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S.
HRG .
99- 530
NOMINATIONS OF WAYNE D. ANGELL
AND MANUEL HOMAN JOHNSON, JR.
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
NINETY-NINTH CONGRESS
SECOND SESSION
ON
THE NOMINATIONS OF
WAYNE D. ANGELL, TO BE A MEMBER OF THE BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM, FOR THE TERM OF 8 YEARS FROM JANUARY 31, 1986
AND
MANUEL HOMAN JOHNSON , JR. , TO BE A MEMBER OF THE BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM, FOR THE TERM OF 14
YEARS FROM FEBRUARY 1, 1986
JANUARY 23, 1986
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
U.S . GOVERNMENT PRINTING OFFICE
58-006 0
WASHIN GTON : 1986
COMMITIEE ON BANKING, HOUSING, AND URBAN AFFAIRS
JAKE GARN, Utah, Chairman
JOHN HEINZ, Pennsylvania
WILLIAM PROXMIRE, Wisconsin
WILLIAM L. ARMSTRONG, Colorado
ALAN CRANSTON, California
ALFONSE M. D'AMATO, New York
DONALD W. RIEGLE, JR., Michigan
SLADE GORTON, Washington
PAUL S. SARBANES, Maryland
MACK MATTINGLY, Georgia
CHRISTOPHER J. DODD, Connecticut
ALAN J. DIXON, Illinois
CHIC HECHT, Nevada
JIM SASSER, Tennessee
PHIL GRAMM, Texas
M. DANNY WALL, Staff Director
KENNETH A. McLEAN, Minority Staff Director
W. LAMAR SMITH, Economist
(II)
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CONTENTS
THURSDAY, JANUARY 23, 1986
Page
Opening statement of Chairman Garn ....................................................................... .
Opening statements of:
Senator Proxmire .................................................................................................... .
Senator Gramm ....................................................................................................... .
Senator D' Amato ..................................................................................................... .
Prepared statement ......................................................................................... .
Senator Cranston ..................................................................................................... .
Senator Gorton ........................................................................................................ .
Senator Dixon .......................................................................................................... .
Senator Mattingly ....................................................................................................
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WITNESSES
Robert Dole, U.S. Senator from the State of Kansas................................................
Prepared statement ............................ ............. ..... .... ...............................................
Nancy Kassebaum, U.S. Senator from the State of Kansas....................................
Prepared statement .................................................................................................
John Warner, U.S. Senator from the State of Virginia...........................................
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NOMINEES
Wayne D. Angell, member of Kansas City Federal Reserve Bank's Board of
Directors........................................................................................................................ .
Involvement in farming ......................................................................................... .
Fiscal conservative .................................................................................................. .
Decision on nonbank banks ................................................................................... .
Independence of the Fed Board .............................................................................
Views on commodity price levels ......................................................................... .
No. 1 priority-stop inflation ............................................................................... ..
New index on a trade-weighted basis .................................................................. .
Failures of agricultural banks ............................................................................. ..
Undue pressure on bankers .................................................................................. .
Matter of tax breaks ............................................................................................... .
Mrr~~rct8r~:~~R~d~~~:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
Need for a stable price level ................................................................................ ..
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Label of hard-money populist .............................................................................. ..
Function best with openness ................................................................................. .
Gang of four ............................................................................................................. .
Regulation of nonbank banks ............................................................................... .
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~~t;:r;
abi::;!~~~fia~~:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
Japanese in the Government securities business ............................................. ..
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Debtor nation status ............................................................................................... .
A 2.4-percent GNP growth rate is no surprise ................................................. ..
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Biographical sketch of the nominee .................................................................... .
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Response to written questions of:
Senator Heinz .................................................................................................. ..
(Ill)
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IV
Wayne D. Angell, member of Kansas City Federal Reserve Bank's Board of
Directors-Continued
Response to written questions of-Continued
Senator D' Amato ................... ........................ .................................................. .
t~::~ ~:o~:tr::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
Senator Dodd .. ................................................ .................. ................................ .
Senator Dixon ................................................................................................... .
Manuel H. Johnson, Jr., Assistant Secretary of the Treasury for Economic
Policy ............................................................................................................................. .
Views on the central bank ...... ...............................................................................
