
confronting an administration that is basing its headstrong course
of action, undeviatingly, on policies that actually are being proven
to us as not working—in fact, so counterproductive that such a
great nation as England is facing civil rights crises, social crises,
and labor crises. And in England, labor was blamed for the reaction that give us Thatcherism.
Mr. Turner, I can understand everything but labor having supported Mr. Reagan. It seems to me, now, that we ought to get some
real good, straightforward answers on all of these three levels:
productivity, Bacon-Davis, and inordinate wage demands by labor.
Mr. TURNER. Well, I meant—No. 3 I talked about before, in
regard to the monetary policy. What is happening here, of course,
is that—going back to those great dynamos of economic action, Mr.
Hoover and Mr. Coolidge. And of course, they are saying the "invisible hand," as defined by Mr. Adam Smith, is going to take care
of everything; and if we put enough money in the hands of the
rich, they will invest it in the appropriate places, so that jobs will
be developed and the economy will work, et cetera, et cetera. But if
we don't do that, why things are going to continue as they are.
Now, the whole history of the United States, going back to at
least the advent of FDR, has been that we had to look at the
demand side of economics. The consumption of a low- and moderate-income laborer is so much greater than that of a higher income
laborer that he will spend almost 100 percent of his money.
Based upon that, the Wagner Act was passed—the right to organize. The Unemployment Compensation Act was passed. Social
security was passed. And of course, they came along with another
part of Lord Keynes' theory, which was that we had to prime the
pumps; so we had the PWA and the WPA, which I remember very
well.
And of course, coming up into the 1950's and 1960's, we had
medicare, we had medicaid, we had all of these things which were
intended to try to take care of the problem of demand. And Mr.
Reagan comes along with a completely opposite philosophy, skipping back 50 years of history, and saying, "Now we're going to go
back to Coolidge and Hoover, and all we're going to do is, we're
going to make sure that the dough gets in the hands of the rich,"
and everybody else will get by on a trickle-down theory.
In a few simple words, that is exactly what is trying to be foisted
on the American people. The American labor movement, with very
few exceptions, fought extremely hard against Mr. Reagan's election. We felt that his economics were wrong, his views were wrong,
even though he kept reminding everybody that he is a former
president of a union, et cetera, et cetera.
On the matter of Davis-Bacon, he promised that he was not going
to repeal Davis-Bacon. I don't know yet that that promise has been
broken. I have seen no real evidence that it has, but there is this
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effort being made to change the regulations. Now, I think the
regulations are very dangerous, very crippling. I mean, if you take
away the regulations or the enforcement of the law, you might as
well not have the law. I mean, that is the kind of shell game that
is involved.
But, I certainly can't accept the idea that labor per se has
supported Mr. Reagan. I have checked out, with some of our local
unions down in Texas, particularly in the Texas City area, and I
find that whereas in the highly organized areas—it may have been
the same thing around San Antonio; I don't know—but we found
that working people in those unionized areas voted like 58 percent
for President Carter and voted perhaps 74 or 73 percent for other
Democratic candidates.
Mr. GONZALEZ. I guess I was referring mostly to the New York
area where, I believe, during the campaign there were some reports about the hard hats supporting Reagan.
In my area, let me point out San Antonio is an anti-labor area.
We have minimal organized labor presence. I have been about the
only political office-holder upholding the right of unionism, even
though I myself—I have never been a member of a union.
Now, when you speak of Texas City, you're talking about the
Golden Crescent, where you have the heaviest presence of organized labor in Texas, the southeast part, the Jack Brooks area. But
we must never forget that in Texas, out of a work force of some 4
million or more, you don't have 350,000 card-carrying union members. Nevertheless, though, I feel that being a faithful witness to
history would make us realize that the free trade union movement
has been an indispensable factor in what is being challenged now
and eroded, which is our American way or American standard of
living. It is inextricable.
I see it under direct attack here, with very little defense. And
this is the reason I am very concerned. Because we see involved in
this is the wholesale, massive transfer of wealth. This is the first
attempt—and it is succeeding thus far, a massive transfer of
wealth from the poorest element and the working element to the
most affluent.
Not only a reversal to Coolidge, which is what it is—it isn't even
to Hoover, according to Stockman. Stockman says he doesn't believe the Government has any responsibility. Well, that was a
Calvin Coolidge doctrine, not Hoover. Hoover at least appointed
study commissions, recognizing there was a responsibility.
But certainly, we can't stand here supinely, and watch this
wholesale transfer, the whole reversal of the American process—
which is mass production based upon mass consumption, supply,
and demand.
But, I want to thank you very much, and I will appreciate
getting these statistics.
Mr. TURNER. I will get them. Thank you.
The CHAIRMAN. Mr. McCollum?
Mr. MCCOLLUM. Mr. Turner, don't you think that the creation of
more and more dollars, the printing press creation of dollars, actually is the primary source of inflation?
Mr. TURNER. Well, I don't think so. I think there are a lot of
factors. It is a very complex kind of phenomenon. But, I certainly
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believe that high interest rates are a cause, and not a cure, of
inflation. I do believe that it can—when you tighten up credit too
much, that it—by means of using the interest rates, why you
tighten up and you cause more inflation.
I think if we could allocate credit in accordance, as I say, with
the 1969 act, we could do a lot better. If we could have an open
market committee that was more representative of the American
people, instead of just representing the bankers, I think we could
get a better result, in terms of their policies on the interest rates.
Mr. MCCOLLUM. Mr. Stafford, one of the primary measures of
inflation is the rise in prices, in one form or another. In order to
control inflation, we're going to have to control prices, in some
form or another, it seems to me, however you consider the source
of the problem.
There is a reasoning in the statement that was given jointly—
including, I assume, yourself—that only a major recession would
cause prices to come down, and the social and economic cost would
be traumatic.
I am curious as to what basis there is for that statement, in your
judgment.
And if there is an alternative to that, to bring prices under
control, what would you suggest that we do?
Mr. STAFFORD. I am on the panel, as one of the people who—it's
like going to a doctor when you're in pain and you're sick. And the
doctor says, "How would you cure your illness?"
I'm not sure. I don't know whether, in fact, we would have to go
through a major recession to, in fact, control prices. I mean, I
believe that—personally, that the Conference of Mayors—in fact,
one of the major contributors to inflation in this country is energy,
and that resource pricing which is beyond even the control of this
country.
And therefore, those measures which we can take—and we are
taking in the city of Seattle—in terms of we control our own public
utilities—so we are doing various kinds of programs with homeowners, to weatherize homes. We are doing things in city hall, in
terms of weatherization, changing our fleet, anything that we can,
in terms to cut down on the amount of energy that the city and the
citizens of our city use, and therefore the investments that we have
to make in utilities.
I am not sure whether we as a country have to go through a
major recession, and that unemployment and the personal disruption in people's lives that that would create. I guess, going back a
long time ago to my economics class, that would be the theory of
things—that if you got enough people on the street, prices would
fall, whether in fact—and prices—people's labor, I suppose, the
prices of people's products. That doesn't seem to be the case any
more in our society, that we go through high unemployment.
The State of Washington's unemployment now is 9 percent—over
9 percent. A lot of that is the lumber products industry, which is
tied to the housing market. How will we get housing back up
again, to get the work products back up again, to get employment
back up?
Mr. MCCOLLUM. YOU know, the Federal Government goes out
and borrows a lot of money to spend for deficit financing and pays
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high interest rates on it, which are part of the interest rates you
discuss in the statement. In essence, then, the Federal Reserve
comes out and historically, under Keynesian concept, creates dollars and increases the money supply, in order to replace those the
Federal Government has taken away from the private market
system.
It seems to me that this is a primary force in causing inflation,
and that by controlling deficit spending and by stopping some of
the creation of these dollars, we could get some degree or some
measure of control on it.
Is that a factor in your thinking, or do you disagree with that
premise?
Mr. STAFFORD. I think that the Federal Government—my personal feeling is that—on the part of the Conference of Mayors—is that
the deficit spending of the Federal Government has been a contributing factor to the inflation of this country.
I have sat through a couple of panels where people have argued
that the inflation rate is—1 percent, 2 percent, 3 percent of it
comes from the deficit in the Federal budget. I think the mayors of
this country are in the process, whether they like it or not—and
the cities are going through a substantial pain—of adjusting to
very major domestic spending cuts, and taking a large share of the
grief, in attempting to balance the Federal budget, to in fact—to
cut down on that share.
I guess my own feeling is that—and this is probably a bit biased,
being a supply officer in the Army for 2 years—that the Defense
Department might take a bit more of the cut themselves. And I
would be willing to give up my tax break, whatever that will be,
for the next 2 years, so that if, in fact, a balanced budget was the
objective of this Government—and, in fact, I think we all agree
that inflation is a major problem in our society and in our cities—
that in fact we go out and solve it this year, and do it, and
moderate the defense increase. And I will be willing to give up my
tax cut.
I think our city will take a lot of pain, in terms of implementing
the cuts that are coming in domestic aid. And let's get it over with
and do it. I'm not quite sure that is the real objective of everything
that is going on.
Mr. MCCOLLUM. Thank you.
Mr. COAN. Mr. McCollum, could I respond to that?
Mr. MCCOLLUM. Yes.
Mr. COAN. If you have
the Government taking too much money
out of the economy, and then replacing it with dollars that chase
goods that are not available yet, you have inflation. We certainly
don't have that now.
High interest rates are restraining the ability of the housing
area to meet the demand that is there. To say that we are creating
printing-press money is, I think, a simplistic approach to the
matter. We're talking about interest rates. Inflation is a composite
of many things; and probably the most severe part of it has been in
energy and food prices—food prices now have moderated.
We are not printing money and giving people money that they
can't find things to spend it on, and therefore driving up the price
of everything. Our industrial plants are not at a capacity where we
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can't meet the demands of the people. We are not enabling that
capacity to function. That is very true in the housing area and in
many other areas. Our plant capacity is underused in this country.
Our need for housing—which can be built—is not being met. We
are not chasing after things that are not there.
Mr. MCCOLLUM. Thank you.
The CHAIRMAN. Mr. Annunzio?
Mr. ANNUNZIO. Thank you, Mr. Chairman.
I know you have another meeting scheduled for 11:30 a.m. I want
to congratulate and commend Mr. Turner and the panel for their
views this morning.
I echoed some of those views yesterday, when Mr. Volcker was
here. After Mr. Gonzalez got through with him, I asked Mr.
Volcker why he never explained—on page 3 of his testimony, he
talked about wages, which was really a ploy. He never criticized
the line of credit of $30-some-odd-billions that has been established
for large corporations. But he continually criticizes any time there
is a wage increase. Anybody who has had any experience in a labor
union knows that wages follow prices; as prices go up, union leaders go in and negotiate for an increase in wages. But the wages
never catch up to prices.
On the other hand, I would like to say to the panel that this is
not a simple problem. You just can't say, "Let's get the housing
industry started." I've introduced legislation that is called a savings certificate. My bill has more in it than the All Savers Act that
is coming out of the Ways and Means Committee.
I can remember back in 1968, when Mr. Patman almost had an
epileptic fit when the discount rate went from 4 to 4.5 percent.
What are you going to do with your own members? You tell me
about housing. The minute the money market funds got going, they
are paying 15 and 16 percent. Everybody took their money out of
commercial banks, thrift institutions—$40 billion, $100 billion went
over to the money market funds; and they're not insured.
There isn't a Congressman on this panel who will tell you that
he got less than 1,000 letters not to touch money market funds.
What are you going to tell the union member who comes to you
and complains about 12 and 14 percent interest and who also says,
"But don't touch my interest that I am earning now. I want that 17
percent."
You see, this is another problem we have. You've got that. How
do you educate the people? How do you get interest rates down
when the national debt is $914 billion; and the interest alone is $65
billion. If I were one of these international bankers, I wouldn't
want the national debt to come down. The $65 billion a year is a
fixed revenue.
We are coming out with a tax bill. Everybody is going along with
it. We all know it is absolutely wrong to decrease taxes at this
time. There should be a surplus, so you could reduce the national
debt. Everybody knows that the Government is in the money
market, competing with private industry, bidding up the interest
rates for money. We all know that.
Chrysler comes in here for a loan, and we have to look at the
balance sheet and see what the assets are, like we did with Lockheed, to make sure we don't lose any money. We could never lose
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any money on Lockheed, because their assets were greater than
the $750 million that this Government guaranteed on the loan, you
see.
The point that I make to you is that our Government has trillions and trillions of dollars of assets. Somebody better come up
with a new idea. We have got to figure out the assets that we don't
need in the national interest, and we have got to sell them. We
have got to sell these assets, just like a corporation, so that you can
bring down that debt of $914 billion.
If you reduce it to $500 billion, it will cut the fixed indebtedness
of the Government that the international bankers and people invested in the Government have.
These are things we have got to start thinking about. We can't
go along year after year, because we are going to run into a stone
wall. Already are running into that wall. You can't go year after
year with the same old tax bills. We have got to have a tax bill like
they have in other countries of the world.
We need a tax bill where everybody pays a flat rate, across the
board. All of these gimmicks to put people in jail—who is going to
jail? The poor guy. Capital gains, no capital gains, taxes on interest
earned, double taxation, triple taxation, real estate taxes, you can
go on and on and on. You don't need all of this hocus pocus. They
have got a tax bill, that Ways and Means Committee, that benefits
two people: lawyers and the people who make out the taxes, the
accountants; that is all. They are going to make a fortune.
Who writes the tax bills? Lawyers and accountants. This is what
we are up against unless we reduce what we owe, unless we can
make up our minds that we just can't take a tax cut. We have got
to be true to ourselves. We must educate our membership. You
holler when you pay 12 percent interest on a car loan, but when
you invest your money, you want 17 percent. So that's your problem and my problem.
I thank you very much for your testimony this morning.
The CHAIRMAN. Mr. Wortley?
Mr. WORTLEY. Thank you, Mr. Chairman.
Gentlemen, I have listened to you tell us what is causing inflation. But I wonder if you can tell us what organized labor's program is to control inflation?
Mr. TURNER. We feel that—first of all, we have felt for a long
time that the tremendous increase in energy costs has been the
most important factor in the growth of inflation. We have advocated that the Government set up a corporation which would purchase all foreign oil, and would thereby, we hope, try to cut down
some of the problems that exist there. We think we can probably
work out a better rate along those lines.
Mr. WORTLEY. YOU think the Government could purchase oil
cheaper?
Mr. TURNER. We think a corporation that* would be set up to buy
all foreign oil and reallocate it to the different companies which
wanted to buy it—but it would be done through a government
corporation—we believe it might be a way of trying to reduce some
of the impact of OPEC on the market.
We also believe that in terms of hospital costs, health costs, that
we need to concentrate on ways and means of trying to contain the
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increases that we are getting in hospital costs and health costs. We
certainly believe that in regard to interest rates—that interest, as I
said—one of the greatest economists in America, Leon Koslick
[phonetic], says that we ought to have at least a 4 percent increase
in the money supply, growth rate in the money supply each year,
and higher than that to achieve, in that year, an annual growth
rate
Ms. OAKAR [presiding]. Mr. Turner, would you yield for just a
moment? Your Congress Member, Jack Brooks from Beaumont,
Tex., wanted to just drop in to say hello. And I think it's only
appropriate.
Mr. TURNER. That's my hometown. I'm glad to see Jack Brooks.
Ms. OAKAR. I'm sorry to interrupt you.
Mr. TURNER. But Mr. Koslick says that 4 percent in any year is
required to achieve an annual growth rate of the real GNP from
not less than 4 percent.
I would subscribe to what he says. I think that we have a growth
rate of about 2.5. The trouble with this whole program of the
Federal Reserve is it is great for some industry and some people,
but it is terrible for the kind of groups that are represented here at
this table this morning. It is terrible for local governments, it is
disastrous for housing, the construction industry.
I represent a union of 425,000 members: 16 percent of them are
out of work today, which is a very high percentage of people who
are out of work.
I believe that if money could be available to move ahead with the
numerous construction projects that are needed, if we had interest
rates in some reasonable area, these projects could go forward.
There is a tremendous amount of work that is on the shelf that
can't move forward.
Mr. WORTLEY. But if we limit the growth of the money supplies,
isn't that going to force the interest rates up?
Mr. TURNER. I believe that the present level of 2.5, as I recall it,
is limiting the money supply too much, yes. I believe that if we
were to get up to 4 percent, as is advocated by Koslick, I believe
this would make money—more money available to do the things
that need to be done. But the money needs to be allocated in terms
of what is needful, what is appropriate for the economy, as is
contained in the 1969 act, which could be applied.
I think these are some of the things that could be done to fight
inflation.
Mr. WORTLEY. Yesterday Mr. Volcker suggested some wage restraints. In fact, I think he alluded to the fact there is a 4.8-percent
cost-of-living adjustment for Federal employees. Would organized
labor agree to something like that?
Mr. TURNER. I don't know what his proposal was in regard to
government employees. I would say this, that 4 or 5 years ago—I
guess it was 1975 or 1976, the AFL-CIO passed a resolution. It
must have been 1978. The AFL-CIO Executive Council, of which
I'm a part, passed a resolution in which—which we sent over to
President Carter, in which we advocated the application of controls
across the board.
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Speaking for myself personally, I would go for that, but include
rents, dividends, profits, et cetera, et cetera. I don't think just
wages ought to be controlled. It ought to be across the board.
Mr. WORTLEY. You are urging wage and price and rent controls?
Mr. TURNER. Wages, prices, profits, everything. If we're going to
have controls, let's have it across the board.
We passed that kind of a resolution. It didn't get anywhere with
Carter.
Mr. WORTLEY. I would like pursue the dialog with you, but my
time has expired.
Thank you.
Ms. OAKAR. Thank you.
Mr. Lowry.
Mr. LOWRY. Thank you, Madam Chairman.
I'm glad that my friend, Bill Stafford from Seattle, spoke. He is
the first person I have heard on the panel voluntarily bring up the
defense budget and the attacks decrease. I don't know how we're
going to get a handle on the capital needs in this country for
housing and energy and everything else when we spend $1.6 trillion in the next 6 years on defense.
The defense increase is $34 billion next year over this year. It is
a $150 billion increase 3 years from now, over this year's spending.
People come before this Congress to talk about these very costly
capital needs, but if we're just going to have blinders on defense
spending, I just don't see how we ever are going to get to where we
can help.
We have an opportunity, before we leave this August, though, to
do something about interest rates.
I would like to ask any member of the panel: What do you think
the effect on the financial market and the interest rates would be
if we passed an amendment to the tax bills that are coming before
us that said defer tax cuts and defer perhaps, other tax cuts, until
the budget is balanced? If we did that, what do you believe the
effect on the interest rates and financial markets would be?
Mr. MULLINS. Well, I would assume, if you deferred those and
brought the budget into balance, that it would definitely impact
with lower interest rates. It would have to.
You would get, No. 1, one of your biggest borrowers out of the
money market, the Federal Government. You would release funds
into the private sector that could be applied to the housing industry, the construction industry, agriculture—put that money to
work in places where it is productive and not in deadend spending,
like the Defense Department.
Mr. LOWRY. Thank you.
Mr. Fry, what do you believe the effect of that vote, before we
left here, on the tax bill would be?
Mr. FRY. Well, I think it is indisputable. The accomplishment of
a balanced budget would reduce the competition for funds in the
money market and lower everyone else's interest rates. I think that
is clear.
Mr. LOWRY. Mr. Turner.
Mr. TURNER. Well, first of all, I believe that the increase in the
defense budget ought to be along the lines of perhaps 3 percent
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real increase, which is what we have asked our allies to do in
Western Europe.
I think the request of the President is far beyond the 3 percent,
and so I would want to limit to that. I have no need for a tax cut. I
would not object to some writeoffs or favorable tax treatment in
terms of the new plant and equipment, which I think is probably
needed, which—it has been adopted much more in Western Europe
than it has been here.
Mr. LOWRY. Mr. Samuel.
Mr. SAMUEL. I would support that.
Mr. LOWRY. Mr. Coan.
Mr. COAN. That is an interesting concept. I don't know whether
it is a realistic one to consider. I agree that there is no sense in
cutting taxes if the result of those tax cuts is either an expanded
deficit or the elimination or gutting of necessary Federal programs
to help those who are not able to help themselves.