Results of Treasury's study ................................................................................... .
Gross private savings up 19 percent .................................................................... .
Foreign funds have helped corporate expansion ................................................
$500 billion debt by 1990 ........................................... ............................................. .
Debtor nation for 200 years ....................................................................................
Enormous world leadership burden ..................................... ................................ .
Baker's three point plan ........................................................................................ .
Growth of Ml ........................................................................................................... .
Reciprocity with the Japanese ........ ................................... ........ ........................... .
Redeployment of factories offshore ...................................................................... .
Decline in foreign holdings of Government securities .................. ................... .
Biographical sketch of nominee ........................................................................... .
Response to written questions of:
Senator Heinz ................................................................................................... .
Senator D' Amato ............................................................................................. .
Senator Mattingly ........................................ ....................................................
Senator Proxmire ................... .............. ................ ........................................... .
Senator Dodd .............................................. ... ....................................................
Senator Dixon ................................................................................................... .
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NOMINATIONS OF WAYNE D. ANGELL AND
MANUEL HOMAN JOHNSON, JR., TO BE MEMBERS OF THE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
THURSDAY, JANUARY 23, 1986
U.S. SENATE,
CoMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The committee met at 9:30 a.m., in room SD-538, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
Present: Senators Garn, Heinz, D' Amato, Gorton, Mattingly,
Hecht, Gramm, Proxmire, Cranston, Riegle, Sarbanes, Dodd, Dixon,
and Sasser.
OPENING STATEMENT OF CHAIRMAN GARN
The CHAIRMAN. The Banking Committee will come to order.
This morning I want to welcome Dr. Wayne Angell of Kansas to
the Banking Committee.
Dr. Angell has been nominated to the Board of Governors of the
Federal Reserve System to fill an unexpired term that runs until
January 31, 1994.
Dr. Angell is currently a professor of economics at Ottawa University in Kansas. His graduate work was done at the University of
Kansas and he's been teaching economics since 1954. Dr. Angell's
background, however, has not been limited to economic theory.
He's been an active partner in a 3,300-acre farm since 1950. He has
also served as president of a small bank in Missouri since 1972 and
as chairman of a small bank in Kansas since 1975.
Given the serious problems besetting American agriculture and
our agricultural banks, I believe Dr. Angell's extensive hands-on
experience, not just theoretical, but actual hands-on experience in
agriculture and in agricultural banks, will be of considerable value
to the Federal Reserve Board.
The high regard which his fellow bankers have for Dr. Angell is
evidenced by their having elected him three times to serve as a director of the Federal Reserve Bank of Kansas City.
Dr. Angell, we're happy to have you with us this morning and
particularly happy that the majority leader is here and on time.
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STATEMENT OF ROBERT DOLE, U.S. SENATOR FROM THE STATE
OF KANSAS
Senator DoLE. The reason he said that is we both left the same
meeting and I didn't know he would beat me here but he did.
Let me just-I think the chairman has given a pretty good summary of Dr. Angell's qualifications. I want to stress the point you
made about agriculture. I think it's been the wish of the chairman
for some time and I think other members of this committee that
we have agriculture represented on the Fed and we are in deep distress. We are particularly proud in Kansas because as far as we
can find out you're the first Kansan who's ever been on the Fed
and we think it's about time.
If we look whether it's the Midwest, the Southeast, wherever we
look in rural America we have real problems. Wayne Angell is a
real live farmer. He farms out in southwest Kansas and he's not
someone who's an absentee landlord. He knows what it's all about
and been doing that since 1950.
In addition, as the chairman has ~inted out, he's been a
member of the Fed in Kansas City. Hes been active in banking.
He's a professor of economics. I think he has outstanding credentials. Beyond that, I think it may be helpful to the committee to
know that many times we introduce people that we've known but
we really don't know. In this case, it's someone I really know. I
mean, I have worked with Wayne Angell. We happen to be Republicans. He was one of my campaign chairmen in the Second Congressional District in Kansas. He was a candidate for the U.S.
Senate defeated in a close primary by Nancy Kassebaum, so it's another indication of the respect he has in our State, not just among
Republicans but Republicans and Democrats as well.
And I think it's very important and the fact that he's been out
on the firing line, as we all have, trying to persuade people at the
ballot box I think is another consideration, a positive consideration
of this nominee.
So I'm just pleased to be here. I would ask that my statement be
made a part of the record. I've been telling farm groups ever since
the President submitted this nomination that I would expect and I
would hope that Dr. Angell, if confirmed, would spend a great deal
of time visiting with rural bankers, visiting with agribusiness
types, farmers themselves, to see if there is some relief that we can
bring from the top for a very troubled segment of our economy.
I know that this committee is very diligent in considering nominees, as you should be. I know that Dr. Angell is prepared to
answer any questions that anyone on this committee will raise.
I would ask that my statement be made part of the record. I
would also indicate that the nomination has the full support of our
entire delegation, Republicans and Democrats. My colleague, Senator Kassebaum, is not in Washington today and could not be here. I
would ask that her statement be made a part of the record. I thank
you, Mr. Chairman.
The CHAIRMAN. Without objection, your statement will be, and I
do have Senator Kassebaum's statement which we will include in
the record, and we thank you very much for your willingness to be
here this morning.
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[The complete prepared statements of Senators Dole and Kassebaum follow:]
STATEMENT OF SENATOR DoLE
Mr. Chairman: For me it is a great pleasure indeed to have the opportunity to
present to this committee a very distinguished Kansan, one who will serve the country well. Wayne Angell brings outstanding credentials to the job of central banking
and regulation of financial institutions, and I am sure this committee and the
Senate will want to expedite his nomination to the Federal Reserve Board.
UNIQUE EXPERIENCE
Mr. Chairman, since 1979 Wayne has served as a director of the Federal Reserve
Bank of Kansas City, so he is well-versed in the workings of the Federal Reserve
System and understands the exceptional responsibilities which the Board of Governors must carry. In addition, Dr. Angell has extensive experience in banking with
both banks and bank holding companies. Coupled with Wayne's business experience
is his exceptional academic background, both at Ottawa University and in his own
studies.
Those credentials make it clear that Wayne Angell will bring top-level skills to
bear upon the problems faced by the Federal Reserve. Not only that, but Wayne has
the unusual virtue of coupling a strong banking background with experience in agriculture. He has been active in farming since 1950-he understands the farm economy, its unique challenges and problems. No qualification could be more important
for a position of high responsibility in determining the economic course of our
Nation.
CRfflCALTIME
Mr. Chairman, this is certainly a time when we need individuals of the highest
caliber to serve at the Federal Reserve. Both Wayne Angell and Assistant Secretary
Manuel Johnson-another outstanding nominee before you today, though unfortunately not a Kansan-will have their work cut out for them at the Fed. The course
of monetary policy will not be smooth, given the conflicting domestic and international pressures that are at work in this late stage of economic recovery. At the
same time, weakness in some sectors of the financial services industry is contending
with pressures for further relaxation of the barriers separating different types of
financial institutions. So all told, your nominees this morning will have their work
cut out for them.
Finally, let me note that we can do both of these gentlemen-and Chairman
Volcker-a huge favor by acting to reduce the budget deficit, take some responsibility ourselves, and reduce the burden on the Federal Reserve to maintain the confidence of the financial community.
Again, I am proud to present Wayne Angell to this distinguished committee.
STATEMENT OF SENATOR NANCY KAssEBAUM
Mr. Chairman, it is with a great deal of pleasure that I offer my support today for
the nomination of Wayne Angell for appointment to the Board of Governors of the
Federal Reserve. I believe this committee will find Dr. Angell to be an outstanding
individual who possesses all the requisite credentials for service on the Federal Reserve Board.
Wayne Angell has a breadth of experience that is hard to match. He haa worked
in nearly every field of the real world. As a professor, he has seen the enthusiasm of
young people seeking to understand their world better. He has shown that he can
both teach and learn. As a banker, he understands the demands of the financial
system on a practical level. He has worked with small businesses, farmers, and individual consumers. As a farmer and rancher, he is uniquely aware of the challenges
facing agriculture today and he fully understands the impact of macroeconomic decisions on family farms and rural America. Finally, as a member of the Kansas City
Federal Reserve Bank's Board of Directors, he has the knowledge and broad perspective necessary to serve the entire country effectively.