However, if by doing so we can achieve the preservation of a
reasonable level of necessary housing and other programs, then
forgo the tax cut.
Mr. LOWRY. If there were to be a vote by this Congress that
defers the tax cut in general, maybe with a few investment incentives still being possible, until we have a balanced budget—what do
you think the effect would be on the interest rates?
Mr. COAN. I suspect it would tend to bring them down. I would
wonder what Mr. Volcker and the Federal Reserve would do about
the money supply, though. We have no assurance that such an
action is necessarily going to convince them to loosen up the money
supply, given their approach and view that the basic issue is how
much money is out there.
Certainly if the Federal Government reduces its demand, that
leaves a little bit more. But what are we talking about? $20, $30,
$50 billion out of hundreds of billions of dollars? I mean, we're
talking about a relatively small percentage of the total, are we not?
Mr. LOWRY. Well, we're talking about $50 billion right now,
which is approaching a third of the amount of money available to
be loaned.
Mr. Stafford.
Mr. STAFFORD. Well, we would certainly find out if a balanced
Federal budget would solve the inflation rate. We might find out
that, in fact, there are other factors in this society which are
causing inflation. And I think then we would convince 90 percent
of the American people that, in fact, the unbalanced budget is the
primary, if not the the only, cause of inflation.
I think we might find out next year we still have inflation and a
balanced budget. And I think we would really be in trouble.
Mr. LOWRY. Of course, my question was interest rates. My question was, what is the effect on interest rates, not inflation.
Ms. OAKAR. Mr. J. Coyne.
Mr. J. COYNE. Thank you very much.
I would like to focus, if I may, on a question that has been raised
about your feeling that we should be allocating credit. I suppose I
should be very flattered. It seems that many of you gentlemen
think that we here are the ones best qualified to make the decisions of allocating the credit. Apparently you feel that the freedom
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of the American marketplace has made these decisions unwisely. It
seems to me that we have had a 200-year history in this country of
the American voter, the American investor and saver making these
decisions about the allocating of credit. And you would prefer to
replace this freedom of the American with, I suppose, the political
wisdom of the assembled panel here.
I suspect you are pleased with the way Congress allocated credit
to Lockheed and Chrysler. And I am curious whether you think
that the political wisdom of Congress would always make allocation
decisions wisely? What is it in your mind that makes the American
Congress and our political motivations better suited to allocate
credit than the free decisions of the American voter, the American
consumer, buyer, saver, and investor?
I'm especially concerned, about what might happen after this
Government-allocated system is in place. Let's say that Mr. Turner
would like to get money for the construction of nuclear powerplants, and he goes to his bank and he is told that the American
Congress has reached the political decision that credit should not
be allocated to nuclear powerplants; or that Mr. Samuel goes into
his bank and finds that the American Congress has decided that
credit should not be allocated for the construction of new housing
in cities that have rent control; or that Mr. Stafford goes to American Congress and finds out that they have decided, in their political wisdom, to allocate credit to the hard-hit Northeast and not to
the prosperous Northwest. Would all then feel equally that the
wisdom of Congress is sufficient to make these decisions?
Mr. TURNER. There seems to have been some misunderstanding,
Mr. Congressman. My position was that the 1969 act which was
passed by the Congress provides that the Federal Reserve Board,
with the approval of the President, either initiated by him or by
the Board, has the authority to allocate credit, to put restraints in
certain areas and not in others. In fact, they did utilize that power
in March of 1980 under Carter. And the interest rate dropped down
from almost 20, down to about 11 or 12.
Mr. J. COYNE. I wasn't asking for a discussion of that act. I was
asking for a discussion of the wisdom.
Mr. TURNER. I do not believe that the Congress of the United
States ought to perform that duty. I believe that the Federal Reserve Board should do it in accordance with the law.
Mr. J. COYNE. The Federal Reserve is somehow more intelligent
or wise or capable to make these credit allocation decisions than
the American people themselves. If the Fed told you that, "No,
we're going to respond to the overwhelming pressures upon us not
to allocate credit to the construction of new water projects or new
nuclear powerplants." Would you accept that decision?
Mr. TURNER. I feel, sir, that the present application of the law
divides the Nation. It is great for big corporations. It is great for a
lot of organizations. It is hell for the construction industry, for the
housing industry, for municipalities, for States, for people that
have to get money. It is killing the nuclear industry. We are trying
to become independent, in terms of energy, of the Middle East. But
we can't become independent unless we develop our own nuclear
power, our own power, and exploit our other areas.
And let me finish answering your question.
383
And so, Mr. Chairman, as far as I am concerned, I believe that
the Federal Reserve Board would be—as an expert, in accordance
with the law that is passed, would be appropriate to do this. I don't
think the Congress—it is at all feasible for them to do it. And I
don't see how it could be done.
My good friend here wants to add a few words.
Mr. SAMUEL. I would just like to comment, Congressman. I think
any Member of Congress who thinks that the people now have the
free choice of credit—probably also believes in the tooth fairy. The
fact is that we don't have the free choice of adequate credit.
My son would like to buy a house right now but can't afford the
mortgage payments. Why is that? Because the real choices are
being made by giant corporations and conglomerates who are busy
gobbling each other up. They are bidding up the price of credit to
the point where the average worker, the average consumer cannot
afford it. That is where the choice is being made.
Are you telling me that the conglomerates are better able to
make that kind of decision than the elected representatives in our
democratic society? I think our democratic society has worked
pretty well over the last 200 years. I'm not afraid of giving our
leaders, who can be elected or dis-elected if we don't like what they
are doing, to make that choice—better than the conglomerates,
who are elected by nobody.
Mr. J. COYNE. I just heard two completely different positions.
Your colleague to your left says let the Federal Reserve, which you
know is not elected, make these decisions. And you're saying, Don't
let the Congress make the decision.
Mr. SAMUEL. You're talking about administrative arrangements,
Congressman. I think the act already indicates areas in which
credit can be directed. And I think Congress can do that. I think
the specific day-to-day decisions obviously will be made by
Mr. J. COYNE. I wanted to clarify the allocation of credit to our
private sectors—not made by collection of 19 or 10 or 15 corporate
executives. It is made by probably the most diverse set of financial
institutions in the world, which includes tens of thousands of corporations, stockholders, investors, savings institutions, and what have
you. And I appreciate your paranoia of a conspiracy theory, but I
would be far more afraid of 10 or 15 Federal Reserve Commissioners than I would of the diversity of the American financial institutions.
Mr. COAN. Mr. J. Coyne, we have credit allocation now by the
Federal Reserve. It is credit allocation by the decisions they make
on the money supply. It is an allocation by price.
Is this society of ours one in which the benefits go only to those
who pay the highest price? If that is so, then I don't think we
should have any government whatsoever. We have allocation now;
it is a price allocation.
Mr. J. COYNE. I would love to answer your question. I have to get
leave from the Chairlady to do it. My time has expired.
Ms. OAKAR. YOU can respond, in about 30 seconds.
Mr. J. COYNE. In no way do I support the allocation of credit by
the Federal Reserve as they currently exist. Of course, Congress, in
its wisdom, responding to the request of many of the savings institutions, demanded that the Fed be given that authority. That au-
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thority was wrong. We are beginning to pay the price for that
artificial constraint of free market forces in a competitive marketplace.
Mr. COAN. And then you would do away with the Federal Reserve?
Mr. J. COYNE. I would certainly not do away with the Federal
Reserve, but I would suggest that their artificial controls, telling
people that they are only allowed to earn 5 percent on their passbook savings account, telling them that they are only going to get
70 percent of the Treasury bill rate, is a very, very artificial restraint. We should give the true American marketplace the right to
determine those rates. That would be far more effective than
trying to give the Federal Reserve or elected politicians such authority.
Mr. COAN. Well, I would say, unless the Federal Reserve has
some function, then it should be done away with. And that function it is exercising right now—and what we're saying is that it is
exercising that function in a fashion that hurts, unjustly and disproportionately, important segments of this economy—housing,
small business, agriculture, the ability of communities to build
their infrastructure.
Ms. OAKAR. I'm going to have to interrupt.
Mr. Frank.
Mr. FRANK. Thank you, Madam Chairman.
I'm not sure if I should address my questions to my colleague or
the panel, so I will try the panel.
I apologize for missing the initial presentation. I did get a chance
to read the statement. There has been a lot of emphasis on the
Federal Reserve's decision to make the money supply very tight
and some question about whether they have that much
independence.
The Congress is not, on the whole, participating in that decision
to tighten, but it does seem, in fairness to Mr. Volcker, that the
responsibility for that decision ought to be shared.
My understanding—and I would like your comments on it—is
that, in fact, the Federal Reserve was under pressure from the
administration earlier this year because it wasn't being tight
enough, that Mr. Sprinkle was, in fact, beating Mr. Volcker over
the head fairly regularly, until some kind of a peace treaty was
worked out.
We heard Mr. Volcker yesterday. The logic of his testimony, the
thrust of his testimony was, in fact, to argue against at least a
third round of tax cuts and perhaps more.
In answer to what somebody raised before, Mr. Volcker made it
very clear, after a lot of work, that that third round of tax cuts in
particular locked in, without any commensurate ability to cut
spending in that way in advance, and it would have upward pressure on the interest rates. And my sense is that there has been sort
of accommodation between the Fed and Mr. Volcker. Mr. Sprinkle
won't criticize Mr. Volcker's monetary policy, and Mr. Volcker
won't criticize Mr. Reagan's tax policy. But I think we ought to
understand that this proposal to tighten the money supply and
that the excessively high interest rates we now have is not really
385
wholly the Fed's decision. It was—wasn't there an awful lot of
Reagan administration pressure to reach, in fact, that goal?
Mr. TURNER. It was a decision made by Mr. Volcker before
Reagan came in as a matter of fact. Some 4 weeks after Mr.
Volcker had taken office, I was speaking to a high administration
member of the Carter administration, and I said, "What has happened here?" And he said, "Well, Volcker is out of control; he's out
of control." Actually the Federal Reserve, as we said—as I said, at
least, in my earlier statement here, I think is entirely too independent of the Congress, too independent of the executive. And
anyone who is charged with the responsibility of trying to have a
full-employment economy needs to have control over their monetary policy as well as their fiscal policy, which you don't have.
Mr. FRANK. I understand that was the general direction, Mr.
Turner, and I guess it is one of many commentaries on the Carter
administration, that 4 weeks after making that major appointment,
they were professing total lack of responsibility or accountability.
But it is true, wasn't it, that during this year, the Reagan administration, to the extent that it was pressuring the Federal Reserve,
was pressuring them to tighten up on the money supply?
Mr. TURNER. Yes, that is correct. But they are appointed for 14
years, and the pressures of the President sometimes don't work
very well. There have been a number of cases where, beginning
about 1953, where there has been disagreement and conflict between the President of the United States as well as the Congress
and the Chairman of the Federal Reserve. Normally, the Federal
Reserve Chairman seems to be able to dominate the Board.
Mr. FRANK. I don't think there's any question about that.
With regard to what we are getting nojv, I would just like to
follow up a little bit on what Mr. Lowry was asking. The Reagan
administration does seem committed—and let's focus in part on
them, because they're going to have the decisions—to the extent
that we're going to get any anti-inflationary policies, to the extent
we're going to get restraint in trying to wring some of the inflation
out of the economy in the next couple of years, as I look at the
proposals for spending—some social cuts, but also some defense
increases and with really very large tax cuts—it looks as if, to the
extent there is anti-inflationary policy at all in the next 2 or 3
years, it is going to be monetary policy.
What is the effect likely to be on various sectors you represent of
an almost total reliance on monetary policy? In fact, as we look at
what's going to be going on with the budget, it is going to be a
reliance on monetary policy to offset what looks to almost everybody to be somewhat stimulative fiscal policy. What do you think
the impact is going to be on the sectors you represent?
Mr. TURNER. The sectors we represent are going to be adversely
affected, and I think that is why we are here—because we in
particular, whether it is the intent or not, people who need a lot of
credit are the ones who are hurt the most by this policy. And of
course there are so many industries like, as we've talked about, the
auto industry, we talked about construction, we talked about housing, we talked about farmers, we talked about municipalities,
States, et cetera—it isn't only the cost of the loan, but it is the
carrying of the loan. It is just like with the Federal Government—
386
$85, $96 billion, whatever it is, for the cost of interest on the
Federal debt.
Mr. FRANK. If I could interrupt, I really would like to ask everybody to respond to this. The independence of the Federal Reserve
Board is a fact, at least, for the foreseeable future. The question is,
as you said, Congress has a choice, the Fed having made it clear
that they're going to keep the money supply tight and interest
rates consequently quite high, as long as that deficit persists and in
fact grows in some ways—Mr. Volcker made that clear—would you
propose some effort to change that tradeoff over the next few
years?
It looks as if, as I said, we're going to be told it's going to be all
monetary restraint over the next few years, and the only way we're
going to be able to effectively lessen that is by some moderation of
the fiscal crunch which seems to me to be some lowering of the
proposed tax cuts and some reduction in defense spending.
I would like all of your opinions on that tradeoff.
Mr. COAN. I would endorse lowering the tax cut and reducing
defense spending.
Mr. STAFFORD. I would do the same. Also, I think, as representatives of the public, if we go with the free-market approach to credit
allocation, if you continue as you have in the past, agencies like
EDA in the Department of Energy and so forth to have credit and
SBA to have credit allocation tools for those high-risk parts of our
society where the public and local governments need help.
Mr. FRY. Speaking only as a private individual, I would endorse
both of those moves.
Mr. MULLINS. I would also.
Ms. OAKAR. Thank you, Mr. Frank.
Mr. Coyne?
Mr. W. COYNE. Thank you, Madam Chairman.
I would like to commend Mr. Stafford for being, first of all, the
one on the panel—it may be because he was the first to have a
chance to recommend that maybe we do forego the tax cut as a
way of reducing the deficit and ultimately reducing inflation and
hopefully reducing interest rates. But I would like to ask Mr.
Samuel if there are any conclusive studies that your organization
has done that could be submitted to this committee that indicate
that a higher interest rate structure in the country ultimately
leads to higher unemployment.
Has your organization done any studies at any time that would
show that?
Mr. SAMUEL. We have not. I think such studies are available. We
are not a research organization. But studies have been available
which certainly link high interest rates to unemployment and inflation. And I think—I'm not sure you were a Member of Congress
at that time, but during the consideration of the Humphrey-Hawkins bill a good deal of discussion was devoted to this subject, and I
think the consensus of Congress and the administration at that
time was—that is why it is called the Humphrey-Hawkins Full
Employment and Balanced Growth Act—recognizing the links between those aspects and stating as public policy in this country
that full employment makes more sense in terms of a rational
387
economy rather than unemployment, which is a direct consequence
of high interest rates.
Mr. W. COYNE. Well, I understand that you are not a research
organization. I just thought that the American labor movement
being committed to a full employment economy might have somewhere in their files that kind of a study. But as you indicate, that
may have been submitted during the debate on the HumphreyHawkins Act.
Thank you.
Ms. OAKAR. Mr. Hoyer?
Mr. HOYER. I want to join my colleagues in thanking everybody
on the panel for the work that has gone into this study. I am
particularly concerned, as I know Mr. Turner is and particularly
Mr. Coan, with the depressed nature of the housing market.
Other than high interest rates, Mr. Coan, what specific actions
would you suggest that Congress take with respect to the housing
industry?
Mr. COAN. Well, partly as a result of high interest rates, we are
confronted with a destabilization of the principal source of mortgage financing for housing. The savings and loans and mutual
savings banks, the principal lenders for the single-family house are
not in the business of making many loans these days.
I don't know an answer to that, other than bringing the rates
down and therefore bringing the cost of their money down. Until
that happens, you're not going to get much money out there.
Certainly, one thing we should do is look to other sources of
money for mortgage credit, and one of those is the pension funds—
an idea and a subject that has been discussed at great length in
this committee and other committees of this Congress for—well,
I've been involved in those discussions for 12 years, and I'm sure
they took place for many years before I got involved in them.
There are $300 to $400 billion in the pension funds. I would
subscribe to the theory that they have a social responsibility to put
some percentage of their funds into housing investment. And if
they don't do it, they should undergo a penalty under the tax laws
or something because of that.
We need some time to try to balance out these great wild swings
or wide swings that take place in housing. Unless and until that is
done, you are going to continue to have shortages and bidding up of
prices on housing, when we are not producing enough. Then you
are going to have shortages of materials and capacity in the plants
that produce those materials when you get up at the top of the
cycle. We never seem to be able to get anywhere near an even
production level. Certainly some variation would be all right, but if
the savings get too wide, they're just outrageously harmful to that
industry and to the people that are looking for housing and to the
whole economy of the country.
Mr. HOYER. Thank you. One more question, if I might.
I think it was pretty much a universal view of the panel, as I
understood it, that we forego the tax cut. Now is that an across-theboard foregoing of the tax cut? Obviously, there are two aspects to
the tax cut—essentially the personal tax cut and the business
incentive, if you will, aspect of the tax cut.
388
I would like just briefly if each one of you could say whether or
not you perceive them to be separate.
Mr. TURNER. Well, as an individual, I would say that I favor
the—I'm against any tax cut for individuals. I think in terms of the
business tax cuts, as I indicated later, that I think that we ought to
look at incentives in the tax structure that will cause a greater
investment in new plant and equipment. And so to that extent, I
would be in favor of some tax cuts for business.
Mr. SAMUEL. Could I just add one comment which, perhaps, will
amplify that? Incentives, we hope, which would lead to useful
investment, unlike 10-5-3 where 40 percent of it will go to the oil
companies and regulated public utilities.
Mr. HOYER. Would anyone else like to respond?
Mr. COAN. Well, I think I would somewhat share the view of Mr.
Samuel that certainly those tax incentives that produce a real
result are the ones that should be encouraged. I have a somewhat
jaundiced view as to whether that is a successfully achievable
thing. And I also have a jaundiced view as to whether it is achievable to forego the tax cut, at least to some extent. Certainly, the 3year proposal, going so far out in the future, doesn't make sense.
Mr. HOYER. We are apparently all suffering from that jaundice.
Thank you, Madam Chairman.
Ms. OAKAR. Thank you, Mr. Hoyer.
Mr. Patman?
Mr. PATMAN. Thank you, Madam Chairman.
Let me just address the entire panel, and if you could make your
answers as short as possible, I would appreciate it.
Is the prevailing high interest, the one that we have had over
the last couple of years, artificially high by reason of the actions of
the Federal Reserve?
Mr. TURNER. In my opinion, that is-true.
Mr. PATMAN. DO you have any idea of what it would be, absent
the actions of the Federal Reserve?
Mr. TURNER. I do not. But I think that entirely too much emphasis has been placed upon it. And I know that some people have
been recommending that Congress enact legislation requiring the
Federal Reserve Board to do all it can to reduce interest rates by 2
percentage points a year, instead of increasing them, until interest
rates are at least 50 percent lower than they are now.
The problem here now is that the Fed has such great independence that it acts pretty much the way it sees fit.
Mr. PATMAN. DO you see the interest rate as being lower, were it
not for the Federal Reserve's actions in raising the discount rate
and other actions?
Mr. TURNER. Yes.
Mr. COAN. Mr. Patman,
I agree that it is artificially high. It is
interesting that another member, Mr. Weber I believe it was,
talked about the interest rate reflecting an inflation factor plus a
standard earning on money, which I think is around 3 percent. If
that were so, we would have lower interest rates today with the
inflation rate having come down somewhat in the last several
months.
Mr. PATMAN. What portion of our present inflation rate is a
result of the artificially high interest rates that we have had in
389
effect over the last couple of years? Does anybody care to make a
stab at that?
Mr. COAN. I don't think anyone can say specifically.
Mr. PATMAN. But you feel that—is it correct to say that each one
of you feels that the inflation rate that we now have is higher
because of the high interest rate policy?
Mr. SAMUEL. Let me venture a response to that. Not specifically,
because I don't think that is possible, Congressman. But it is, I
think, by a number of economists assumed that something like 60
percent of our inflation is caused by microfactors—energy, interest
rates, and food costs being the principal ones.
Mr. PATMAN. IS it true then—I assume that it is, and one of you
alluded to it a moment ago—that interest rates, high interest rates,
are being used as a form of credit allocation intentionally?