I am convinced that the presence of a person with hands-on experience in banking, education, and agriculture will be of benefit to the Board and to the Nation.
The Federal Reserve Board plays a crucial role in determinini overall credit conditions and the future growth of our economy. Wayne Angell s nomination by the
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President and confirmation by the Senate will underscore our commitment to policy
choices which will benefit everyone without sacrificing anyone.
Kansas is proud today to offer one of its most distinguished citizens as the next
member of the Federal Reserve Board. I know that a review of Wayne Angell's
record of private and public service will show that he is not only qualified and deserving of confirmation, but that he will be an invaluable member of the Board. I
thank the committee for the opportunity to express my support for and confidence
in Dr. Wayne Angell.
The
CHAIRMAN.
Senator Proxmire.
OPENING STATEMENT OF SENATOR PROXMIRE
Senator PROXMIRE. Mr. Chairman, these nominations concern me
deeply. I think the Federal Reserve Board has been the one powerful instrument of reason and stability in the Federal Government
economic policies that have otherwise gone bonkers.
For the past 5 years we have suffered a series of appalling deficits, $109, $195, $175, $202 billion, and this year we are on our way
to another $200 billion deficit even with Gramm-Rudman-Hollings
cutting the deficit by $11.7 billion.
In most of the past 6 years the Federal Reserve has followed a
monetary policy which was vehemently criticized by many. But despite our grossly irresponsible and inflationary fiscal policy the Fed
broke the back of the worst inflation in the Nation's history.
Meanwhile, the Chairman of the Fed, Paul Volcker, has been
properly and rightly reminding the Nation and the Congress that
the present fiscal policy of huge back-to-back deficits through an
economic recovery period is an unmitigated disaster.
Today we have before us for confirmation two able and respected
appointees to the Federal Reserve Board. One of them might very
possibly succeed Chairman Volcker as chairman in August 1987,
less than 2 years from now.
Both of these impressive, articulate, highly intelligent nominees
seem to see little if any danger in the deficit. In fact, both appear
to favor a monetary policy that will accommodate the deficit. They
want a monetary policy that in my judgment would be aimed temporarily in the short run of holding down interest rates-I want to
emphasize in the short run.
In the long run, I firmly believe these policies will cause superinflation and maybe worse. Even if neither succeeds to the chairmanship of the Fed, these nominees provide a basis along with other
appointees of this administration for a radically new Federal Reserve policy. The policy will differ not only from that pursued by
Chairman Volcker, but also Chairmen Burns and William McChesney Martin.
In the 28 years I have been in the Senate and on this committee,
that policy has been bipartisan and consistent. It's often been severely criticized, but it's served the country well and now it's about
to change.
The last thing we need on the agency that determines the Nation's supply of credit, in my judgment, are members who believe
that the Federal Reserve Board should accommodate the colossal
deficits by supplying the credit the deficits demand.
Dr. Johnson has said that he believes the Federal deficits have
little to do with interest rate fluctuations. Dr. Angell has apparently written or said little about the economic consequences of the
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deficits, but he appears to believe that monetary policy can function with little or no reference to the size of Federal deficits.
He writes in the letter he provided to Senator Dole and which he
graciously provided to me:
When U.S. monetary policy moves from ease to firmness the international
demand for dollars can be expected to soar. Mf primary disagreement with the
Board of Governors in my 6 years as a class A Director at Kansas City has been in
allowing the dollar to appreciate in excess of 70 percent against most international
currencies.
So Dr. Angell does not blame the deficits for the rise in the
dollar value and the consequent deterioration of our trade balance.
Instead, he blames what this Senator has construed as the anti-inflation policy oi the Fed moving from ease to firmness to break the
back of inflation.
So I admire the quality of both these nominees and their remarkable ability to make their views appealing, but I am deeply troubled by the consequences of these nominations for our economy.
Big inflation, here we come.
The CHAIRMAN. Senator Gramm.
OPENING STATEMENT OF SENATOR GRAMM
Senator GRAMM. Mr. Chairman, let me say that I appreciate
having had the opportunity to visit with both Dr. Angell and Dr.
Johnson. In my year in the Senate, I don't know of two appointees
that I have seen who have been better qualified.