Mr. TURNER. I think they are intentional in the sense of trying
to cool off the economy, but the result is not that way. There is no
evenhanded impact. And those of us at this table feel that we are
being impacted unduly, whereas other sectors of the economy are
not being impacted. Or if they are being impacted, it probably is
favorable rather than nonfavorable.
Mr. COAN. I don't think it is being done with the intent—the
action of the Federal Reserve is intentional—to put the money into
the hands of this set of borrowers as opposed to that set of borrowers.
Mr. PATMAN. I'm talking about when you raise the price. Then
you exclude a lot of people who cannot obtain credit.
Mr. COAN. Commonsense tells you where it's going to go when
you raise it as high as it is today.
Mr. PATMAN. Well, you have kind of an odd situation with the
short-term rates being higher than the long-term rates. And that is
one of the fundamental problems in the whole situation, isn't it?
Mr. TURNER. Well, eventually the long-term are going to continue to go up. Of course, there is the expectation that they will go
down eventually.
Mr. PATMAN. Well, the question that I really have now—and I'm
really running out of time—is, who on behalf of the President last
year, President Carter's policy, got him to lay off the Federal
Reserve when they started boosting the rates back up? Who got the
administration to sit on the sidelines while they were tightening
the screws? That sort of led this country toward possibly a deep
depression or at least a severe recession.
Ms. OAKAR. In other words, do any of you gentlemen take credit
for that?
Mr. PATMAN. Well, if you will tell me about that, I would like to
know for my own personal information just what happened on
that.
Mr. COAN, I think Mr. Carter wanted a person in as Chairman of
the Federal Reserve who had credibility and respectability in the
financial community, and Paul Volcker did have that. I think that
if you could have looked back at Paul Volcker's past views and
philosophies that you could have predicted to some extent the
degree or the route which the Fed has taken.
I think it is also fair to say, as Mr. Frank has pointed out, that
the Federal Reserve is doing what this administration wants them
390
to do right now, to some extent, maybe not always to the same
degree they would want, but that has just pushed the Fed even
further into this approach.
Mr. PATMAN. Well, I don't doubt that it is working hand-in-glove
with the administration now. But in the previous administration,
I'm surprised that they were able to do what they did without some
complaint from the administration.
Ms. OAKAR. I think your time has expired, Mr. Patman; I'm
sorry.
Mr. Vento?
Mr. VENTO. Thank you, Madam Chairperson. I appreciate your
indulging me in a couple of questions. I will try to be brief.
I appreciate your coming forth. I think it rather unique to have a
statement put together by various sectors from labor, utilities, the
farming sector. It almost looks like part of my State, the DFL.
But, Madam Chairman, it is interesting to listen to the discussion that we've had, and I'm sorry I was not here for all of it, but
one of the points was, the October 1979 monetary aggregate policy
really leaves the Fed with less control over the interest rate. In
other words, they are targeting the monetary aggregates, whatever
they are—MIA, B and so forth and so on. And the fact of the
matter is, that they are looking less at the interest rates, and
claiming that monetary control is actually being accomplished by
virtue of a free marketplace. That is to say, the banks and others
are making those determinations on their own. So we have sort of
this pulling and pushing in terms of the prime rate.
Now of course, you are probably aware of the fact that the prime
rate has been a major issue under the leadership of Chairman St
Germain. The chairman has pointed out that the prime rate, whatever the psychological effect of it is, is not uniform and there are
many disparities between what any two customers might pay at a
bank. So the fact is that we do have today, for instance, a circumstance where it isn't really the Fed that is making the determination as to who is getting credit, but it is financial institutions, and
very seldom does anyone pay exactly what the prime rate is.
But what is the effect or what has been the effect of that in the
various sectors? Utilities, I think we see an example here where we
have just about destroyed the long-term bond market. With housing, we see the number of starts suppressed for the second consecutive year with this policy. And you see the Federal Reserve Board
really exercising no control over this. They are dealing with monetary aggregates; they are not keying to interest rates.
Do you think that the Fed ought to focus more on what the
interest rate is again, as they had prior to this October 1979
change, Mr Turner?
Mr. TURNER. Well, the result is the same. I mean, when they try
to limit the money expansion to 2.2, which they are doing now, as
against what a lot of economists ought to be about 4-percent monetary growth each year, why anyone can predict what the results
are going to be.
And this tightening down of money, I think, has obviously
become a cause and not a cure for inflation. And of course, as it
cuts across the economy, there are so many in small business,
construction, the groups represented at this table and others who
391
are not here who are adversely affected, while other groups seem
to do quite well with it. Money is available; large corporations have
the money, and so it is a discriminatory type of a program in terms
of the business world. It certainly is as far as workers are concerned.
Mr. VENTO. But I think, though, when they were keying to
interest rates, they had more direct control over it, and there was
less of these disparities than we are seeing today. In fact, the
disparities have grown under the Fed's policies. And so I would
hope that we would look at those policies try to bring the Fed
along, so that they would not use the system that they have been
using. I think that the Fed has failed miserably in terms of what it
has been doing in terms of credit extension and the cost of credit. I
hope that we on this committee, at least, with Mr. Patman's help
and others, can get the administration to recognize the shortcomings of the particular policies, both fiscal and monetary, that they
have been advocating.
I would yield back the balance of my time.
Mr. TURNER. If Mr. Patman's father were alive today—well, he is
probably turning over in his grave now.
Ms. OAKAR. Let me just conclude by asking my few questions.
There have been a lot of articles, one I have in front of me that
makes some recommendations and reference to the Federal Reserve Board. Apparently some people feel they have been given
awesome powers that initially they were not supposed to have.
Because the term of the Board members is so long, combined with
the failure of the Board to really represent a cross-section of individuals who are so dramatically affected by their decisions; such as
business, labor, farmers, consumers, et cetera, do you feel that we
ought to change the manner by which Board members are appointed in terms of the length of term and background? Does anybody
have any views on that?
Mr. TURNER. I think the term ought to be 7 years instead of 14
years. I believe that the chairman's term ought to be concurrent
with that of the President. I think that we need to have a much
broader base in the composition of the Federal Reserve Board of
Governors. They are restrictive and limited in their experience and
orientation and economic views, as coming from the banking community primarily, almost entirely. And I think we ought to see to
it that business, labor, farmers, consumers are represented on the
board. I feel it is just like putting the fox in charge of the henhouse
to let the bankers determine what the interest rates are going to
be. And I think that the Open Market Committee itself ought to be
much more representative of a cross-section of the economy that
being as it is now, five members drawn from the banking institutions, and then you have—I think you have a total of 19 on there,
but they all come out of the banking institutions. Even though they
may wish to be completely objective, when every time the interest
rate is going to be raised, presumably you are going to get more
profit, I just wonder how objective they can be.
And I think on the matter of, well, we mentioned before that
there is a law on the books from 1969 that ought to be applied, but
which was applied briefly in March, April and May, I believe, of
1980, which did result in a drop in the interest rates. But then that
392
was changed very quickly. I think really the Federal Reserve Board
in the United States is more independent of the Congress or the
parliament and the executive than at any other ones of the modern
industrial societies.
I don't know how Congress or a President can be held responsible
for a full employment economy when they can't control their monetary policy. They may be able to control their fiscal policy, but
they can't control their monetary policy under the kind of
independence that we have given the Federal Reserve Board. It has
been in effect since 1912, 1913 and it is high time for an overhaul
of that law.
Ms. OAKAR. Mr. Mullins?
Mr. MULLINS. I just wanted to make one comment. During the
confirmation hearings of the last member of the Board, in the
Senate report that accompanied that confirmation, the Senate
made it very clear, at least their feeling was that the next member
of the board should come from the community representing either
small business, or agriculture, and be a little bit more representative of the populace as a whole. I do hope, when and if this
administration gets an opportunity for the next member of the
Board, that they will pay heed to that Senate report.
Ms. OAKAR. Thank you. We had about 350,000 bankruptcies filed
in 1980. What percentage of those do you think are small businesses? I know in my own area I am very concerned about developers
and builders. On the outskirts of northeast Ohio there are small
farmers who are going bankrupt. That seems to be a problem,
doesn't it? And to what extent can we blame interest rates?
Mr. TURNER. Well, we have been told by our staff that the
number of small business bankruptcies is soaring. We will ask our
people, our staff people, to try to get some information on that, but
the percentage is much higher than it was, as you indicate.
Ms. OAKAR. Did you want to comment, Mr. Mullins?
Mr. MULLINS. Well, I can't attribute a number to bankruptcies,
but you know we are losing several thousand farmers a week.
When you consider that this year interest will be the single largest
expenditure in the budget, that has to impact on particularly the
new, beginning entry farmer that has every little equity. So it
certainly impacts when interest makes up that big a portion of
your cost sheet.
Ms. OAKAR. Let me ask one last question, and then we will feel
you have really done your duty today. We had, in my city of
Cleveland last Friday, the Commissioner of Social Security who
was supposed to talk to a group of people about social security, but
he got into the whole program of economic recovery. One of the
comments that he made to the audience was that if the economic
recovery package, the interest rates obviously a part of it, is successful and if Congress does not obstruct Reaganomics, we will
have so many jobs that we are going to have to look to the foreign
market to full positions. We won't have enough Americans to fill
those jobs.
Now, you are chuckling. It sounds preposterous, but that is one
of the comments that was made by someone in the higher eschelons of the cabinet, and I wonder if that is your projection with this
so-called economic recovery package which we have before us.
393
Mr. STAFFORD. I think in Seattle we are trying to, and we've done
quite a bit of work on the entire program as far as its not only
geographic impacts, because all things will not happen the same in
every location. What the impacts will be in Cleveland will be
different than Seattle. Second, the timing of things. And I think,
you know, maybe there is, I think, what we have been saying, a
sunny day coming. But it's at least a 2 to 3 year gulf in talking to
our local corporations as to when that will hit, and I think even
right now, how do you get over the next 2 to 3 years?
Boeing, the largest corporation in the State, is laying off. The
largest employer in the city limits of Seattle is our University of
Washington and they are laying off because of the cuts in the
education budget, the tuition increases and the student loan cuts.
Our health industry is a major factor in Seattle; that is going
down. The Port of Seattle Airport, we have had the first decrease
in years in the people coming through. Tourism is a major industry
in our State, and that is going down because of the airline situation
and the Amtrak and the cost of fuel. And so when you look at the
local sectors of one economy, Seattle's economy which is supposed
to be the booming west, you know, we keep hearing we're the
winners of this whole thing and the mayor keeps shaking his head
and saying, "I'd hate to meet one of the losers."
You really wonder when it is going to come and where. And we
have been unable, in our local economy, to see anything in the
next 2 or 3 years, even if things work. Boeing tells us even if the
defense contracts come they are not going to be hiring major
numbers of people, at least for 3 to 4 to 5 years. The B-l bomber is
in the late 1970's, and so when you take that, the timber industry
sees nothing for 2 to 3 years. It is—I don't know, I hope it comes.
Ms. OAKAR. Your futuristic projection is not quite the same as
the Commissioner's?
Mr. STAFFORD. We know it is better than Cleveland's, and we
hope you send us some of the largesse.
Ms. OAKAR. My Republican mayor opposes the package too, I
want you gentlemen to know.
Mr. Samuel?
Mr. SAMUEL. MS. Oakar, I just wanted to comment briefly.
Almost every prediction made by almost every economist of whatever hue, suggests that where the employment situation is going to
get far worse before it gets better. I think the point that has to be
made is that it is already bad, and has been for several years.
Ms. OAKAR. SO you don't see that in the future we are going to be
importing all of these people to fill jobs, as the gentleman who
came to my city told our senior citizens? One of the rationales for
all of the social security cuts was that the savings would stimulate
the economy and balance the budget. While I thought it was a
preposterous statement, it was made nonetheless.
Mr. SAMUEL. It sounds as if he's trying to lay the groundwork for
either the administration's guestworker program, which is not
needed now, or the social security program which would keep
people at work until age 68. Neither of those programs are warranted by the circumstances we face today.
Mr. STAFFORD. Of course, we're already bringing in 168,000
Southeast Asian refugees into the third largest State in the coun-
394
try, and we see those refugees in our schools now. They represent
about 10 percent of the student body.
Mr. TURNER. If I could just put in one word here. A speech made
the other day by Mr. St Germain, the chairman, said that, "The
monetarist theories remind me of nothing so much as a great
medical practictioners of the middle ages who used to treat illness
by bleeding their patients/'
Ms. OAKAR. Well, on that happy note, let me thank you on behalf
of the chair for being here, and since the committee's schedule for
tommorow is in flux, the hearings on monetary policy will continue
subject to the call of the chair.
Thank you very much, gentlemen. The committee is adjourned.
[Whereupon, at 12:35 p.m., the hearing was adjourned to resume
on Thursday, July 23, 1981.]
[The following additional material was submitted for inclusion in
the record. A statement of Dr. Jack Carlson on behalf of the
National Association of Realtors, and a letter from Douglas A.
Fraser, president, United Automobile Workers, dated July 22, 1981,
with attachment, regarding the restrictive monetary policy of the
Federal Reserve Board. The material follows:]
395
STATEMENT
on behalf of the
NATIONAL ASSOCIATION OF REALTORS®
for
MONETARY POLICY HEARINGS
to the
HOUSE COMMITTEE ON BANKING, FINANCE
AND URBAN AFFAIRS
by
DR. JACK CARLSON
July 24, 1981
Chairman St. Germain, Congressman Stanton, and members of the
Banking Committee, my name is Dr. Jack Carlson.
I am Executive Vice
President and Chief Economist of the NATIONAL ASSOCIATION OF REALTORS®.
I appreciate the opportunity to submit this statement on monetary
policy in behalf of the 7QQ,QQQ members of the NATIONAL ASSOCIATION
OF REALTORS®.
Summary
Since October 1979, we believe the Federal Reserve Board has
attempted to fight inflation including offsetting inflation fiscal
policy followed by the Congress and the Administration.
This has
resulted in very limited growth in bank reserves and high interest
rates.
o In pursuing this tight monetary stance, the Federal Reserve
Board has moved away from moderating excessive fluctuations in short
term interest rates toward attempting (with mixed success) to
control the growth of credit aggregates.
As a result, we have
experienced wide swings in short term interest rates which directly
reduces investment activity, particularly in sensitive areas such
as housing.
For example, we estimate that as much, as 20% of the
396
decline in housing activity last year was due to excessive fluctuations in short term interest rates and 80% was caused by record
average interest rates over the period.
o The uncertainty created by the new techniques of monetary
control of the Federal Reserve Board, the very slow overall growth
targets for credit aggregates and a continuing failure of both
Congress and the Administration to demonstrate the ability to bring
down inflationary deficits have all pushed up the real rate of
interest--the premium for saving and cost of funds above expected
embedded inflation.
Whereas real long term interest rates
averaged 2 to 3 percent over most of the post World War II period,
they have averaged 5 to 6 percent over the past two years.
o Together with the marked acceleration in inflation, this has
pushed interest rates to record levels, with conventional mortgages
currently costing over 16.5 percent and the prime loan rate over
20 percent.
o These persistently high interest rates together with the
transition to deregulation of commercial banks, savings and loan
associations, and mutual savings banks, as specified under the
Depository Institutions Deregulation and Monetary Control Act of
1980, are placing severe strains on the thrift institutions.
yields on competing credit instruments are causing outflows of
High
397
savings at th-.2 nation's savings and thrift institutions and reducing
the supply of mortgage funds.
For example, so far this year, savings
and loan associations have suffered a net outflow of savings of over
$5 billion.
o To prevent even larger outflows of funds, thrifts have
increasingly been forced to fund new and existing mortgage loans by
issuing short term instruments such as 6-month money market certificates.
o Since in many cases the cost of funds to these institutions
is greater than the yield on existing assets, the viability of many
thrifts is threatened.
Problem cases being monitored by the FSLIC
have risen from 79 eighteen months ago to 263 in May 1981.
The
figure could reach l,6Q0 (or 1/3 of all S&L'sl by the end of the year.
o The difficulties of many savings institutions, record high
interest rates and slow growth in people's incomes have also caused
severe downturns in the housing industry and other interest rate
sensitive sections of the economy.
Housing is currently suffering
from the deepest and largest recession in post-war history, with
starts at a one million unit annual rate (less than 50 percent of
the demand for new housing) and sales of existing homes at a 2.6
million unit annual rate (or 60 percent of the demand of households
to upgrade to more adequate housing or to find housing where better
jobs are located).
o Bringing down inflation is a necessary step before lower
interest rates can be achieved.
We agree with Chairman Volcker
398
that an effective program to restore price stability requires a long
terra policy reducing growth in money and credit over time to rates
consistent with the growth of output and employment at stable prices.
However, the current targets are too restrictive given the underlying
rate of inflation and continuing high deficits.
o Even with a continuation of the Federal Reserve Board's
tight credit policies, inflation and inflationary expectations are
not likely to fall substantially below 8 percent over the next two
years without slower growth in federal spending and smaller deficits.
Trying to squeeze out more inflation with a too severe restriction
of credit growth only stifles real growth and continues to place a
disproportionate share of the burden of the inflation fight on
housing and other interest sensitive investment.
o We believe that the Federal Reserve Board should allow a
slightly faster growth of credit during the remainder of this year
and in 1982 and that this can be achieved without jeopardizing the
fight against inflation.
Specifically, we believe that the Fed's
target range for growth, in the broadly defined money stock (M2) be
increased to 7 to 10 percent for both 19 81 and 19 82 (up 1 percentage
point from the levels announced by Chairman Volcker on July 21)
and that other credit growth targets be adjusted accordingly.
o Consistent with, these targets, the Federal Reserve Board
should also attempt to reduce excessive fluctuations in short term
interest rates.
In other words, the monetary authorities should
399
move to include dual targeting system (of interest rates and credit
growth) used for monetary policy before late 1979.
o Inflation cannot properly be brought under control by restricting money supply alone.
Federal deficits must be reduced.
The Administration and Congress have begun the process of turning
the tide of increasing government spending, but it must do more
if the federal deficit is to be reduced.
We advocate further
slowdown in government spending and that any additional tax
relief must be tied to lower spending so that the federal deficit
will trend downward each year towards balance over the next 4
years.
Also a larger share of any future tax relief should be
devoted to increasing savings and investment.
o Although, the proposed Tax Exempt Savings Certificates will
provide some relief to thrift institutions, the short term nature
of the plan reduces its effectiveness in stimulating savings and
meeting long term housing and industrial needs.
The proposed
expansion of the Individual Retirement Account and Keogh provisions,
while a step in the right direction, are also insufficient to provide the needed long term boost in personal savings.
o A slightly less restrictive monetary stance and a tighter
and better directed fiscal policy would more evenly and fairly
place the burden of fighting inflation, would be more effective
400
in lowering inflation and interest rates, would better encourage
investment in housing and industry, would prevent a renewal of
long run inflation in the future from capital housing shortages
and would lend to stronger growth pverall.
The Impact of Monetary Policy on Thrifts and Housing
Excessive and sole reliance has been placed on monetary policy
in the fight against inflation rather than monetary policy being
used in concert with fiscal policy.
The result of this predominant
use of monetary policy has been record interest rates causing disproportionate suffering by small business, the nation's savings
institutions, and credit sensitive industries such as housing and
autos.
The impact of the housing industry has been severe.
The
housing industry is currently suffering from the deepest recession
in post-war history.
Housing starts are at a 1.03 million unit annual
rate currently, and expected to average only 1.27 million units for
1981—virtually the same as last year.
We expect only 1.66 million
starts in 1982 and 1.86 million starts in 1983.
Since the underlying
demand for replacement and new housing is about 2wmillion units per
year, housing supply is expected to continue far below the underlying
housing demand.
The implication is for housing to be in short supply
throughout the 1980's as industry capacity will not be able to both
supply the growing needs of expected demographic demands and the
leftover unsupplied demand of the current housing recession.
This
401
will only add to future increases in housing prices and rents, and
increase upward pressure on the long term rate of inflation.
Housing prices account for 10% of the consumer price increase.
Inasmuch as the growing shortage will likely cause 1 to 2 percentage
points faster use in housing prices as the average of all prices,
we can expect the CPI will increase by 0.1 to 0.2 percent each year
just from this source alone.
Resale activity has also dropped from its November 1978 peak
of 4.02 million units to a low in May 19 80 of 2.35 million units.
The level of resale activity has not recovered to the 1978 level
even as of this June.
This 32-month old protracted housing recession
is therefore not only the steepest, but also the longest housing
downturn since statistics have been gathered on the resale market
(see Table 1 ) .
TABLE 1
PERIODS OF DECLINE IN EXISTING HOME SALES
(Seasonally Adjusted Annual Rates, Million of Units)
Housing
Recession
Peak
Trough
Recovery to
Prior Peak
Percent
Decline
Peak to
Trough
Total
Duration
Peak Through
Recovery
1969-1970
Dec. 1968
1,710,000
Mar. 1970
1,370,000
Aug. 1970
1,720,000
-20%
20 months
1974-1975
Feb. 1973
2,500,000
Jan. 1975
2,040,000
Sept. 1975
2,600,000
-18%
31 months
1979-1981
Nov. 1978
4,020,000
May 1980
2,350,000
???
-42% (?) 32 months so far
402
This exceedingly long housing recession has had wider economic
impact than new starts and resale activity.
The slow sales pace
during the current housing recession has certainly been having a
tremendous impact on the overall economy and on the economies of
local communities throughout the country.
When an existing home is
sold, many people besides the buyer, seller, mortgage lender and
real estate practitioner gain from the transaction.
There are a
host of businesses that depend on a healthy housing market for
their livelihood.
Some businesses benefit directly at the time
of sale (household movers, attorneys, appraisers, insurance and
title companies, etc.); some before the sale (local merchants and
contractors selling supplies or services to fix up the home for
sale); and some after the sale (businesses selling supplies, services,
furniture and appliances to the new homeowner to customize his or
her new home).
It is estimated that these direct expenditures (again excluding
expenditures going to real estate practitioners and mortgage lenders
and the sales price of a home) generated prior to, during and after
a home is sold may typically amount to $5,000 to $7,000 for each
home.
The impact is even greater when the subsequent rounds of
spending that are generated are considered.
These indirect expen- .
ditures may add an additional $10,000 to $15,000 for each home sold.
Thus, the estimated economic benefit derived from each resale transaction may range from $15,000 to $20,000.
With sales of existing
403
single-family homes off about 1.2 million units in 1980 and a
similar loss expected in 1981, the loss to the local business
each year is $18 to $24 billion, excluding purely real estate and
financial services.
This is equivalent to about one-half million
jobs just from this limited estimate of harm created by disproportionate harm to existing home transfers.
The current problems of the housing industry are to a large
degree the result of the inability of our nation's thrift industry
to cope with the high and volitile interest rates that result from
overreliance in restrictive monetary policy to fight inflation.
The thrift industry, due to high market interest rates, and new
deposit opportunities for small savers, has suffered large outflows
from deposit accounts which, had regulated fixed interest rates
ceilings.
These accounts represented more than 50 percent of savings and
loan deposits in the past and ensured a stable cost of funds for
thrifts.
This stability in borrowing costs had allowed the thrifts
to offer long term fixed rate financing for home purchases and
allowed the proportion of American families owning their homes to
grow from less than 48% in 1930 to more than 65% £oday.
Now, however,
the regulated rate accounts represent only 20% of savings and loan
deposits, and the predominant share of deposits are in market rate
yielding accounts with 6 months maturity.
The result has been that
the cost of mortgage credit continues to be staggering.
Mortgage
interest rates have remained record high throughout the first half
of 1981, keeping many potential home buyers on the sidelines waiting
for more favorable times.
The average effective commitment rate on
404
80 percent, 30-year mortgages stood at 16.8 percent in June, up from
the 15.6 percent average it had been holding during the first five
months of the year.
Mortgage rates are expected to decline gradually
through the next few months and should drop below 15 percent by late
summer.
However, without a dramatic decline in interest rates and
the average cost of funds at thrifts, currently at 10 percent, it is
unlikely that mortgage rates will drop much below 14 percent in the
near future.
Average Effective Commitment Rate
On Conventional Home Mortgages
(80 Percent Loans with 30 Year Term)
Rate
1978
1979
1980
9. 78
11. 35
14. 02
1981: Jan
Feb
Mar
Apr
May
Jun
15. 40
15. 36
15. 50
15. 59
16. 16
16. 81(Record)
Source:
Change in Percentage Points
0 .76
1 .57
2 .67
0 .45
-0 .04
0 .14
0 .09
0 .57
0 .65
Federal Home Loan Bank Board
The transition to deregulation of commercial banks, savings and
loan associations, and mutual savings banks, as specified under the
Depository Institutions Deregulation and Monetary Control Act of 1980,
along with persistently high interest rates are placing severe strains
on the thrift institutions.
The ability of these institutions to
attract and keep deposits is obviously a key factor in maintaining a
viable housing market as together they account for nearly 75 percent
405
of all mortgage loan originations.
The health of the S&L's is of
particular importance since these institutions alone originate nearly
half of the total dollar volume of mortgage loans.
Unfortunately, in today's money market environment the S&L's
are in desperate condition.
High interest rates offered by competing
investments and the federal government's tight credit policies have
led to substantial deposit outflows from these traditional mortgage
lenders.
After a huge outflow in March, net deposit outflows from
savings and loan associations hit a staggering $4.6 billion in April,
followed by a much smaller decline in May.
Money market mutual funds
have been the chief competitor for these deposits--since the beginning
of the year these funds have gained an average of $2.7 billion per
week.
Deposits are not expected to exhibit the strength of previous
years until a noticeable reduction in the yields offered by the money
market funds.
Net New Savings Received at
Federally Insured S&L's
(Millions of Dollars)
Amount
1978
1979
1980
1981: Jan
Feb
Mar
Apr
May
$23,462
15,030
10,669
559
879
-2,137
-4,638
-161
Cumulative
Amount
_
599
1,478
-659
-5,297
-5,458
Source: Federal Home Loan Bank Board
Money Market Mutual
Fund Shares
(Millions of Dollars)
Amount
Increase
$ 10,300
43,600
75,800
$ 6,500
33,300
32,200
80,700
92,400
105,600
117,100
4,900
11,700
13,200
11,500
n/a
n/a
Source: Board of Governors
of the Federal Reserve System
406
The thrift institutions, the housing industry, small business,
and all other credit sensitive industries will remain depressed until
both inflation and interest rates are brought down.
Since October 1979, the Federal Reserve Board has been
attempting to fight these inflation causing loose fiscal policies
with .very limited growth in bank reserves and high discount rates.
In pursuing this tight monetary stance, the Federal Reserve Board
has moved away from moderating excessive fluctuations in short term
interest rates toward attempting (with mixed success) to control
the growth of credit aggregates.
As a result, we have experienced
wide swings in short term interest rates which directly reduces investment activity, particularly in sensitive areas such as housing.
For example, we estimate that as much as 20% of the decline in housing
activity last year was due to excessive fluctuations in short term
interest rates rather than the high average interest rates over the
period.
The uncertainty created by the new techniques of monetary
control of the Federal Reserve Board, the very slow overall growth
targets for credit aggregates and a continuing failure of both
Congress and the Administration to demonstrate the ability to rein
in spending growth and bring down future deficits have all pushed
up the real rate of interest—the premium for saving and cost of funds
above expected inflation.
Whereas real long term interest rates
averaged 2 to 3 percent during the post-war period, over the last
2 years they have risen to 5 to 6 percent and higher.
407
Together with the marked acceleration in inflation, this has
pushed interest rates to record levels—20 percent or more for the
prime loans, 16.8 percent for new mortgages and 15 percent for sixmonth money market certificates.
With interest rates this high,
the thrift industry could lose $4 to $6 billion in 1981, forcing many
savings and loans to fail.
The problem cases being monitored by
the FSLIC has increased from 79 in December 1979 to approximately
263 in May 1981, and could reach; as ma.ny as 1,6.0.0. or 1/3 of all S&L's,
according to the FHLBB chairman. By th.e end of the year.
The impact of a large number of thrifts in distress on the
financial industry, housing and economy in general should not be
underestimated and would require expensive government aid.
The
impact on the housing industry would be nothing less than catastrophic.
We agree with Chairman Volcker that an effective program to
restore price stability reuires a long term policy reducing growth
in money and credit over time to rates consistent with the growth of
output and employment at stable prices.
However, the current targets
are too restrictive given the underlying rate of inflation and continuing fiscal indiscipline.
Given current and expected conditions,
the targets leave too little room for real economic growth..
Even with a continuation of the Federal Reserve Board's tight
credit policies, inflation and inflationary expectations are not
likely to fall substantially below 8 percent over the next two years.
Trying to squeeze out more inflation with a too severe restriction
of credit growth only stifles real growth and continues to place a
408
disproportionate share of the burden of the inflation fight on
housing and other interest sensitive investment.
We believe that the Federal Reserve Board should allow a
slightly faster growth of credit during the remainder of this year
and in 1982 and that this can be achieved without jeopardizing the
fight against inflation.
Specifically, we believe that the Fed's
target range for growth in the broadly defined money stock (M2) be
increased to 7 to 10 percent for both 1981 and 1982 (up 1 percentage
point from the levels announced by Chairman Volcker on July 21) and
that other credit growth targets be adjusted accordingly.
Consis-
tent with these targets, the Federal Reserve Board should also attempt
to reduce excessive fluctuations in short term interest rates.
In
other words, the monetary authorities should move partially back
towards the dual targeting system (of interest rates and credit
growth) used for monetary policy before late 1979.
Inflation cannot properly be brought under control by restricting money supply alone.
Federal spending must be reduced to
bring government deficits down.
The Administration and Congress
have begun the process of turning the tide of increasing government
spending and deficits, but much, more must be done.
We advocate
further slowdown in government spending than has so far been proposed
and that tax relief must be tied to lower spending so that the federal
deficit will trend downward each year towards balance over the next
4 years.
409
In particular, we are concerned that the spending slowdowns
proposed by Congress may not be realized, especially in FY1983
and FY1984.
This failure to achieve targeted spending slowdowns
has already begun.
The spending slowdowns were originally expected
to result in total spending cuts of about $46 billion, limit FY1982
spending to $695 billion (up 6.1 percent from FY1981) and result in
a deficit of only $28 billion.
However, the mid-year budget estimates
have revised the budget upward to $705 billion.
The subsequent
"re-estimates" are likely to increase the budget to $715 to $725
billion.
This would increase the deficit from $28 billion to $50
to $60 billion, no lower than the FY1981 deficit.
While overall, tax relief should be smaller than spending
slowdown, a larger share of tax relief should be devoted to increasig
savings and investment than is proposed in the bills currently before
Congress.
The Administration and Congress have moved to improve the
depreciation portion of the planned tax relief by eliminating the
discriminatory treatment on rental housing proposed earlier--all
real property would at least be subject to uniform tax lives under
the new plan.
However, the plans call for little direct stimulus to savings
and housing beyond the first 15 months.
Although the proposed Tax-
Exempt Savings Certificates will provide some relief to thrift
institutions, tlxe short term nature of the plan reduces its effectiveness in stimulating savings and meeting long term housing and
investment needs.
The proposed expansion of the Individual Retirement
410
Account and Keogh provisions, while a step in the right direction,
are also insufficient to provide the needed long term boost in personal savings.
A better mix of federal economic policies—with a slightly
less restrictive monetary stance and a tighter and better directed
fiscal policy—would more evenly share the burden of the inflation
fight, would be more effective in lowering interest rates and inflation, would better encourage increases in investment and housing,
would prevent a renewal of long run inflation in the future from
capital housing shortages and would lend to stronger growth.
411
D E T R O I T ,
M I C H I G A N
4 8 2 1 4
INTERNATIONAL UNION, UNITED AUTOMOBILE, AEROSPACE I AGRICULTURAL IMPLEMENT WORKERS Of AMERICA-UAW
DOUGLAS
A.
FRASER,
PRESIDENT
RAYMOND
MAJERUS,
SECRETARY-TREASURER
OWEN F. BIEBI
July 22, 1981
The Honorable Fernand J. St. Germain
Chairman
Committee on Banking, Finance and Urban Affairs
U.S. House of Representatives
Washington, D. C. 20515
Dear Chairman St. Germain:
I deeply regret that I was unable personally to attend your hearings on current monetary
policy. The restrictive monetary course pursued by the FRB — with the Reagan
Administration's blessing — is among the most important and most harmful public
policies affecting the 1.3 million members of the UAW, and their families, today.
For the last two years the Federal Reserve has conducted a disastrous monetarist
experiment. Its sustained policy of tight credit has no precedent in American history,
as Table 1 (attached) demonstrates.
The expansion and contraction of money and credit regulate the growth of our economy.
As we have learned from bitter experience during these last two years, when credit
is prevented from expanding in consonance with the underlying momentum of the
economy, that momentum is slowed or even shifted into reverse. As soon as brakes
on credit are applied, sales of items normally purchased on installment are hurt: money
for buying homes, cars and other durable goods dries up. When these credit-sensitive
sectors are forced to reduce output, they drag the rest of the economy down with
them.
Sowing the Seeds of Future Inflation
The monetarist experiment has had results that should disturb anyone concerned with
investment and inflation. No sector of the nation's economy has escaped unscathed.
Recessionary clamps on the growth of credit have pushed interest rates to all-time
highs, even in relation to inflation rates. As financial institutions have expanded new
forms of credit, the Fed has hit the brakes even harder on the forms of credit under
its control.
The restriction of credit has two related effects on investment. First, as the reduced
supply of credit depresses the entire economy, companies no longer want to expand
production capacity. Second, high interest rates lead firms to abandon projects they
would have undertaken at lower rates. The reduction in productive investment now
will mean more inflation later; no doubt, that will be used to justify the next round
of monetarist travesty — if we let it.
412
The instability of interest rates — both real and nominal — has taken its toll as well.
The rollercoaster path of interest rates has created a bizarre feedback effect: borrowers
accelerate their demand for credit when interest rates spurt because they expect them
to rise still more, and postpone borrowing as rates fall because they expect them to
fall yet further! The uncertainty that surrounds future borrowing costs has made it
impossible for firms to evaluate the desirability of all but the shortest-term investments.
The Impact of Tight Money on UAW Members
The UAW represents literally hundreds of thousands of workers in credit-sensitive
industries, including auto and auto parts, construction equipment, farm implements,
and commercial aircraft, among others. Production and employment in all of these
industries have been clobbered by tight money. Since these industries all manufacture
durable goods, the great bulk of their sales are financed with credit.
In the case of two producers' goods that UAW members build — construction equipment
and heavy trucks — tight credit has pummelled sales and employment, as potential
buyers have lost access to credit, or have been able to obtain it only at exorbitant
rates. Even more important has been the derivative effect: many buyers of construction
equipment and heavy trucks have found it unnecessary to add to or replace equipment
to handle their shrunken volume of construction or freight business. As a result, sales
of medium- and heavy-duty trucks during the first six months of 1981 stood 41 percent
below the level for the same period in 1979. Similarly, after seasonal and inflation
adjustments, shipments of construction equipment were down 24.4 percent in the first
quarter of 1981 from the third quarter of 1979. Employment in that industry dropped
apace: more than 25,000 workers — fully 15 percent of the total workforce — lost
their jobs.
Tight credit has also hit the demand for agricultural implements. The volume of
shipments in that industry fell 20.3 percent from the fourth quarter of 1979 to the
first quarter of 1981, putting 18,000 workers (11 percent of the workforce) on the
street.
Parts supplier companies, especially smaller ones, have been hurt in unprecedented
fashion by the credit crunch at a time when they have been forced to borrow heavily
for working capital purposes, to finance new investment, and to develop the new
products demanded by their customers. Thousands of jobs have been lost as many of
these companies have cut back their operations or gone out of business. Business
failures among transportation equipment companies rose from 38 in 1978 to 55 in 1979
and 92 in 1980.
To the extent that tight money has contributed to an unwarranted surge in the value
of the dollar in recent months, there has been a further depressing effect on these
basic industries as imports have been stimulated and U.S. exports have become less
competitive in world markets.
Tight Money Crushes Auto Sales and Employment
The Federal Reserve's restrictive credit policies have played an important role in the
nation's worst auto crisis since the 1930s. That crisis, now in its 28th month, continues
unabated. Relative to the same period in 1978 — the industry's last healthy year —
domestic car and truck sales are down 32%. In the big car companies alone, over
413
150,000 auto workers remain on indefinite layoff; that is down only two-fifths from
the 1980 jobless peak. By contrast, three-fourths of laid-off auto workers had been
called back within a year of the 1975 jobless peak. Countless thousands more remain
unemployed in the supplier sector, where in the last 18 months we estimate that at
least 180 plants have permanently closed.
While our nation's tragically misdirected trade policies clearly played a greater role
than did tight money in permitting the current disastrous crisis to develop, restrictive
monetary policy has been a critical factor in deepening and prolonging the crisis. The
oil crunch of March 1979 swelled small car demand, to the great advantage of imported
models. The downturn in auto, coupled with a tightening of monetary policy, threw
the economy into recession. As real incomes fell, the usual recesionary switch in
demand toward smaller, cheaper vehicles swelled import demand further still. Tight
money also reinforced this switch through its effect on credit cost and availability.
As Table 2 and Chart 1 of the Appendix show, tight money choked off sales recoveries
in the spring months of both 1980 and 1981. Domestic sales had responded to the
loosening of credit in December 1979 and January 1980, only to be slammed by the
severe tightening of February-April 1980. Similarly, the rebound of Summer 1980 was
stalled by the credit tightening that began in the FaU of 1980.
The most recent, further tightening of the monetary screws has doubtless been a
significant cause of the latest disastrous automotive sales news. For the first ten
days of July — 28 months after the onset of the current crisis — General Motors'
sales were down 13.8% from their already-depressed year-ago level. Ford was down
34.2%; American Motors was down 18%; and even Volkswagen of America was down,
by 14.6%. Only Chrysler showed a gain over its horrible previous year, with sales up
13.6%.
Compared with 1978, the declines were across-the-board at the Big Three, and even
more severe: GM, down 40.3%; Ford, down 42.6%; Chrysler, down 24.4%. The annual
sales rate for domestic new cars during the first ten days of July was 5.6 million —
far below the 8.8 million annual rate of the comparable period in 1978.
The adverse effects of restrictive monetary policy on the automotive market are so
serious that I want to cover them at some length, detailing the separate effects on
consumers, manufacturers, and dealers. Most important, tight money does what its
advocates intend it to do: it recesses the economy and holds down purchasing power.
This affects all consumer expenditures, but postponable items — such as autos — are
particularly hard hit. The purchase of consumer durables such as cars and trucks is
also made more difficult by higher average monthly payments on loans and by the
restricted availability of credit.
High interest rates raise the manufacturers' unit interest expense, which must be
recouped in the sales price. Tight money also forces dealers to choose between losing
sales due to inadequate inventory and risking bankruptcy by holding adequate inventory.
All of these effects are well documented. Real per capita disposable income declined
7.5 percent from the second quarter of 1979 through the second quarter of 1981. Over
the same two years, the average new car finance charge rose a whopping 46.5 percent,
while the average loan-to-purehase price ratio dropped — another indication of credit
stringency.
414
The impact on cost and availability of new vehicle financing has been accompanied by
tight money's devastating impact on manufacturers' financial condition and costs.
Between 1978 and 1980, for example, Ford Motor Company experienced a 122% increase
in interest expense despite a dollar sales decline of 13 percent. Between the same
two years, Chrysler Corporation reported a 114 percent increase in interest expense;
dollar sales tumbled 32 percent. The unprofitable position of these companies (itself
caused in part by tight money) compelled them to take on more debt; moreover, higher
interest rates contributed greatly to the skyrocketing of their interest expenses.
Countless supplier companies have found themselves in an even worse predicament.
Their auto company customers resist price increases necessitated by higher interest
expenses that have been swollen by higher bank and finance company charges, sometimes
in excess of 5% above "prime."
Borrowing costs have been rising just as the need for new debt has been at its peak.
High interest costs are making an already painful "auto transition" unnecessarily
expensive. This transition is vital to restoring our industry's competitiveness; yet the
high cost of financing that transition threatens further erosion of U.S. automotive
competitiveness, vis-a-vis Japanese and other foreign carmakers who have access to
credit in their home countries at far lower rates.