In listening to our distinguished colleague from Wisconsin, I rejoice in the fact that the Fed is no longer in the battle against the
ills of deficits alone. We in the Congress have committed ourselves
to a 5-year program that will be tough on politicians but will be
good on the people who do the work, pay the taxes, and pull the
wagon. It will require, however, recognition at the Federal Reserve
that as we reduce the degree of fiscal stimulus by reducing the deficit, that it's important that there be a transition so that the private sector can expand demand and fill the gap left by the reducing deficits which I hope we produce under the Balanced Budget
Emergency Deficit Control Act.
I think during that period we do need an expansive monetary
policy but a steady policy and I believe we can accommodate the
transition to expanding private demand. Quite frankly I rejoice at
the fact that we have two excellent nominees before the committee
today who can provide the leadership that we're going to need.
I guess there are those who think we have too many economists
in Government today. I think quite frankly we don't have enough.
But I especially am pleased about the fact that Dr. Angell is not
just an economist and a distinguished academician but that he has
practical experience as well. I guess now you have to own a bank to
be in farming in Kansas, but with your broad experience, I think
the practical knowledge you bring combined with an understanding
of the economy, I think is going to be a real contribution to the
Federal Reserve. This will be at a time when we're going to need
strong leadership and I'm very proud of these two appointments by
the President and I vigorously support them both.
The CHAIRMAN. Thank you, Senator.
Senator D' Amato.
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OPENING REMARKS OF SENATOR D'AMATO
Senator D' AMATO. Thank you, Mr. Chairman.
Mr. Chairman, I have several questions for the record and an
opening statement with respect to both nominees. I'm not going to
comment about whether we need more or less economists in Government. That's a matter for debate, but I am pleased that the two
nominees have backgrounds and demonstrated sensitivity to the
issues that will serve the country well. This is something that is
necessary at the Federal Reserve because I think there have been
times when the Federal Reserve has been less than responsive to
some deep economic problems facing this country because, at times,
I think Mr. Volcker inflicted a little too much pain on the country.
We forget those days-and there was a Congress with almost a
united voice that said, "My God, loosen up on the money supply.
Bring down that discount rate. We're putting people out of business unnecessarily."
I think it's important to have some people who may look at this
with a broader pel'Spective. I would ask that the balance of my remarks, Mr. Chairman, be placed in the record as if read in their
entirety.
The CHAIRMAN. Without objection.
[The complete prepared statement follows:]
STATEMENT OF SENATOR ALFONSE M. D'AMATO
Senator D' AMATO. I want to welcome Dr. Johnson to the committee this morning to address certain issues that will confront him as
a member of the Board of Governors of the Federal Reserve. Due to
the role that the Fed plays in shaping monetary policy, which in
turn affects the inflation rate and real economic growth, I believe
that a Governor of the Federal Reserve System is one of the most
important nonelected officials in the Federal system. The influence
exerted by the Fed on economic policy and our financial system requires that it jealously guard its status as an independent agency
of the Federal Government.
During his tenure, Dr. Johnson will be required to address issues
that range from the regulation of junk bonds to deposit insurance
reform, in addition to making decisions affecting monetary policy.
Due to the nature of these issues and their impact on the economy,
the decisions of the Board must be guided by public policy considerations rather than political expedience. This does not mean that
the positions of my colleagues or the administration should be ignored; rather, they should be accorded proper deference. Although
I share the opinion of Dr. Johnson regarding the general role of the
Fed, which is to support policies fighting inflation and promoting
stable economic growth, and certain specific reforms of existing financial regulations, I question his commitment to the deregulation
of the financial services industry.
Despite this difference, Dr. Johnson's academic and professional
accomplishments recommend him for the position to which he has
been nominated. I look forward to working with him in the future.
The CHAIRMAN. Senator Cranston.
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OPENING REMARKS OF SENATOR CRANSTON
Senator CRANSTON. I welcome the nominees and I welcome the
distinguished introducer of the nominee at the table.
I have one comment. I think that the President should have
more ability to have the Fed accommodate the administration's
economic policies more directly. We then will have a firmer picture
of who is responsible for what is happening to the economy. One of
my concerns about the Fed has been that it is somewhat removed
from the political process.