High interest rates also expose dealers to unprecedented risk. In 1978, according to
Automotive News, domestic auto dealerships closed their doors at an average rate of
8 per month. As interest rates rose, the monthly failure rate increased to 56 in 1979
and to 134 in 1980. In total, an astounding 2,537 auto dealerships — 10.6% of the
total — disappeared between January 1979 and March 1981.
Conclusion
We have documented the havoc wreaked by a policy of tight money on industries
employing UAW members. Others have testified eloquently about the effect of high
interest rates on construction and other sectors of our economy. Western leaders,
who met earlier this week in Ottawa, are lambasting the Reagan Administration —
and the Federal Reserve policy it backs — for recessing the entire developed capitalist
world economy in a misguided attempt to bring down inflation.
The only way that tight money policies fight inflation is by halting the growth of the
real economy. The Administration and the Fed apparently are so concerned with
lowering the inflation rate that they are willing to risk perpetual economic stagnation.
This path is cruel, short-sighted, and inequitable. Moreover, it carries phenomenally
high political and social costs. Monetarism, after all, came two years earlier in Britain
than in the U.S.; one of the lessons to be learned from the British experience is that
engineered austerity can undermine even the most stable society.
So long as monetary policy continues to depress the durable goods and construction
industries, economic prosperity will elude our grasp. When the Fed once again permits
normal credit expansion, those industries should rebound and give a vital lift to the
American economy.
Sincerely,
Douglas A. Fraser
President
415
APPENDIX
TABLE 1
Real Prime Interest Rates
Nominal
Prime
1973
Real
Prime
6.1%
5.5%
7.0
9.1
9.8
7.3
8.3
8.6
9.3
12.3
-3.0
10.9
12.0
11.0
9.4
11.9
14.4
1.5
0.1
0.6%
-0.3
0.8
1.2
-3.4
9.0
7.3
7.6
7.6
10.1
6.8
6.9
7.1
6.5
3.2
5.2
4.4
5.8
3.6
1.7
2.7
0.7
6.3
6.4
6.9
7.7
6.0
7.7
5.1
5.5
-1.3
8.0
8.3
9.1
7.2
0.8
11.0
-3.7
10.8
6.9
8.2
2.2
2.6
11.8
11.7
12.1
15.8
8.4
7.8
7.8
8.1
3.4
3.9
4.3
7.7
16.4
16.3
11.6
16.7
9.3
9.8
9.2
10.7
7.1
6.5
2.4
6.0
9.8
9.4
8.5e
10.4(
19.2
18.9
SOURCE: De
e = estimated
GNP Deflator,
Annual Rate
4.5
7.0
7.1
-1.1
-2.8
0.6
0.5
0.3
1.8
2.2
nmerce, Business Conditions Digest, v
416
TABLE 2
Prime
Interest Rate
11.54%
Retail Sales of New
Auto Industry
Domestic Cars and Trucks
Unemployment Rate
(seasonally adjusted annual rate)
8/79
11,200,000
9/79
8.5%
10/79
14.39
11/79
8,800,000
12/79
12.7
1/80
15.25
2/80
9,900,000
3/80
15.7
4/80
19.77
5/80
6,900,000
6/80
24.6
7/80
11.48
8/80
9,200,000
9/80
21.6
10/80
13.79
11/80
9,200,000
12/80
17.5
12/80
20.35
1/81
8,600,000
2/81
18.9
4/81
17.15
5/81
7,900,000
6/81
NR
5/81
19.61
6/81
7,600,000
7/81
NA
6/81
20.06
7/1-10/81
7,300,000
8/81
NA
7/79
NR = not relevant: callbacks for GM model changeover dominate other effects.
NA = not available.
* Imported vehicles are excluded because indications are that most are not bought
on credit. This is partly due to the age and income distribution of import buyers,
and partly to the fact that banks are getting out of the car loan business and
import carmakers lack U.S. credit subsidiaries.
SOURCE: Ward's Automotive Reports; U.S. BLS.
DOMESTIC NEW
VEHICLE SALES
(annualized)
RATE
1
CD
i
I
CO
i
1 ) * i
UD
1 i
I
i
1 i
1 i
I
• I
i
I
i I
.
I
|
(
,
(
t
CONDUCT OF MONETARY POLICY
THURSDAY, JULY 23, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 10:20 a.m. in room 2128 of the Rayburn
House Office Building; Hon. Fernand J. St Germain (chairman of
the committee) presiding.
Present: Representatives St Germain, Gonzalez, Annunzio,
Fauntroy, Neal, LaFalce, Evans (Ind.), D'Amours, Vento, Barnard,
Garcia, Schumer, Patman, Hoyer, Stanton, Wylie, Hansen, Leach,
Paul, Shumway, Weber, McCollum, Carman, Wortley, Roukema,
Lowery, and J. Coyne.
The CHAIRMAN. NOW, back to the realities and difficulties of life
in these United States of America.
This morning the committee continues its semiannual review of
monetary policy. Our review began with testimony from the three
depository institution insurance agencies. They cautioned that continued high interest rates could hurt savings and loan and mutual
savings bank safety and soundness. We then heard from Federal
Reserve Chairman Paul Volcker who told us it would be imprudent
to expect interest rates to decline in the near future. Yesterday we
heard from a variety of witnesses who told us, in unambiguous
terms, of the profoundly harmful effects of the administration's
monetary and fiscal actions on small businesses, farming, housing,
the cities, and employment generally.
No one disputes the need for a noninflationary monetary policy.
The ravages of inflation must be brought under control. On that
point we all agree. We differ, however, in the execution of that
policy. The administration's approach to monetary restraint places
unbelievable burdens on the housing, auto, and farming industries
and is starving small businesses with a lack of credit. In contrast,
big corporations can raise $40 billion overnight for speculative
bidding wars, despite high interest rates. Every morning you pick
up the paper and the bidding for at least one company keeps going
higher.
Chairman Volcker told us that only one of those credit lines
would be exercised and would have virtually no effect on credit
availability. However, even as he was speaking, Mobil Oil was
reportedly exercising its $6 billion line of credit and transferring
the funds to London.
We are told that this is for the national good. We are even
expected to believe that defense spending increased to the levels of
the Vietnam War, a tax cut, and the inevitable recession resulting
(419)
420
from the administration's approach to monetary control is going to
reduce the deficit.
Where will it end? When will the administration realize and take
steps to minimize the enormous risks it is imposing on small business, financial institutions, and local economies? When will the
administration understand that one of the reasons interest rates
are so high is because uncertainty is so high? We in Congress are
uncertain; the financial markets are uncertain; and increasingly
the public is uncertain whether the vast economic and social experiment the Reagan administration has involved us in is really
going to turn out to be in the country's best interests.
We hear so much about the need for level playing fields. Where
is the level playing field in our fight against inflation? What I see
is a policy that decimates small business, housing, farming, and
local economies across the country that depend on them. I see a
policy that raises the giant corporations to positions of unprecedented power.
Last spring this committee was asked in the most urgent terms
by the Federal Reserve Board, the FDIC, the Home Loan Bank
Board, and the NCUA for broad merger and acquisition authorities
and for increased deposit insurance resources to assist in the preservation of financial services and local markets. The Reagan administration scuttled that legislation and to date has offered nothing in its place.
The administration's approach to monetary control is increasingly risky, inequitable, and destabilizing. If monetary policy does not
contribute to improved production, employment, and price stability
on the local level, it will fail to be beneficial nationally. When the
health of local industries, including financial institutions, is jeopardized, economic conditions deteriorate, production declines, and
unemployment rises whether we are talking about auto dealers,
homebuilders or the banks, credit unions, mutual savings banks
and S. & L.'s on which they depend. If the economies of towns and
cities across this country are to remain strong, these institutions
must remain viable.
Mr. Stanton?
Mr. STANTON. Mr. Chairman, I wonder if we can interrupt just a
minute. The clerk is over here, and if we can just record those who
are here now for quorum purposes; it might accelerate matters as
we go on. Would that be all right, just to record those who are
here?
The CHAIRMAN. The clerk will call the roll.
The CLERK. Mr. St Germain?
The CHAIRMAN. Present.
The CLERK. Mr. Reuss?
[No response.]
The CLERK. Mr. Gonzalez?
Mr. GONZALEZ. Here.
The CLERK. Mr. Minish?
[No response.]
The CLERK. Mr. Annunzio?
Mr. ANNUNZIO. Here.
The CLERK. Mr. Mitchell?
[No response.]
421
The CLERK. Mr. Fauntroy?
[No response.]
The CLERK. Mr. Neal?
[No response.]
The CLERK. Mr. Patterson?
[No response.]
The CLERK. Mr. Blanchard?
[No response.]
The CLERK. Mr. Hubbard?
[No response.]
The CLERK. Mr. LaFalce?
Mr. LAFALCE. Here.
The CLERK. Mr. Evans of Indiana?
[No response.]
The CLERK. Mr. D'Amours?
Mr. D'AMOURS. Here.
The CLERK. Mr. Lundine?
[No response.]
The CLERK. MS. Oakar?
[No response.]
The CLERK. Mr. Mattox?
[No response.]
The CLERK. Mr. Vento?
Mr. VENTO. Here.
The CLERK. Mr. Barnard?
[No response.]
The CLERK. Mr. Garcia?
[No response.]
The CLERK. Mr. Lowry?
[No response.]
The CLERK. Mr. Schumer?
[No response.]
The CLERK. Mr. Frank?
[No response.]
The CLERK. Mr. Patman?
Mr. PATMAN. Here.
The CLERK. Mr. Coyne?
[No response,]
The CLERK. Mr. Hoyer?
[No response.]
The CLERK. Mr. Stanton?
Mr. STANTON. Here.
The CLERK. Mr. Wylie?
Mr. WYLIE. Here.
The CLERK. Mr. McKinney?
[No response.]
The CLERK. Mr. Hansen?
Mr. HANSEN. Here.
The CLERK. Mr. Hyde?
[No response.]
The CLERK. Mr. Leach?
Mr. LEACH. Here.
The CLERK. Mr. Evans of Delaware?
[No response.]
422
The CLERK. Mr. Paul?
Mr. PAUL. Here.
The CLERK. Mr. Bethune?
[No response.]
The CLERK. Mr. Shumway?
Mr. SHUMWAY. Here.
The CLERK. Mr. Parris?
[No response.]
The CLERK. Mr. Weber?
Mr. WEBER. Here.
The CLERK. Mr. McCollum?
Mr. MCCOLLUM. Here.
The CLERK. Mr. Carman?
[No response.]
The CLERK. Mr. Wortley?
Mr. WORTLEY. Here.
The CLERK. Mrs. Roukema?
Mrs. ROUKEMA. Here.
The CLERK. Mr. Lowery?
Mr. LOWERY. Here.
The CLERK. Mr. Coyne?
[No response.]
Mr. MCKINNEY. Mr. McKinney, here.
The CHAIRMAN. Did the clerk call Mr. LaFalce?
The CLERK. Mr. LaFalce is recorded as present.
The CHAIRMAN. We have how many members?
The CLERK. Twenty present, sir.
The CHAIRMAN. And we need?
The CLERK. Twenty-three.
Mr. STANTON. Would it be possible, Mr. Chairman, as we go
along in the hearings that we would interrupt for the purpose of
establishing a quorum?
The CHAIRMAN. We will keep the rollcall open. The Chair will
interrupt as members arrive. As soon as we hit the 23, the magic
number, we will strike.
Mr. Stanton, would you be heard?
Mr. STANTON. Thank you very much, Mr. Chairman.
I certainly join you, Mr. Chairman, in welcoming two of the
newer members of the Reagan administration's team at the Treasury Department to these hearings. We have expanded, obviously,
the hearings on the Humphrey-Hawkins bill this year, to hear
from outside witnesses. I believe this is good, Mr. Chairman, because of course, we are involved with the future economic wellbeing of the Nation. While the Federal Reserve plays a prominent
part in the overall goals and operations and aspirations of the
Humphrey-Hawkins bill, certainly the administration, the Congress, and the private sector as well, contribute to the economic
well-being of our country.
I wish to make one quick observation, having read the testimony.
[ am pleased to see the degree to which the witnesses have understood and have done their homework. They obviously have prepared well, in reading the back history of testimony before our
committee, and I, for one, appreciate that. I have only one other
comment, Mr. Chairman, in the light of the overall operations of
423
the Humphrey-Hawkins Act. Mr. Sprinkel has just returned with
the President from Ottowa. I am sure this committee would appreciate enlightening information which he could give us on the
Ottowa conference with regard to the international economic situation in which this committee is always interested. We would appreciate your doing that, Mr. Sprinkel.
Thank you, Mr. Chairman.
The CHAIRMAN. I thank the gentleman. I certainly agree that
that would be most welcome to the committee.
At this time I would take advantage and advise the clerk to note
the arrival of Mr. Hoyer and Mr. Schumer, bringing us much
closer to the magic number. We're now at 22; 1 to go.
The Chair now recognizes the genial gentleman from Idaho.
Mr. HANSEN. Thank you, Mr. Chairman.
I wonder if it would be in order, as ranking member of the
Subcommittee on Domestic Monetary Policy, for a brief statement
before Mr. Sprinkel proceeds?
The CHAIRMAN. Well, whether it is or not, you're going to give it,
so go ahead.
Mr. HANSEN. Thank you, Mr. Chairman. I thank you for the
opportunity we have of hearing these witnesses regarding this very
significant problem of monetary policy.
I have faithfully supported the Reagan economic package from
its inception during the last year's election and to date, and the
program in total I feel offers long-term hope for the future. But I
do feel that there are short-term problems such as painfully high
interest rates, which I feel that we need to address. I believe there
are solutions in the short term. I'm not talking about phony money
from the Federal Reserve and I'm not talking about credit allocation, which many of my colleagues on the other side of the aisle
seem to flirt with from time to time.
Chairman Paul Volcker of the Federal Reserve Board has presided over that institution for the past 2 years, and during that
time, for whatever reasons, we've been plagued by double-digit
inflation, 20-percent-interest rates, and MiB, which the Federal Reserve pays the most attention to, has been wandering and rambling
all over the place for the past several years. Although the Federal
Reserve may hit a particular target during that particular quarter,
more often than not the Fed has failed to hit its targets during the
past several years and this committee repeatedly has urged the
Federal Reserve to lower its targets, and more importantly, to
achieve its targets.
Secretary Sprinkel, I believe you correctly point out in your
testimony, and I urge you in your behind-the-scenes discussions
with the Federal Reserve, to keep their feet to the fire to meet
their targets. I would hope that, Secretary Sprinkel, you would
take this message back to the Treasury Department with you today
and put your best economists to work to find some immediate help
to take the hardship out of high interest rates.
Chairman Volcker has admitted in the press today that the
policy of the Fed creates an uneven impact. I take it it is this
uneven impact that we have to address ourselves to; that on the
one hand, you have the oil companies announcing unprecedented
profits and the housing industry and the automobile industry dead
424
in the water, so to speak. I like to think of our economies in terms
of medical analogies. The Reagan administration, I believe, is on
the right path to achieve a long-term cure for the cancer of inflation. I fully support you in these efforts. But what we need, I feel,
is some simple, fast-acting, quiet relief aspirin for the immediate
and painful headaches of high interest rates.
Our economy has been hooked on the heroin of deficit spending
and today we are suffering from the DT's of this addiction. What
we are looking for is an interim painkiller made up of moral
confidence and certain available relief measures so that these temporary convulsions in our economic patient will in fact be relieved.
I can point to a dear colleague letter from such people as my
colleague, Mr. McKinney, and others, who stated that for instance,
the administration could issue certain regulations that have been
longstanding with regard to HUD regulations so that we could get
moving on construction of certain section 8 housing units and this
type of thing. I think there are things that can be done to help
keep this part of the economy going so that we don't have a
gangrenous arm drop off in the Federal economy while we're waiting for the overall cure.
There are many quack doctors around today, and perhaps many
witch doctors that will prescribe various types of medicine for these
maladies. Some would like to operate on the economy. To do this,
some would like to perform an autopsy, or whatever. Before we
know it, our economy would soon become a cadaver, drawn and
quartered with such devices as credit allocation by many well
intentioned people in the Government. If we are successful in
dividing a basically cohesive economy, we will be left as a disjointed carcass by the side of the road.
Mr. Secretary, I think it's time for us to get to work to try to
address ourselves to the areas where we are having this tremendous impact. When you have the bigs, as Mr. Chairman has stated,
able to get interest rates at much lower rates than the people who
are suffering this severe dislocation when they're talking about
multibillion dollar mergers, then I think there is something wrong.
And the rest of the statement I'll put in the record.
I think it is absolutely important that you address yourself to the
unevenness of what's happening, so that we don't lose the patient
while you are trying to achieve the cure.
The CHAIRMAN. Without objection, the gentleman's statement
will be placed in the record.
[The complete opening statement follows.]
425
OPENING STATEMENT OF HON. GEORGE HANSEN
HEARINGS ON THE CONDUCT OF MONETARY POLICY
JULY 23, 198]
MR, CHAIRMAN:
LET ME BEGIN BY EXPRESSING MY APPRECIATION FOR YOUR TESTIMONY TODAY ON THE
CONDUCT OF MONETARY POLICY, I WANT YOU TO KNOW THAT I HAVE FAITHFULLY SUPPORTED THE
REAGAN ECONOMIC PACKAGE FROM ITS INCEPTION DURING LAST YEAR'S ELECTION TO DATE. THE
PROGRAM IN TOTAL OFFERS US LONG-TERM HOPE FOR THE FUTURE.
THERE ARE, HOWEVER, SHORT-TERM PROBLEMS—SUCH AS PAINFULLY HIGH INTEREST
RATES—WHICH I FEEL THAT WE NEED TO ADDRESS,
IN THE SHORT-TERM.
I BELIEVE THERE ARE SOLUTIONS
I AM NOT TALKING ABOUT MORE PHONY MONEY FROM THE FEDERAL
RESERVE, AND I AM NOT TALKING ABOUT CREDIT ALLOCATION, WHICH MANY OF MY
COLLEAGUES ON THE OTHER SIDE OF THE AISLE SEEM TO FLIRT WITH FROM TIME TO TIME.
CHAIRMAN PAUL VOLCKER OF THE FEDERAL RESERVE BOARD HAS PRESIDED OVER THAT
INSTITUTION FOR THE PAST TWO YEARS. DURING THIS TIME, FOR WHATEVER REASONS, WE
HAVE BEEN PU\GUED BY DOUBLE-DIGIT INFLATION AND 2 0 PERCENT INTEREST RATES.
Ml-B — WHICH THE FEDERAL RESERVE PAYS THE MOST ATTENTION TO — HAS BEEN WANDERING
AND RAMBLING ALL OVER THE PLACE FOR THE PAST SEVERAL YEARS. ALTHOUGH THE FEDERAL
RESERVE MAY HIT A PARTICULAR TARGET DURING ANY PARTICULAR QUARTER, MORE OFTEN
THAN NOT THE FED HAS FAILED TO HIT ITS TARGETS DURING THE PAST SEVERAL YEARS.
THIS COMMITTEE REPEATEDLY HAS URGED THE FEDERAL RESERVE TO LOWER ITS TARGETS AND
MORE IMPORTANTLY TO ACHIEVE ITS TARGETS. SECRETARY SPRINKEL, YOU CORRECTLY POINT
THIS OUT IN YOUR TESTIMONY, AND I URGE YOU,IN YOUR BEHIND THE SCENES DISCUSSIONS
WITH THE FEDERAL RESERVE,TO KEEP THEIR FEET TO THE FIRE TO MEET THEIR TARGETS.
426
SECRETARY SPRINKEL, I WOULD HOPE THAT YOU WOULD TAKE MY MESSAGE BACK TO
THE TREASURY DEPARTMENT WITH YOU TODAY AND PUT YOUR BEST ECONOMISTS TO WORK TO
FIND SOME IMMEDIATE STEP TO TAKE THE HARDSHIP OUT OF HIGH INTEREST RATES. I
LIKE TO THINK OF OUR ECONOMY IN TERMS OF MEDICAL ANALOGIES. THE REAGAN
ADMINISTRATION IS ON THE RIGHT PATH TO ACHIEVE A LONG-TERM CURE FOR THE CANCER
OF INFLATION, AND I FULLY SUPPORT YOU IN THESE EFFORTS. WHAT WE NEED, HOWEVER,
IS SOME SIMPLE,"FAST-ACTING, QUIET RELIEF" ASPIRIN FOR THE IMMEDIATE AND PAINFUL
HEADACHES OF HIGH INTEREST RATES.
OUR ECONOMY HAS BEEN HOOKED ON THE HEROIN OF DEFICIT SPENDING. TODAY, WE
ARE SUFFERING FROM THE DTS OF THIS ADDICITION. WHAT WE ARE LOOKING FOR IS AN
INTERIM PAINKILLER MADE UP OF MORAL CONFIDENCE AND CERTAIN AVAILABLE RELIEF MEASURES
SO THAT THESE TEMPORARY CONVULSIONS IN OUR ECONOMIC PATIENT WILL, IN FACT, BE RELIEVED.
THERE ARE MANY QUACK DOCTORS AROUND TODAY AND PERHAPS MANY WITCH DOCTORS
THAT WILL PRESCRIBE VARIOUS TYPES OF MEDICINE FOR THESE MALADIES. SOME WOULD
LIKE TO OPERATE ON THE ECONOMY TO DO THIS, AND SOME WOULD LIKE TO PERFORM AN
AUTOPSY TO DO THAT. BEFORE WE KNOW IT, OUR ECONOMY WOULD SOON BECOME A CADAVER,
DRAWN AND QUARTERED, WITH SUCH DEVICES AS CREDIT ALLOCATION BY MANY WELL-INTEM"IONED
PEOPUE IN THE GOVERNMENT. IF THEY ARE SUCCESSFUL IN DIVIDING A BASICALLY COHESIVE
ECONOMY, WE WILL BE LEFT WITH A DISJOINTED CARCASS BY THE SIDE OF THE ROAD.
Fto. SECRETARY, WE MUST GIVE THE PATIENT THE MORAL AND ECONOMIC WILL TO LIVE.
V/E CANNOT AFFORD TO LET HIM SLIP OUT OF THE HOSPITAL AND TO GO OUT ON ANOTHER DEFICIT
SPENDING BINGE. I AM CONFIDENT THAT YOU CAN DEVISE THE MEANS TO RESUSCITATE THE
PATIENT TO ACHIEVE THE FINAL NECESSARY CURE.
427
FOR EXAMPLE, TO HELP BRING INTEREST RATES DOWN I BELIEVE THAT ADDITIONAL
STIMULI WITH LITTLE OR NO TREASURY OUTLAY CAN BE GIVEN FOR BUSINESS AND CONSTRUCTION ACTIVITY THROUGH SELECTIVE ADVANCEMENTS OF COMMITMENT DATES ON OBLIGATIONS THE GOVERNMENT IS ALREADY PLANNING TO UNDERTAKE. IF PROCUREMENT
CONTRACTS OR BUILDING COMMITMENTS ARE IN THE PIPELINE, LET'S GET THEM MOVING
AND PUT PEOPLE BACK TO WORK. SUCH ACTIVITY WOULD PROVIDE A MEANINGFUL SIGNAL
WITHOUT ANY EARLY DRAIN ON GOVERNMENT RESOURCES.
SECOND, I WOULD URGE YOU TO ABANDON ALL GOVERNMENT DEBT OPERATIONS IN THE
MEDIUM AND LONG-TERM ISSUES AND CONCENTRATE ALL NECESSARY BORROWING IN SHORT-
TERM SECURITIES. THIS ACCOMPLISHES TWO THINGS: FIRST, IT EMPHASIZES THE
REAGAN ADMINISTRATION'S DETERMINATION T O DEFEAT INFLATION, BECAUSE IT ANTICI-
PATES LOWER INTEREST RATES AND THUS BORROWING COSTS THAT WOUUD FLOW FROM REDUCED INFLATION RATES IN THE FORESEEABLE FUTURE. SECOND, IT TAKES PRESSURE
OFF THE PARTS OF THE CREDIT MARKETS WHICH ARE ESPECIALLY IMPORTANT TO THE
HOUSING INDUSTRY AND FOR CAR BUYERS, TWO PARTICULARLY DEPRESSED AND INTERESTRATE-SENSITIVE SECTORS.
ffe. SECRETARY, THESE ARE JUST A FEW SUGGESTIONS, WHICH I WOULD LIKE TO
DISCUSS WITH YOU FURTHER. IT IS TIME THAT THE FEDERAL RESERVE LEARNED THAT
THE GYRATIONS OF ITS ROLLER COASTER POLICIES ARE CREATING CHAOS IN THE COUNTRYSIDE. W H Y SHOULD WE EXPECT PEOPLE IN AMERICA T O HAVE CONFIDENCE IN THE FEDERAL
RESERVE, WHEN THE FEDERAL RESERVE CAN'T CONTROL THE MONEY SUPPLY? YOUR APPOINTMENT AS UNDERSECRETARY FOR MONETARY AFFAIRS SHOULD SEND A CLEAR SIGNAL TO THE
FEDERAL RESERVE THAT THE REAGAN ADMINISTRATION EXPECTS RESULTS.
Ffc. CHAIRMAN, YOU KNOW AS WELL AS I DO THAT IT IS TIME THAT WE DO AWAY WITH
BIG LEAPS IN MONEY SUPPLY AND HIGHER AND HIGHER INTEREST RATES. IT IS TIME TO START
TO THINK ABOUT THE LITTLE GUY FROM MIDDLE AMERICA WHO PAYS THE MAJORITY OF TAXES
IN THIS COUNTRY. IT IS TIME TO SAVE AMERICA AND THE AMERICAN DREAM OF AFFORDING
A HOME OR STARTING UP A SMALL BUSINESS. WE CAN DO THIS ONLY BY DECLARING WAR
ON HIGH INTEREST RATES.
428
The CHAIRMAN. The clerk will note the arrival of Mr. Barnard,
Mr. Evans, and Mr. Gonzalez, thereby giving us a quorum.
[Recess.]
The CHAIRMAN. At long last we are happy to recognize today's
witnesses. We will ask Under Secretary Sprinkel to proceed—we'll
put your entire statement in the record, and you may summarize if
you wish. Naturally, in conjunction with the request of Mr. Stanton, we would hope you would make a few remarks on the Ottowa
Summit Conference. The Chair at this time would ask that there
be a little order and decorum up here. I would ask the staff if
they're going to talk with members to whisper, and that the members do likewise.
Under Secretary Sprinkel?
STATEMENT OF HON. BERYL W. SPRINKEL, UNDER
SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS
Mr. SPRINKEL. Thank you, Chairman St Germain, Congressman
Stanton, and distinguished members of the Banking Committee.
Roger Mehle and I are very pleased to participate in your hearings
as you requested. If it is agreeable with your wishes, we would
prefer having questions after each of the presentations because I
will be concentrating primarily on monetaiy policy, Roger Mehle
will be concentrating primarily on the problems in the thrift industry.
The CHAIRMAN. Secretary Sprinkel, I appreciate your request
and your logic, but by the same token, we have a 5-minute rule.
That would mean that the members would have to wait around if
they want to ask one question of you and one question of Secretary
Mehle, and it is just impossible to operate in that way. So we,
unfortunately, cannot honor that. We are going to have to pick and
choose, and I am sure that both of you can handle it admirably.
Mr. SPRINKEL. YOU win. Thank you, sir.
The fight against inflation has begun in earnest. The first step
has been taken and, contrary to other efforts over the past 15
years, this administration is determined that this not be a false
start. The attack on inflation can be successful only if we stay on
the course of persistent slowing in the rate of money growth, with
the ultimate goal of a permanent, steady, noninflationary rate of
monetary expansion.
There is no alternative: long-run inflation can only be beaten by
restricting the growth of the Nation's money supply to match the
trend rate of increase of aggregate production. The budgetary, tax
and regulatory portions of our program are designed primarily to
stimulate the growth of production but, while significantly raising
real output, this would contribute only modestly to an easing of
inflationary pressures. To eliminate inflation, a permanent reduction in money growth is absolutely necessary.
On several occasions since 1965, money growth was slowed in
response to concerns about inflation. But, in each case, the effort
was soon abandoned and the rate of monetary expansion subsequently was accelerated further. In each instance, the economy
suffered the immediate costs of monetary restraint, but was denied
the lasting benefit of reduced inflation. The result was a steadily
rising long-term rate of money growth, which was punctuated by
429
several short periods of monetary restraint. The rising trend resulted in an ever worsening inflation, while the brief bouts of restraint
generated or intensified economic recessions. These episodes eroded
confidence in the willingness or ability of the Government to carry
out its planned monetary policies and led to a strengthening of
inflationary expectations. This psychology is reflected today in the
level of interest rates in the financial markets and in the momentum of inflation. Like everyone else, we abhor high interest rates
and are determined to avoid the expansive policies which make
high interest rates inevitable. The current level of interest rates is
not the cost of an anti-inflationary monetary policy—instead, high
interest rates are the cost which the eonomy now bears for repeated failure to fight inflation in the past. The first task is to break
the strength of inflationary expectations. That requires establishing the credibility of the policy of long-term monetary control.
There has been a strong temptation by governments to pay their
bills and to react to each immediate economic problem in the cheap
and easy way—by running the printing press. As the new dollars
are pumped into the economy, however, the initial applause of the
recipients soon gives way to the cries of pain, even from those who
benefited originally. At best, money creation provides cosmetic
relief, which may temporarily cover up fundamental economic
problems. That kind of policy is deceitful, especially when the
Government claims credit for the initial benefits, and later points
an accusing finger at others when the ultimate costs become evident. This administration is determined to break this vicious cycle
and to concentrate on providing permanent solutions to the problems in the economy. Actions which provide temporary relief, but
which aggravate the underlying problems, are rejected. Thus, we
are quite pleased with the stated policy and apparent determination of the Federal Reserve to reduce the long-term rate of money
growth.
THE IMPORTANCE OF MONETARY POLICY
Restoring economic growth and broadening individual opportunities requires increased incentives to save, invest, and work. Encouragement of real savings and real investment requires that savers
and investors, lenders, and borrowers, be convinced that the dollars
which they expect to receive in the future, either through wages or
investment income, will not be rapidly taxed away by inflation or
by high marginal tax rates.
Inflation aggravates distortions within the economic structure,
reducing economic efficiency, growth, and employment. For example, at a 10-percent inflation, the $3.35 minimum wage would have
to rise to $22.50 after 20 years, just to maintain constant before-tax
purchasing power. At that rate, even individuals who work full
time at the minimum wage would be in the current 50-percent tax
bracket. Employers would face steadily rising labor costs, while
workers would find the purchasing power of their wages, after
taxes, steadily eroding. Not only would total employment be restricted, the burden would fall progressively more on the unskilled.
With a 10-percent inflation, a college tuition of $1,000 soars to
$6,700 in 20 years; a $50,000 house rises in price to $336,000, with
property tax liability increasing accordingly; and an expected re-
430
tirement income of $20,000 declines in purchasing power to $3,000.
With continued inflation, changes in the tax law that go far beyond
the current proposals would be required simply to offset such distortions.
What do these calculations tell lenders—people who lend their
current purchasing power to others by buying debt instruments
such as bonds? The message is clear: If you expect inflation to
persist, you must cover yourself by increasing the interest rate
charged on these loans. But here again, taxes are imposed on the
additional nominal interest income, further distoring the situation.
In short, inflation not only raises nominal interest rates, but also
works through the current tax system to reduce the real rate of
return on many investments. This adds up to a decrease in the
incentive to save.
High interest rates are the rational reaction of credit markets to
the unlegislated tax which inflation imposes on the lending of
money. Even a balanced budget would have only a small effect on
this tax in the face of inflationary money growth.
The Federal Reserve cannot reduce interest rates with new regulations on credit markets or faster money growth. More money
signals more inflation. Any dip in rates which might result from
faster money growth would be temporary and rapidly dissipated.
Interest rates would rise to an even higher level as lenders, now
well trained on and highly attuned to the effects of rapid money
growth, would demand even higher rates of interest. The experience of the past 2 years indicates that this reaction would occur
very quickly, as market interest rates rose almost simultaneously
with each reported increase in the money supply. Since May of last
year, reports of rapid increase in money growth have led almost
immediately to higher long-term rates of interest, which are good
indicators of the market's perceptions about future inflation.
in I D vjieiwaii;
February 1980 to May 1980
May 1980 to November 1980
November 1980 to January 1981
January 1980 to April 1981
April 1981 to June 1981
-5.5
14.7
0.0
10.7
-6.9
^ - ^
-139
+198
-16
+107
-13
x
Not
2
adjusted for shifts into NOW accounts from savings and other interest bearing accounts.
Rate on corporate Aaa bonds (Moody's).
Interest rates also tended to decline quickly in the instances
when money growth has been slowed for several weeks. But these
decreases have been much smaller than the prior rises, indicating
strong skepticism about the long-term prospects for money growth
and inflation. This ratcheting upward of interest rates is a prime
example of the importance of establishing the credibility of the
policy of reducing the long-term rate of money growth. While
short-run variations in money growth probably have little direct
effect on economic activity, such volatility can create uncertainty
about the long-term prospects for keeping money growth on target,
especially when the record of meeting previous targets has been
poor.
431
I believe that the phased deceleration of money supply growth
which we presented in February—M1B growth of 7 percent in 1981
and 1 percent less each year through 1986—is the maximum rate
of monetary expansion which is consistent with eliminating inflationary pressures. Any success in achieving a more rapid slowing of
money growth would be welcome.
All of us are thankful for your past support of this policy of longterm monetary control. For several years, the monetary reports of
this committee, pursuant to the Full Employment and Balanced
Growth Act of 1978—the Humphrey-Hawkins Act—have strongly
supported a gradual deceleration of the money supply to noninflationary levels. The money stock had expanded by more than 8
percent in both 1977 and 1978, prompting this committee in 1979 to
speak out forcefully for a slowing in the rate of money growth. In
your March 12, 1979, and July 27, 1979, reports you recommended
a gradual decline in the growth of the basic medium of exchange,
from about a 7.5 rate of growth which was expected in 1979 to a 3percent rate by 1983. There was only one dissenting view in each
report.
Unfortunately, you did not get what you wanted, and the Nation
suffers the consequences. Instead of the 5-percent growth in 1980,
which would have occurred under the Banking Committee's schedule, the basic money supply (Mi-B) grew at 7.3 percent.
This administration strongly supports the type of monetary
policy which this committee has recommended. We are confident
that the Federal Reserve shares this desire. The deceleration of
money growth over the last several months clearly demonstrates
this policy in practice.
THE ISSUE OF MONETARY VARIABILITY
Separate from the policy issue of the appropriate monetary targets is the question of the best method for achieving a particular
target. While there is general agreement that a slowing of money
growth is desirable, controversy remains about which monetary
control procedure is best suited to the task. I have spoken out on
this issue, with recommendations for some technical adjustments
which I feel would improve the precision of monetary control.
However, this position has often been misrepresented by others
and it is important that we clear up the confusion.
Comments on the dangers of variations in money growth, of the
type that have been experienced since early last year, have been
misinterpreted as implying that the Federal Reserve should attempt to be more precise in controlling money growth in the short
run. Usually, this interpretation has been followed by the argument that tighter control of money in the short run would mean
significantly more variation in interest rates. In short, this view
reduces the issue of monetary control to a tradeoff between variations in interest rates and the precision of short-term monetary
control. However, that view avoids the real issue.
The task in any long-term program, such as targeting the annual
growth of money, is to tailor the short-term actions to maximize
the probability of hitting the long-term target. In the context of
monetary policy, that involves more than consideration of precision
of monetary control on a monthly or weekly basis. In the short
432
term, money would be expected to deviate from the long-term
target path for a variety of reasons, including shifts among various
classes of deposits, unforeseen slowdowns in the clearing of checks,
and irregular seasonal influences. There are two basic approaches
to handling this short-term variability of money.
One. A short-term monetary control procedure would attempt to
anticipate these deviations and take actions to prevent them. Unforeseen deviations would result in explicit action by the Federal
Reserve which would attempt to bring money back to the long-term
target path.
Two. A long-term monetary control procedure would supply reserves on a fairly steady basis, expecting short-term deviations of
money to be random or self-correcting. The key to this approach is
an institutional structure in which short-term variations in money
set in motion forces which bring money back on track automatically.
The first alternative which I have presented—attempting to control money in the shortrun—is not only less likely to provide
sufficient longrun control of money, but would also increase the
shortrun variations in money and interest rates. That approach
would involve the Federal Reserve in a process of continuous tinkering in financial markets, in response to recent and expected
variations in money. Market participants are then encouraged to
concentrate on the shortrun money data, seeking information
about the likely actions of the Federal Reserve in the near future.
In this type of environment, the Federal Reserve would often be
reacting to the shortrun expectations in the market. In addition,
the focus of public attention on short-term movements in money
would detract from the more important long-term target.
For these reasons, the ultimate success of long-term monetary
control is enhanced by moving away from efforts to control money
in the shortrun and instead by strengthening the automatic corrective forces within the long-term control procedure. It is in this
context that I have discussed the benefits of moving to a system of
contemporaneous reserve requirements and more flexible administration of the discount rate. In my opinion, these technical modifications would enhance public confidence that a particular growth
of reserves would result in achievement of the desired long-term
growth of money, with only random variations in the shortrun.
These factors are particularly important for the current control
procedure, which sets targets in terms of nonborrowed reserves.
The modifications would be less important, but still helpful, under
a control procedure which set targets for a broader reserve aggregate, such as the monetary base. Recent evidence, for example,
indicates that much of the short- and long-term variations in
money in 1980 would have
been eliminated by more precise control
of the monetary base.1 According to that evidence, the monetary
base continues to provide an effective constraint on money growth,
even with the prevailing policy on reserve requirements and the
discount rate.
More precise longrun control of money growth would eliminate
the kind of interest rate volatility that has occurred in the last 2
1
Anatol E. Balbach, "How Controllable is Money Growth?", Review, Federal Reserve Bank of
St. Louis, April 1981, pp. 3-12.
433
years. The inflation premium and the uncertainty premium that
results from erratic monetary growth would be greatly reduced.
Interest rates would again reflect the interaction of real saving and
real investment, adjusting to allocate funds efficiently in a noninflationary economy.
THE EFFECT OF MONEY ON THE ECONOMY
With the long-term rate of money growth on course, the growth
of aggregate demand over the longrun will be restrained as indicated last year in the excellent report submitted by Congressman
Parren2 Mitchell of your Subcommittee on Domestic Monetary
Policy.
This evidence relates to total demand in the economy and to the
price level, not to real output. That phenomenon is called inflation.
The main impetus for increased real output in the administration's
program comes from the budget, tax, and regulatory proposals.
These programs would increase the total supply of goods and services in the economy, while the monetary policy will bring growth of
demand back into line. Monetary policy is a necessary complement
to the other elements of the program.
We will not weaken in our support of these proposals. Obviously,
we too would prefer that the budget be balanced immediately, as
the necessary changes in marginal tax rates are put into place.
However, the tax cuts, like the administration's policy of harnessing runaway budget expenditures, cannot wait. There will be no
better time in the future. The permanent detrimental effect of the
current tax structure on incentives for saving, investment, and
work would only get much worse and require even larger remedial
action in the future. The issue of the budget deficit would arise
again, and the numbers would be much larger than those that now
face us. The administration intends to move steadily toward a
balanced budget and believes that we can accomplish the task by
1984. This means that we and the Congress must maintain budgetary discipline in the coming years.
In the meanwhile, deficits of the magnitude which are contemplated in the budget plan would not inhibit the ability of the
Federal Reserve to control money growth. With a steady deceleration of money growth, any effect of the impending deficits on
interest rates would be more than offset by the reduction of inflationary expectations. The major portion of today's high interest
rates is the inflation premium, which would decline steadily as the
trend of money growth is reduced.
With other things unchanged, financing deficits through borrowing would tend to raise the inflation adjusted cost of capital. However, this effect must not be viewed in isolation. We are moving to
cut the size of the deficit further and to increase private sector
saving. The beneficial effects of the administration's tax and
budget programs will allow us to move more quickly toward our
mutually shared goals: A fully employed, inflation-free, competitive
economy, as is described in the formal objectives of the HumphreyHawkins Act.
2
"The Impact of the Federal Reserve Systems Monetary Policies on the Nation's Economy,"
December 1980.