So while reserving final judgment, I am presently and strongly
inclined to support these nominations primarily because both the
people are obviously qualified in this field but, more importantly,
they will reflect the President's views on the Fed and I think that's
appropriate.
The CHAIRMAN. Senator Gorton.
OPENING REMARKS OF SENATOR GORTON
Senator GoRTON. Mr. Chairman, I suppose there are probably
some members on the committee who wish that our own professor
of economics were out there rather than up here.
Senator GRAMM. I'm the minority.
Senator GoRTON. But we're happy to have him up here and I
think that his efforts over the last 6 months may well have made
the task of these two nominees, once they are confirmed, easier
and more likely to be productive than would otherwise be the case.
I feel that these are the two more important nominations which
we have had before this committee during the time that I have
been a member of it with the exception of the renomination of the
Chairman of the Federal Reserve himself. When the Senate and
this committee are dealing with nominations for extended periods
of time which will go far beyond the term of the President who has
nominated them, our responsibilities are particularly significant. It
does mean that their views on economic issues are legitimate subjects for inquiry because of the importance of the Board to which
they have been nominated.
I met with both nominees yesterday. I was both impressed and
encouraged by what they said. I think we often say that hindsight
is 20-20. I'm not sure that even hindsight is 20-20 when we deal
with the subject matter with which the Federal Reserve Board
deals. Clearly, foresight is not, and the degree of wisdom, a willingness to listen, very, very sound academic and business backgrounds
are all major qualifications for these positions. Both nominees, it
seems to me, share those qualities, but I will be most interested in
hearing the detflils of their views on both the immediate past and
the immediate future of the Federal Reserve Board as we go
through these nomination hearings.
The CHAIRMAN. Senator Dixon.
OPENING REMARKS OF SENATOR DIXON
Senator DIXON. Mr. Chairman, I ask that I be permitted to place
some questions for Dr. Angell in the record. I welcome him to this
hearing this morning and simpl:r wanted to comment that I examined his statement and I see he s been a director of a Federal Re-
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serve Bank in Kansas City. I also see he's been a member of the
Kansas Legislature and was once a precinct committeeman and I'm
glad to see that he's well qualified for the job that the distinguished majority leader has recommended him for to this committee and I'm delighted to have him as a guest.
Senator DoLE. And a farmer, too.
Senator DIXON. And a farmer as well. He might be overqualified.
The CHAIRMAN. Senator Mattingly.
OPENING REMARKS OF SENATOR MATTINGLY
Senator MA'ITINGLY. Thank you, Mr. Chairman. I have a statement for the record and will have some questions for Drs. Angell
and Johnson.
I would like to say that obviously you are fully qualified to serve.
I'm, however, a little bit concerned that your birthplace is Liberal,
KS. Some of us would have felt a little bit more secure if that had
been Conservative, KS, but I'm certain that your associate there,
Senator Dole, who's going to speak for you, can take care of the
conservative side. It is good to have another economist in the Government. It's just unfortunate that he's not elected, Senator
Gorton, but nobody is taking shots at anybody. We love economists.
I would like to say welcome really and I know you will do a great
job.
I would like you to address sometime during your remarks the
possibly of the Federal Open Market Committee releasing the minutes of its meeting more rapidly than they currently do. I think a
lot of people are concerned over that delay. As you probably know,
I have introduced legislation, as have others, to make the minutes
more available rather than holding them for 1 or 2 months.
Thank you, Mr. Chairman.
PREPARED STATEMENT Of SENATOR MATTINGLY
Senator MA'ITINGLY. Mr. Chairman, I, too would like to welcome
Dr. Johnson and Dr. Angell to the Senate Banking Committee. I
think the President has chosen two very capable and qualified individuals to serve on the Federal Reserve Board. While I will have
questions for the record, I would like to make a point or two.
Last Congress, I introduced the Federal Reserve Reform Act.
Among other things, it required the minutes of the Federal Open
Market Committee to be released in a more timely fashion. I personally can think of no justification for withholding from the
public that information for 2 months. Senator Garn has expressed
a similar concern. Such action, or inaction I should say, only leads
to speculation in the marketplace. I will soon reintroduce that proposal and intend to hold hearings on the issue in the Economic
Policy Subcommittee which I chair. I hope both nominees will take
a good look at this legislative suggestion.