434
WHAT IS THE ALTERNATIVE
Many years of rapid money growth and high interest rates have
injured all sectors of the economy. Industries such as housing and
automobiles, small business, the Nation's farmers, and the thrift
institutions have been pushed hard by this inflationary policy. The
policies and actions that led to high interest rates and rapid inflation have also severely hurt those in the work force, both those
with jobs and the unemployed. Purchasing power has been reduced
for those who have little room to economize. Employers who face
this environment of fast money growth, high interest rates, and
inflation, do not rush out to make longrun plans for expansion of
productive capacity and more employment. Instead they cut back.
Inflation and high unemployment go hand in hand. The old idea
that it is possible to buy more employment through accelerated
money growth, embodied in what has been called "The Phillips
Curve/' has been sharply contradicted by events.
Where is the sentiment for rapid money growth? This was the
preferred policy of many in 1977. For example, the Joint Economic
Committee's midyear report in 1977 contained the following estimates: Maintaining a constant Treasury bill rate—it was 5.3 percent in 1977—would require the growth in the basic money supply
to accelerate to at least 11 percent in 1978 and 1979. The report
claimed, however, that this would cause a3 modest inflation, full
employment, and a balanced budget by 1980.
In fact, money growth accelerated to 8.5 percent in 1978 and 7.5
percent in 1979. Interest rates? They rose into the double digits.
Inflation—which had been described as built in at somewhere
around 5 or 6 percent in 1976 and 1977—was not expected to rise
significantly. However, the consumer price index rose at a 9.5percent annual rate in the 1978-79, period compared to a 6.5percent increase in 1976. The GNP deflator reported an acceleration from 6.0 to 8.1 percent over the same period.
The American public does not need more experience with fast
money growth. They have literally had enough.
This administration is committed to policies which will bring a
permanent end to high inflation, high interest rates, and high
unemployment. We recognize there are some immediate costs, but
we recognize the inevitability of much higher costs, if effective
action is delayed. The alternative to moving now—a continuation
of fast money growth, higher tax rates, and spiralling Government
spending—poses much higher costs; namely, the destruction of our
economy. Rapid money growth would drive interest rates, inflation,
and unemployment far above present levels.
I am convinced that most Americans, together with the members
of this committee, join with the administration in firm support of
the Federal Reserve's noninflationary monetary policy.
Participants in the domestic and international financial markets
will soon get the message: Expectations of continued rapid inflation
in the United States are wrong. However, expectations are not
brought down by equivocating on monetary policy, or searching for
other means to reduce inflation. There are no alternatives to this
3
The 1977 midyear Review of the Economy, Report of the JEC together with Minority and
Additional Views, September 30, 1977, pp. 35-37.
435
administration's economic recovery program, and the public knows
it.
We are off to a good start and we shall stay the course.
Mr. Chairman, if I may turn for a few moments to the Ottawa
summit, I'll be very pleased to touch upon the major issues that
we're discussing.
Mr. SPRINKEL. I will touch on the microeconomic aspects and
concentrate on the macroeconomic issues.
We were very pleased, frankly, with the results of the summit.
They provided President Reagan, Secretary Regan, and Secretary
Haig an opportunity to meet and work with their counterparts.
It was very clear that the point of view expressed by the American delegation had a major impact upon the contents of the communique that was issued. It was very clear that we set our course
straight, and we were determined not to deviate from it. We intend
to get this inflation down.
As you remember, there was a sentence or two in the communique, indicating that all seven countries at the meeting agreed that
the effective way of getting inflation under control was to reduce
the rate of growth of the money supply.
There also was recognition that money alone isn't enough. And
no one argues that it is, least of all the monetarists.
There was important emphasis placed on budget restraint: getting deficits under control and slowing the rate of rise in Government spending. And again, all governments agreed to that particular point of view.
There was a very pleasing emphasis on the desirability of encouraging free flows of capital between nations and encouraging free
trade. There has been great concern expressed by the participating
countries that because of the poor performance not only of the U.S.
economy but in the economies abroad that there will be great
pressure to move toward protectionism, leading to the results that
occurred in the late twenties and the early thirties, when "beggarthy-neighbor" policies were pursued around the world with disastrous results.
All governments have pledged to do their utmost to resist such
pressures in our present solution of the problems. There was considerable discussion of energy, with primary emphasis on utilizing
the marketplace to increase the production of energy, as well as to
discourage consumption.
There was emphasis placed on the desirability, moving in the
direction this Congress has moved, to increase the stockpiling of oil
so that in the event we encounter problems in the future, we will
not be as seriously exposed as previously.
There was a great deal of discussion, as you are well aware, of
not only interest rates, which we will be discussing today, but also
exchange rates.
Many of the countries have argued that high interest rates make
it very difficult to pursue the policies domestically in their own
countries that they prefer. Therefore, there was some discussion as
to what could be done to bring then under control.
There clearly was a widespread recognition that slowing the rate
of growth in the money supply and getting our budget under
436
control was critically important, both in getting the inflation down
and getting interest rates down.
Finally, on the subject of exchange volatility, it was recognized in
the communique coming out of Ottawa that volatile exchange rates
were very unfortunate. There was an implicit statement to the
effect that the way to eliminate great volatility in exchange rates,
was, of course, to get inflation under control.
I assure you that we are urging our counterparts in other countries to take the same medicine that we're trying to take at home:
namely, get inflation under control.
We prefer stable exchange rates. The only way to make it lasting
is to have low rates of inflation among all important trading nations,
That is a brief summary of what went on. We were very pleased.
The CHAIRMAN. Thank you, Secretary Sprinkel.
Now, with the consent of the committee, again, we'll place your
entire statement in the record, and you may proceed, Mr. Mehle.
STATEMENT OF ROGER W. MEHLE, ASSISTANT SECRETARY OF
THE TREASURY FOR DOMESTIC FINANCE
Mr. MEHLE. Mr. Chairman and members of this distinguished
committee, I appreciate this opportunity to review with you the
present condition of depository institutions, their ability to deliver
credit to all sectors of the economy and the contingency plans
available to deal with any problems confronting the institutions.
Since Dr. Sprinkel has presented the administration's views on
monetary policy, I will not deal with this subject except to indicate
the importance of lower inflation and lower short-term interest
rates to financial institutions.
I would like to review the condition of depository institutions in
the context of how we should be structuring and modernizing them
in the future. Every action we take must be in the best interests of
the public as consumers of financial servicers. We must build a
strong and competitive framework that will give our institutions
the flexibility to respond to a changing financial environment and
shifting market forces with the best and most varied financial
services for years, indeed, for decades to come.
THE FINANCIAL CONDITION OF DEPOSITORY INSTITUTIONS
Despite enormous inflationary pressures, our financial markets
and financial institutions have generally been performing well. The
one problem area involves thrift institutions—savings and loan
associations and mutual savings banks—and to a lesser extent,
small commercial banks whose primary business is financing housing. These institutions have structural problems in their asset and
liability portfolios that make it difficult for them to cope with very
high interest rates, but once this difficult period is passed, they
should resume their valuable role as vehicles for savings and for
housing finance.
Consumers justifiably have confidence in thrift institutions. It is
our job to enhance that confidence by making this industry stronger and more effective in the future. Despite the industry's current
difficulties, the administration is quite optimistic on the long-term
outlook for thrift institutions.
437
At the moment, the distortions and uncertainty caused by inflation, in interaction with continuing asset regulation, are forcing
thrift institutions to use an increasing amount of deposit liabilities
with interest rates that vary with market rates to make long-term
mortgage loans or to carry long-term mortgages made in prior
years. The remainder of the institutions' deposits are under Federal deposit interest rate ceilings and have rates that vary with
market rates only below the ceilings.
However, most thrift institution mortgages have fixed interest
rates set when the loans were made, often years ago at rates
substantially below current market levels. The ratio of variable
rate mortgages to total thrift industry loans is much smaller than
the proportion of rate-sensitive deposits relative to total deposits.
This imbalance between increasingly rate-sensitive liabilities and
long-term relatively rate-insensitive assets is central to the thrift
industry's current problems. In the present inflationary environment, short-term interest rates exceed both the rates on most of
the institutions' existing mortgages and the long-term rates on new
mortgages—an inverted yield curve. As a result, thrift institutions
are paying more for their liabilities than they are earning on their
assets, which means they are operating at a book loss and thereby
eroding their net worth.
Decontrol efforts have not gone far enough in reducing the vulnerability of this industry to high short-term interest rates because
inflation and high rates have constantly exceeded everyone's expectations. Decontrol of thrift institution liabilities has always been
catching up with the need of the industry to remain competitive in
acquiring at least enough deposits to carry existing assets, that is,
meet minimum liquidity meeds. Actually thrift institutions in the
first 5 months of 1981 retained sufficient deposits which, coupled
with other items of cash flow, enabled them to increase their assets
5.6 percent on an annualized basis.
In terms of what they regarded as their fair share of available
money, however, the institutions were less successful in meeting
competition from alternative investment instruments with market
interest rates. In the first 5 months of 1981 money market mutual
fund assets increased about $43.2 billion, while total deposits at
insured savings and loan associations increased approximately $6.5
billion and at mutual savings banks $.1 billion.
One proposed solution to this competitive shortfall would be to
moderate the ability of money market mutual funds to pay high
interest rates. Several proposals have been advanced to achieve
this objection, but these would merely penalize the public and not
create a competitive balance; even if severe restrictions were enacted to drive investors out of money market funds, they would
only seek other high interest yielding alternatives—Treasury securities, commercial paper, bankers, acceptances, and so forth and
raise the demand for still more restrictions. Imposing new controls
on our financial markets would be the wrong approach to assisting
the thrift industry. It would be treating only a sympton of the
industry's real illness which is high-interest rates. What the industry meeds most at the moment, along with the entire economy, is
less inflation and lower short-term interest rates. But any longterm solution to the industry's problems must also deal with the
438
asset regulatory structure that so limits the ability of thrifts to
deal with changing economic circumstances.
APPROACHES TO THRIFT INDUSTRY PROBLEMS
Mr. Chairman, we think that the President's economic recovery
program of balanced tax, budget, and monetary policy features will
work collectively to further reduce the rate of inflation which has
already begun to decline. This, in turn, should lead to lower interest rates and a normal yield curve. The tax program, by increasing
the return on savings, should also lead to greatly increased savings
rates. All these elements should improve the position of the thrift
industry.
Currently, the thrift industry does have ample cash flow with
which to conduct its business and meet its obligations to depositors.
Interest income, mortgage principal repayments, and Federal
Home Loan Bank borrowings more than offset withdrawals of
thrift industry deposits in the first 5 months of 1981. The excess
funds have been invested in new higher yielding assets, mostly
mortgage loans. Nevertheless, it must become more competitive in
acquiring the deposits it needs to insure its continued growth.
To enable all depository institutions to be more competitive in
obtaining funds, the Depository Institutions Deregulation Committee on June 25 adopted a 4-year phaseout schedule for deposit rate
ceilings. In the first phase, beginning August 1, rate ceilings are
removed on all deposits with maturities of 4 years or more and
ceilings on deposits with maturities of 2V2 years to 4 years are tied
to the yield on 2V2 year Treasury securities. This further deregulation of liabilities should make depository institutions immediately
more competitive with other intermediaries paying market interest
rates. Insofar as thrift institutions benefit from this action, so
should homebuilding for which these organizations are the primary
source of credit.
But while thrifts must be able to pay market interest rates on
deposits in order to attract sufficient loanable funds, they must
also have the ability to invest in a portfolio of assests which will
provide greater stability and allow a sufficient rate of return
during all phases of the business cycle. There is a schedule now for
the phaseout of deposit rate ceilings but asset power deregulation
is lagging. Earlier this year substantially liberalized alternative
mortgage instruments were authorized by the Federal Home Loan
Bank Board and the Comptroller of the Currency. The Congress is
currently considering legislation to preempt State usury ceilings on
consumer loans. The Depository Institutions Deregulation and
Monetary Control Act of 1980 preempted State usury ceilings on
mortgage and commercial loans, if the State legislatures do not
reinstate the ceilings within 3 years from the effective date of the
act. We favor the preemption of usury ceilings on consumer loans
in the same manner.
The regulators have developed proposals for broader deregulation
of thrift industry asset powers which the administration is still
considering. In general, we support these efforts and are preparing
detailed views on these proposals which we will express shortly.
I should point out that expansion of the industry's asset powers
does not imply that we believe thrift institutions will significantly
439
dimish their attention to housing. The new mortgage instruments
and the industry's existing familiarity with housing should substantially enhance its role as the major supplier of credit to homebuyers. Whatever other powers thrift institutions exercise should
supplement these activities and reduce the cyclicality of the industry's earnings.
We are confident that these liberalizations are the key to addressing the thrift industry's long-term structural problems.
However, until short-term interest rates decline, thrift institutions also will have the immediate problem of operating losses
eroding their capital. The decline in net worth is important because at some point the industry's depositors and lenders may
become troubled by the erosion of an account regarded as a mark
of an institution's financial soundness. (Depositors of $100,000 or
less generally will not have the same level of concern since their
funds are insured by the Federal deposit insurance agencies.)
In addition, some State regulatory officials and others concerned
with the industry's condition have come to accept net worth declines below some arbitrary minimum level as tantamount to insolvency. This is true despite the fact that such a decline in net worth
will not necessarily inhibit the institutions' day-to-day operations
based on cash flow. This rule-of-thumb "insolvency" concept bears
no relationship to the customary concept of insolvency, that is, the
inability to meet money obligations when due. I think it is important to note that during the first 5 months of this year when the
net worth of savings and loan associations declined an estimated
$1.4 billion their assets increased approximately $14.4 billion. This
is hardly characteristic of an industry with no money to pay its
bills. Nevertheless, the decline is net worth presents a problem for
the reasons outlined above. The best solution, of course, to the
problem of eroding net worth world be lower short term interest
rates. Then the industry would realize earnings with which to
rebuild its depleted capital.
In the meantime, the Federal deposit insurance agencies are
considering financial instruments and other means to bolster thrift
institutions' net worth where such assistance is needed and merited. Since this type of action will reinforce some of the traditional
measures of capital adequacy, it will enhance acceptance of these
institutions as going concerns, independent of arbitrary definitions
of insolvency. We believe the Federal deposit insurance agencies
and other regulators with whom we have been in close contact can
deal adequately with any seriously troubled depository institutions
that may need special assistance before short term interest rates
decline.
Thank you, Mr. Chairman; that concludes my testimony. I will
be pleased to answer any questions the committee may have.
The CHAIRMAN. Thank you, gentlemen.
If you would, we'd ask your indulgence while we go to vote. We'll
be back promptly and begin the question and answer and colloquy
section.
[Recess.]
The CHAIRMAN. Secretary Sprinkel, we'll get the questioning
going here. The other members will be back within moments, I'm
sure.
440
In your testimony, you acknowledge, point out, and agree with
most members of the committee and a lot of people around this
nation that at the present time the automobile industry manufacturer, the car dealer, the car purchaser, the home building industry, the home purchaser, and the small businessman is severely
impacted by inflation and in particular by high interest rates.
Now, in the past week or so, we've seen some unusual goings on
here. Major corporations in this country are seeking enormous
lines of credit. Within the past seven days, it has zoomed to about
$37.2 billion.
Pennzoil has a line of credit of $2.5 billion. They don't even know
what they want to bid on, but they figure they want to be part of
this game.
Many of the others are involved in the Conoco war. The bids
again this morning went up dramatically.
Mobil has drawn down its money, and we're informed, perhaps
accurately, perhaps not, that they have deposited this money in
some London banks. That's $6 billion.
And you know, the odd thing is here's Mobil, they draw down $6
billion, and they're paying right now to have that money at hand.
Now, here you are following a tight money policy to attempt to
cure the long-term ills of the economy. And you and many others
say, "Well, a lot of people are suffering, but in the long run it's to
their benefit. It's like taking a cure. The short-term cure is difficult, unpalatable; but the long-term benefit is worth what you have
to go through."
But when you're the small businessman who needs $50,000 or
$100,000, and you look at these major corporations who are taking
money, as in the case of Mobil, not because they have to buy a
house, or to educate a son or a daughter, but just to play the game,
the monopoly game. It makes one wonder about what is happening.
Does the administration have any thoughts whatsoever of speaking to these people and saying, hey, wait a minute now, you are
supporting—and Mobil is supporting your program. By the way,
those ads are fantastic.
Now, how can they, on the one hand, support your program with
those ads—you know, "This plant has been closed for many years,
but now it will reopen under the new economic policies"—when
they are acting contrary, it would seem to me, to your policies?
Are you going to talk to those people? Are you going to jawbone
them a little bit?
You know, a lot is based on psychology. Paul Volcker and his
predecessors have testified that a lot of it is based on psychology—
what do people expect? Does these events help the psychology of
the nation at large?
Mr. SPRINKEL. I share your concern about the damage being done
by all sectors of the economy with high interest rates. My father
used to be a small farmer, and I remember what high interest
rates did to him in the Great Depression, so it's not as if I'm not
aware of the damage.
Let me say first that tight money policy does not cause high
interest rates. The easy policies of the past brought on the high
interest rates. If I could wave a magic wand and erase the errors of
the past, obviously we would do so. We can't. We have to face
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reality. And the reality is that today we still have very high rates
of inflation, very high rates of interest. We are exerting every
effort in cooperation with the Congress and the Federal Reserve to
get those interest rates down.
Now, turning to the question of allocation of credit, as you are
well aware, there is a difference between commitments and loans.
There have been some of each, but there have been many more
commitments than there have been loans.
The CHAIRMAN. Secretary Sprinkel, when there's a commitment,
the bank that makes the commitment has to be ready to fulfill the
commitment; therefore, that's stagnant money. It's not available to
the automobile dealer who has to finance his floor plan.
Mr. SPRINKEL. Mr. Chairman, I spent 28 years in the banking
business, and I assure you, we did not lock up that money down in
the vault because we'd made a commitment. That is, it's a commitment that must be honored; it's an insurance policy for the borrower, and the banks makes a commitment to stand ready to make it.
But that doesn't mean that they do not continue to utilize the
money that exists in the institution.
Now there have been some borrowings under those commitments.
The CHAIRMAN. Secretary Sprinkel, I know you spent a lot of
time in the banking industry, but when you're looking at the
numbers involved here, I'm sure you made a lot of commitments
for $1 million, $2 million, $5 million, $50 million, but when you're
talking billions of dollars, I think those bankers scratch their heads
and say, "Well, we've got to be prepared."
Mr. SPRINKEL. They are typically commitments between a group
of banks, and they are prepared. I have no doubt what, if called
upon, the banks that made that commitment will perform according to the contract. But that does not increase credit in the commitment form. When it becomes a loan, there is an increase in
total credit.
So that what you're really suggesting, it seems to me—and correct me, if I'm wrong—is that the Congress or the administration
should set down a list saying:
These are good things to do, and these are bad things to do. This is the efficient
way to use that credit; this is the inefficient way to use that credit.
And frankly, I have much more confidence in the free market's
allocation of credit than I have in my ability to decide what's good
or in the Congress ability to decide what's good.
We have a very efficient credit system out there where individuals spend full time deciding what is the most efficient way of
allocating money.
The CHAIRMAN. Therefore, you have no problem with this monopoly game that's going on at the present time?
Mr. SPRINKEL. I have no problem of avoiding the experiment that
was attempted in 1980, which was overkill of the most gross kind,
which led to serious problems in monetary control; and which was
followed by massive increases in money growth. We do not want to
engage in a credit control experiment. It has been tired many
times in this country and abroad, and we do not intend to go down
that road.
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The CHAIRMAN. YOU know, Paul Volcker expressed grave concern
this week when he appeared before this committee; before the JEC,
he wasn't that concerned. But it's accelerated. He came before this
committee the day before yesterday and expressed concern.
You have no concern?
Mr. SPRINKEL. I have concern about high inflation and high
interest rates.
The CHAIRMAN. That's not my question, you know. My question
is, do you have concern about the fact that these major corporations, these large corporations, are playing the game of takeover
and going forth and obtaining these large commitments from financial institutions.
You have no concern about that?
Mr. SPRINKEL. NO, sir. It's the policy of this administration that
bigness is not necessarily bad. What we are concerned about is
monopoly, and we will pursue vigorously those areas where monopoly threatens. We will not just automatically assume that a merger
is a bad thing.
The CHAIRMAN. You've answered the question. Thank you.
Secretary Mehle, less than 90 days ago, the regulators went
before the administration with legislation to address the problems
of thrift institutions. Incidentally, when you listed the problems of
thrifts, you listed the S. & L.'s, the mutuals, and some commercials. You did not list or mention the fact that there are credit
unions that are suffering at this point in time as well.
I take it, you agree that that situation exists, does it not?
Mr. MEHLE. Well, there are some that are suffering, but on the
whole, they are in reasonably good condition, as I think Mr. Connell testified in his appearance before this committee recently.
The CHAIRMAN. All right. In any event, the legislation that was
advocated by the regulators was given thumbs down by the administration.
Last week, the agencies came before us and they did indeed say
that the performance differs under varying interest rate assumptions. They gave the committee computer runs. The projections
indicate that if the interest rates don't decline from their present
levels in the next 12 months, the resulting volume of thrift institutions failures could cripple the Federal deposit insurance funds.
The Home Loan Bank Board's Mr. Pratt said on July 8, that S. &
L. losses could reach $60 billion and completely decimate the Federal Savings and Loan Insurance Corporation Fund.
Chairman Volcker said it would be imprudent to expect that
rates will decline significantly in the near future.
Now it's all well and good to tell us that you're reviewing Mr.
Pratt's recommendations. But that doesn't address the present
problem and the problem that will exist if there is a persistence of
high interest rates.
My question to you is, do you, the administration, have any
contingency plans? Or do you just expect to come to us and say,
"Well, the insurance fund has run out, so we're going to have to
appropriate more funds for the insuring agencies"?
Mr. MEHLE. The insurance funds right now, as you know, are
large—$11 billion in the case of the FDIC, about $6 billion in the
case of the FSLIC.
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The CHAIRMAN. The market value is about $4.4 or $5 billion the
FSLIC, depending on which way you slice it.
Mr. MEHLE. SO far as the administration is concerned, those
funds are adequate right now, together with the back-up lines that
each of these two funds has to borrow from the Treasury.
The CHAIRMAN. $750 million on the part of FSLIC. One institution. Whammo, it's gone, one big one.
Go ahead.
Mr. MEHLE. Adequate to cover the problems that may exist with
any given institution. I think it might be worth a moment to
elaborate on the point raised that you alluded to that was raised in
the testimony of the other regulators. That's the question of thrift
institutions running out of net worth.
I talked about this a little bit in my prepared remarks. It's
terribly important to be able to distinguish between a depository
institution's financial condition when it is losing money and that of
an ordinary nonfinancial corporation.
As I mentioned, while the thrift industry in the first 5 months of
1981 has lost about $1.4 billion of net worth, this is out of a total
amount of net worth of about $30 billion. During the same time,
the footings, the assets of the industry, have grown about $14.4
billion. This means that during a period of experienced losses—
negative earnings—the industry has not only been able to fund the
cash flows out of the institutions because of those losses, but also
has been able to add net to its asset base.
There's a very good reason for that and one that often escapes
public understanding. That is that the thrift industry's expenses
which are of course charges to income and charges to net worth, by
and large are noncash expenses, whereas the industry's income is
virtually, entirely cash income. So while there will be or can be
booked a loss during an accounting period as the result of a negative difference between cash income and accrual expenses, there is
in fact a growth of the institution during that period of time.
This is different from the ordinary corporation's status which
experiences a loss of cash when it has an earnings loss—negative
earnings—because all nonfinancial institutions largely pay their
bills in cash. Depository institutions, though, generally pay the
major part of their bills by crediting the account of their depositors. That essentially leaves the funds on deposit and enables the
institution to finance its growth. You might call it a forbearance of
lenders, which is, of course, how the industry is designed to work.
I want to emphasize that point, because while the industry is
having an earnings problem which is decreasing net worth and
causing it in some cases to go to some low number or to zero, which
has been the subject of much writing and discussion and alarmed
views, constituents of the industry by and large are continuing not
only to fund any withdrawals of deposits from them, but also net to
make new mortgages.
Now they are not doing that at the same rate that they did it in
the past. And as I said, the industry does not consider that it's
getting a fair share of the deposit funds that it should have. Certainly, it's not happy at all with the negative earnings, which I
thoroughly understand and sympathize with. But this is very dif-
444
ferent from an industry group that is on the verge of bankruptcy.
It simply isn't.
And I think we should all be very grateful that it isn't, because
obviously if we had to fund the payment of depositors, all depositors in, let's say, savings and loans and mutual savings banks,
there is not enough money right now in the insurance funds to do
that. But we do not look for that as a likely outcome.
One very important thing we must do, though, is to reassure the
public that the industry can continue to do business, can continue
to make new mortgages, and can fund any withdrawals that may
be made by depositors.
Something else that must be done—that has been done, thankfully, on June 25—is to give the thrift industry the ability to bid for
funds, so that it will be able to attract money that would otherwise
fly away to money market funds or some other open market alternative, even if the industry were as sound as the Rock of Gibraltar,
because it can only offer 5.25 percent to depositors. Although it
might have a very handsome net worth, the depositors would
simply say:
We're not interested. We think you're very sound and rock solid, but you're only
offering 5.25 percent, so we're going to go to the alternative that yields 15 percent.
On June 25, DIDC, created by this Congress in 1980, took an
important step in permitting the industry to bid in the open
market for funds. Effective August 1, the first effort under that
deregulation schedule will take place, and I, for one, hope that the
industry will be able to offer much more vigorous competition to
money market funds and attract deposit funds to a greater extent
than it's been able to in the last several months.
Mr. STANTON. Mr. Chairman, excuse me. We are going to have to
go vote in a minute. Before I leave —and I will be right back—I
wanted to make sure, Dr. Sprinkel, our staff has told us that you
have a previous commitment at 12:30; is that correct?
Mr. SPRINKEL. 12:30. I'm due at 12:45.
Mr. STANTON. It is obvious that if this keeps up, you will not be
able to give the members an opportunity to ask you questions, and
I would hope that you will raise a time, Mr. Chairman, soon that
Dr. Sprinkel could come back, because we have no control over
these calls. The members have been looking forward to asking you
some questions.
Mr. SPRINKEL. Yes, sir. Til be very pleased to return after that
commitment, if you would tell me when.
The CHAIRMAN. Secretary Mehle, No. 1, you haven't told me yet
whether or not you have a contingency plan. I assume since you
went through a very complete answer without mentioning any
contingency plan, the answer is that you don't have a contingency
plan; is that correct?
Mr. MEHLE. I think that all the contingency plans that are now
in place are adequate to the task of dealing——
The CHAIRMAN. In other words, you don't have anything beyond
what is in place today.
Mr. MSHLE. No, not in the way you suggest as a plan.
The CHAIRMAN. And you don't contemplate anything.
Mr. MSHLE. Not a plan.
445
The CHAIRMAN. But, you know, you say June 25 was a great day.
You're going to let the industry bid for funds. But in your own
testimony, you also brought out the fact that these institutions
have low yielding assets—assets yielding about 9V2 percent.
How can they go up against the money market funds?
Mr. MEHLE. HOW can they? Well, it's a simple thing to do.
The CHAIRMAN. HOW can they pay their depositor a higher rate
than they're getting on their assets, which is 9V2 percent?
Mr. MEHLE. This is part and parcel of what I was discussing
about their noncash expenses. If they offer a depositor—let's say, a
passbook account depositor—5 percent, and let's say the ceiling is
kept on and that it is lower than 9V2, that would mean that they
would not have any negative carry.
If the depositors all take their funds out, it doesn't matter whether you offer 5 percent because you will have to liquidate your
assets in order to pay off the depositors, which is the worst kind of
situation to be in.
On the other hand, if you offer 15 percent and you carry mortgages of 9V2, because in large part the interest expense is not cash
but instead is an accrual which is credited to the depositor's account and there is no departure of funds from the institution. For
example, in your experience and certainly in my own, if you have a
passbook account, you periodically take your passbook in and the
institution credits your interest. At that time, you don't draw it
out; you draw it out when you feel like drawing it out. However, it
is credited to your account as of then, and it shows up as an
expense to the institution at the time they credit it to you.
But fortunately for them—and this is part of the business of
banking—you leave it with them, and you only take it out if you
think you ve got a better opportunity elsewhere or you're scared
that unless you take it out then and there, you may never get it
back again. The latter concern I think we ought to put completely
out of mind, because I don't think the thrift industry is in that
position. The former concern, we are trying to deal with with the
DIDC.
The CHAIRMAN. Well, we are obviously coming from different
directions here. I've been sitting up here for a while, and I've now
had three Home Loan Bank Board Chairmen come in and tell me
that the situation is grave and that contingency plans are necessary. That's Mr. Pratt; that's Mr. Dalton; that's Jay Janis—all
three of them, in my opinion rather levelheaded people, not alarmists in any way, shape, manner, or fashion.
You know, a statement was made about an institution in New
York last week. As a result of that statement, there was $7 million
that went out of that institution in 1 day. So you know, they just
didn't take the interest out; they took the deposits, the principal,
out.
I just find it difficult to conceive that—difficult to conceive that
we shouldn't look to an effective contingency plan here, have it in
place, rather than have it come up to us overnight and say, "Pass
this overnight," because if you do, I'm going to cite this testimony.
I can't cite private conversations, but I'll cite this testimony.
Mr. MEHLE. That's certainly fair, but let me talk about the plan
for 1 minute. I think there are a number of contingencies that are
446
already available which don't necessitate the creation of any new
plan or scheme or anything of the kind. For one thing, importantly, there are the insurance funds which at the level that they are
funded are not insubstantial. For another, there are the Treasury
borrowing lines which are now in place. For a third, there are the
Home Loan Banks themselves which routinely make advances to
thrift institutions. A fourth is the idea that the Savings and Loan
Insurance Corporation and the Home Loan Bank Board are studying right now, to bolster the thrifts' net worth, which would treat
the problem of public confidence which might be shaken somewhat
in the event of a decline in net worth. The development of this
means of assistance, I understand, is underway and will be soon
available as needed and merited. A fifth alternative is lending for
liquidity purposes that the Federal Reserve is able and prepared to
do.
The CHAIRMAN. We asked Chairman Volcker about that. That's
still not in place. I've been advocating that since last October,
because the Monetary Control Act required it.
Mr. MEHLE. That is right.
The CHAIRMAN. It's still not in place. I hope the Treasury encourages the Fed on that one.
Mr. MEHLE. I think, to the best of my knowledge, that while
there may be some aspects to be sorted out procedurally, the Federal Reserve would be prepared to make any liquidity loans it might
have to make or might feel it is in order to make, to members of
the thrift industry. So there are five fallbacks, if you like. I don't
think we would ever foreswear any legislative initiatives, as the
Secretary of the Treasury mentioned in his April 28 testimony
before the Senate Banking Committee. We are watching the situation very carefully, and if it seemed that new measures ought to be
taken, we would certainly endorse their being taken.
The CHAIRMAN. Let me just make this statement. I called the
regulators and the Fed up to my office last October. I said, "Get
your heads together and let's find out what we need and let's put it
into place ahead of time; not wait until you have to do it overnight." The reason for that was that the situation back then was
not as severe as it is today, so we could have adopted the legislation and have it in place.
But if you come in and look for overnight relief, then you say to
the people at large and it becomes very apparent to the people out
there, that there is a severe situation. That's the instance wherein
what happened in New York this past week can happen again—a
great deal of funds can be withdrawn within a 24-hour period.
That's why I'd hoped that we could get together on something
ahead of time, rather than rely on that which you have enumerated. It's not my idea that more was needed. It's the idea of the
regulators who work in this area every day of the week.
Mr. Fauntroy?
Mr. FAUNTROY. Thank you, Mr. Chairman.
Mr. Sprinkel, I am very pleased to have the opportunity to hear
you and to just raise a couple of questions that have been of great
interest to me. During the past week, we have had an opportunity,
as you know, to talk with the Chairman of the Federal Reserve,
and my primary concern has been focusing on the cost of tight
447
money policy where there is no adequately supported or appropriate fiscal policy. My concern is that the administration's policies—
fiscal policies and tax policies—will impose such a severe burden
on the Fed that it will ultimately accommodate inflation caused by
those factors or allow the economy to enter into a prolonged recession.
In your view, does slower monetary growth have any effect on
output in the short run or the long run?
Mr. SPRINKEL. It depends on how quickly inflationary expectations decrease. Almost certainly they will not decrease instantaneously. Therefore, under most circumstances, one would expect
that a slowdown in monetary growth would not only slow the
growth in nominal income, but would lead to poor performance in
the short run on real income.
If you remember our recently released numbers for the last half
of this year, our planning numbers and our best guess show, I
believe, as Chairman Weidenbaum said, a very spongy performance, or some such phrase. That is, we are not ignoring the possibility that we will have a quarter or two of negative real growth.
The alternatives are worse. If we were to move back to stimulus,
we'd get some good news in the short run on real output. Very
probably, at least, since that's been the history. But almost certainly as day follows night, we will move into higher rates of inflation
and even higher interest rates. So I see no alternative to pursuing
the kind of policy that's been enunciated by this administration,
and certainly agreed to by the Federal Reserve Board. It is not a
high interest rate policy.
Again, you indicated that we had a tight policy causing high
interest rates. Tig;ht policies at the Fed cause low interest rates. It's
easy money policies in the past that caused the inflation and the
high interest rates.
Now, the burden is on the Fed. I understand they have a very
difficult problem and I don't want to make their difficulties worse.
We want to work with them; we are doing so; and we are quite
supportive of their general strategy and the way they are going
about getting money under control.
However, I would point out that there is no correlation between
the size of deficits and the rate of money growth. We did a study
recently on this issue. It turns out that you can find periods of
large deficits with low money growth and with high money growth;
periods of low deficits or no deficit—we've had only 1 in 20 years—
with high money growth, and a few periods of low money growth.
There is no technical relation nor any necessary causal relation
between the size of the deficit and the rate of money growth.
It is also true that there is no relation between the size of the
deficit and inflation. It all depends upon how that deficit is financed. If you finance the deficit with new money creation, as we
have often done in the past, we end up with higher inflation and
high interest rates.
This administration had pledged to avoid asking the Federal
Reserve to pump in a lot of money to finance our deficits. We are,
at the same time, pursuing a policy on taxes and spending designed
to supplement that recommended monetary path; namely, with the
cooperation of the Congress, together we have already succeeded in
448
cutting planned outlayed something on the order of $38 to $40
billions. That won't be the last time we try. With your help we
plan to continue to keep restraint on spending.
In addition to that, again, hopefully with the cooperation of the
Congress, and we expect with the cooperation of the Congress, we
have a tax package designed to encourage savings, encourage work,
and encourage investment. That's a deflationary philosophy, increasing the long-run capacity of this economy to grow and at the
same time avoiding inflation.
Now, am I saying I think deficits are a good thing? I certainly
am not. The sooner we can get rid of them, the better.
Mr. FAUNTROY. I am pleased to hear that, because while my time
is running out rapidly and while I was tempted to engage you in a
discussion of whether or not the deficit is a problem, I really
wanted to focus more precisely on the short-term effects on output.
You have indicated that in all probability there will be some shortterm effects. I wondered if you could tell us how long? Is it 1
month, 3 months, 6 months, 9 months, 1 year, 2 years? What would
be the period we can expect, given your projections at this point?
Mr. SPRINKEL. If we knew for sure we would certainly inform you
and other members of the Congress. We don't. It's our belief that it
will be a relatively short period of time and that the pain in the
short run will be more than offset by the benefits as we move into
1982 and 1983. I do not know how long it will last, but I assure you,
as we get inflation expectations down, the impact will be where we
want it to be, namely, on inflation and not on employment where
we don't want it to be.
Mr. FAUNTROY. Since you can't tell us any time frame, how much
of a turndown do you think a public official ought to be willing to
accept? You, in response to the chairman's question about the
precision with which credit decisions can be carried out in the most
efficient manner by the market, failed to take note that we as
politicians have to be concerned about the social effects. How much
of a turndown should we, who are public officials, ought to be
willing to accept to end inflation through monetary policy—2 years
of 8 percent unemployment? Three years at 7.5 percent? What if
unemployment reaches 10 to 15 percent?
Mr. SPRINKEL. I understand the pressures on the Congress and
the administration, I am sure, much better today than I did 7
months ago. I am sympathetic to your concerns not only for your
constituents but also for the Nation as a whole. If there were one
thing that I could change as an economist it would be a very
simple thing. That is, when we pursue restrictive policies we get
the good news in the short run and the bad news later on. Or
conversely, when we pursue easy policies, that we get the bad news
immediately and the good news much later. Unfortunately, it
works in reverse. And I understand the concern that you have
about paying short-run costs. In my judgment, the American people
are fed up with inflation, all of the damage that it does to the poor,
to the middle class, and to the upper class. They voted to get this
inflation under control and I urge you to support our efforts that
are directed precisely at that direction. We do not expect massive,
long-lasting unemployment.
449
Mr. FAUNTROY. You've given us a promise of misery without
really an assurance of a cure, however, Mr. Secretary. It's most
distressing to me that I see no sign of sensitivity for the concern
about how inequitable a policy and social troubles an induced
recession creates.
Mr. SPRINKEL. I am very sympathetic.
Mr. FAUNTROY. I yield.
The CHAIRMAN. Mr. Stanton?
Mr. STANTON. Thank you very much, Mr. Chairman.
Dr. Sprinkel, I've reread your statement three times. I did that
because you do put the case for the fight against inflation as well
as I've seen it in a long time on page 4, when you reiterate the
damages of 10 percent inflation. Your testimony clearly spells out
the problems, of course, of where we are and where we would be
down the road 5 years from now with this 10 percent continuous
inflation. I think the first man ever to do this was Alan Greenspan
a few years ago. He used at that time a 6-percent inflation rate to
determine where we would be. I remember well at the year 2000
the average income would be something like $69,000 or $70,000 per
year under Mr. Greenspan's scenario.
You also did a very good job with regard to discussing the importance of the money supply and the need to control the money
supply. Moreover, you tied it in with the goal of this committee
and especially our former chairman, to keep control of money
supply growth to noninflationary levels. The message seems to be
getting out to the point where everybody may believe it, but I was
surprised and somewhat disappointed to see the drastic market
reaction to 1 week's change in the money supply, up $7 billion. I
stated to Chairman Volcker that there was far more reaction to 1
weeks' money supply than there will be to the reconciliation bill of
the Congress, in which we reduce Federal spending by billions of
dollars.
I said that to one of my financial writer friends. He said that's
true, and he said further that that is what the administration
preaches. I looked at him and he said, yes: they put far more
emphasis on the supply of money than they do on a balanced
budget. And your statement this morning sort of leans in that
direction. You did an excellent job in explaining the need to control inflation by controlling the growth of the money supply, but it
is important to put this issue into proper perspective.
Not only that, but also I think, that the marketplace thinks that
the tax bill is inflationary, and so there may be a contradiction
here. This may be a temporary problem that will resolve itself, but
it is a general layman's feeling of the problem.
Mr. SPRINKEL. Thank you, Congressman Stanton. Let me address
the two issues that you raise and I will try to do it briefly. I want
to make very clear that I do not disregard deficits. I do not think
they are a good thing. They absorb savings; they must be financed;
and if we are not going to finance them with new money, we have
to finance them by absorbing savings. That means those savings
cannot be going into the productive sectors of the economy. This is
why this administration has pledged that we will get that deficit to
zero as quickly as possible. I wish it were zero today. But we
inherited this deficit and we are going to get it down with the
450
cooperation of the Congress. We're going to do it through, on the
one hand, restraining spending and, on the other hand, encouraging real growth through tax adjustments, which does increase savings.
Now, the reason so many believe that a tax cut is inflationary is
that, to put it one way, they look at the world through Keynesiancolored glasses. If you go back and read the Keynesian textbooks,
they will tell you that a cut in taxes leads to an increase in income,
which in turn leads to more spending, which leads to more income;
and you get that marvelous multiplier soaring. For each $1 cut in
taxes you get a multiple increase in spending.
That's indeed true, if you finance that tax cut with new money.
If you don't finance it with new money, that spending multiplier
stalls out but you do get an increase of incentives at the margin to
save, to invest, and to work. And that's exactly the heart of this
program. We will not permit that tax cut or monetary policy or
other policies to lead to the sorry state of inflation that we've bee
@FedFRASER