Last, I would like to remind the nominees, although I am preaching to the choir, that while the Government may have an answer
for every problem, in most instances, the solution can be more effectively and efficiently addressed by the marketplace. A recent example of unnecessary Government intervention is the Fed decision
to limit the use of junk bonds. As Fed Governor Seger said, the de-
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cision will lead to "heavy-handed bureaucracy." I hope the Fed will
reconsider the issue. In my opinion, more government is not always
good government.
Again, I congratulate both nominees and look forward to their
speedy confirmation.
The CHAIRMAN. Senator Cranston.
Senator CRANSTON. Mr. Chairman, after all these comments
about economists, I want to say one more thing. Another nominee
of the President, Ted Cummings, was before the Foreign Relations
Committee sometime ago to be Ambassador to Austria. In the
course of his testimony he was asked why is Austria's economy
working so very well in a Europe where things were not going too
well at that time? He said it's because of their export policy. A
member of the committee said, "Their export policy? What is
that?" He said, "They exported all their economists to the United
States." [Laughter.]
The CHAIRMAN. Now if we could just include attorneys with the
economists, we would be all right.
Dr. Angell, could I have you stand and be sworn, please, before
you testify.
[Whereupon, the witness was duly sworn.]
The CHAIRMAN. Dr. Angell, we are pleased to have you with us
today. Before I have you begin I would like to comment in general
on your qualifications. Over a number of years many of us on this
committee have felt very strongly that the Federal Reserve Board
has not had the broad geographic representation, which is called
for in the Federal Reserve Act.
Over a period of years we have found many ways to circumvent
the geographic requirements-if somebody attended a California
college he was from California; if they were born in Illinois that
was fine even though they left at the age of l; and we were getting
a concentration of those who essentially were from the Washington
economic establishment.
There also have been many bills that require representatives
from small business, from labor, and from other economic sectors.
Over the last 5 or 6 years, both Senator Proxmire and I, have
insisted that this administration and the Carter administration
before it comply with the intent of the law regarding geographical
representation.
You, Dr. Angell, certainly fit that requirement, coming from
Kansas. Senator Dole pointed out that you will be the first Kansan
on the Board. Even more importantly I think is your background.
You are an economist, but not just an economist. You also have
had wide experience in agriculture, which is particularly important
at this time, and in small business. So I guess we could call you a
three-fer-agriculture, small business, and economics.
I felt it was important to give you that little bit of background
and once again state that in the future I'm sure the committee will
insist that we have a broader background distribution on the Fedboth in experience as well as in geography-to fit the terms of the
law.
If you would like to proceed with your statement at this time we
would be happy to hear from you.
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STATEMENT OF NOMINEE DR. WAYNE D. ANGELL
Dr. ANGELL. Thank you, Senator Garn. I am most honored to be
a nominee of President Ronald Reagan and to have the wholehearted support of the majority leader of the U.S. Senate, Robert S.
Dole.
Last July, Senator Dole asked me to write out some monetary
policy ideas which would be of particular significance for agriculture. Since that time Senator Dole has circulated the paper to
members of this committee and to the press. I have saved my comments on these ideas expressed in that paper until this committee
held its hearing regarding my nomination.
INVOLVEMENT IN FARMING
I am not going to go into as much detail concerning my farm
background as I might have because of Senator Garn and Senator
Dole's introduction of me as a farmer, but I assure you that my involvement in farming has been a lifetime involvement. I was a
young person during World War II; I reached age 14 in 1944.
During the war, I suppose farm families needed farm help more extensively than at other times, so I was promoted to combine driver
at age 14. Of course, after the harvest I was back on the tractor
doing a one-way disking operation.
Since I attended college and went on for my doctorate at the
University of Kansas, I returned to the farm every summer and
was a resident in Plains, KS, where the farm is located, since 1950,
so farming has been an extensive part of my life. My wife has been
the reluctant mover at times, and has disrupted her life to move to
western Kansas, but we've done that as a family and our four children have grown up there and been involved in farming.
So, I have all the sense of the spirit of farming, and I have that
sense from my heart in terms of the pain and the agony that have
been associated with farmers during this period.
I want to make it clear that I do not believe that the answer to
the farmers' problem is reinflation. Senator Proxmire, during my
entire time at the Federal Reserve Bank of Kansas City I have established a reputation for being an inflation-fighter. The farm
problem has its origins in the period of inflation, in the speculative
activity in regard to buying farm equipment spurred on by tax
laws that encouraged overbuying; the impact of inflation on commodity prices, leading directly to a rapid increase in farm land
values, is the real root problem that's there.
Now it was impossible for this generation of older farmers to
pass on the mantle of farming to a new generation of farmers with
those ridiculously high land values, so the ones who are to blame
primarily for our farm difficulty are those who put policies in place
that led to inflation.
I pledge to this committee and I pledge to the American people
that in my time on the Federal Reserve Board I will be ever-watchful for any reemergence of inflation. I consider it the primary responsibility of monetary authorities to preserve the value of the
dollar, and that is my pledge.
I hope we will never see commodity prices as high as we saw
them during the 1970's and early 1980's. We have indicated and
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demonstrated our commitment to reducing inflation; and I say we
because as a director of a Federal Reserve Bank in Kansas City I
have voted in favor of more discount rate increases than any directors prior to my time. I did that because I recognized that it was
essential that the country's and the world's monetary leadership
reduce inflation and there is no way that I will ever advocate any
policy that will return our Nation to a course of inflation, which
would in a sense cause us to fight this fight all over again. There's
been too much pain and too much agony on the farm for us to
slacken our stand against inflation again, and I give you my pledge
in that regard.
FISCAL CONSERVATIVE
Now, Senator Proxmire, I would indicate to you that I'm a fiscal
conservative. There's been no time in my entire adult life that I
have ever advocated deficits as a way of alleviating difficulties.
During my young teaching days as an economist I never accepted
the Keynesian notion that Government budget deficits should be a
part of policy. I believe that Government spending always places a
burden upon the private sector of our economy, and it has an
impact upon economic growth.
I do not excuse Government deficits and their role in causing the
dollar to be high. The dollar in a sense moved high for several reasons and I think those are, as Senator Proxmire pointed out, that
Government deficits do, of course, contribute to an upward movement in U.S. interest rates, although not as much I believe our tax
system does with loopholes that in a sense impose different burdens upon different people. I believe that lowering tax rates would
be more effective than even decreasing deficits, but reducing deficits is very important, and I commend this Senate and the Congress for taking the steps that need to be taken to bring the deficits
down.
I have felt that the Federal Reserve, if it's to be faulted, should
only be faulted for not understanding how effective its policy would
be in bringing the inflation rate down. It seemed to me very clear
that the policies adopted in 1979, were going to be successful. I
didn't vote for those discount rate increases because I thought that
inflation would still soar ahead, as many did. It seemed to me very
clear that the Federal Reserve laid out a new standard on October
6, 1979, and that was to make the dollar more scarce than any
commodity in the world.
Now once we did that, then the dollar necessarily began to rise,
from its low level of about 78 indexed to 1970, and by December
1982 the dollar had risen from 78 to a level of about 128 on that
index. Senator Proxmire, I asked the Chairman of the Federal Reserve at that time, having the opportunity to sit at his table during
a directors' meeting, "How important do you believe exchange
rates are in establishing monetary policy?" He leaned back in his
chair and he said, "I believe that exchange rates are more important than we made them be." But after that time, the dollar rose
from 128 to 161. I cannot imagine how anyone thought our economy could operate with such a high level for the dollar.
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So what I called for on July 5 in my memo that you have, was
for the Federal Reserve to be willing to use some of its open
market operations to engage in exchange rate intervention so as to
readjust the world's thinking in regard to inflation.
But my policy overall has been one of support; I am a Fed loyalist in the sense of getting inflation down, and I think that's the
most important thing we can do.
In closing, I want to point out to all of you that our banking
system-the banking system including savings and loans, commercial banks, credit unions-has in it assets that are not of the highest quality. We have more risk assets there than we would like to
have. I believe we are in a dangerous period in American history.
If there's a second major responsibility of the Federal Reserve it is
to ensure that the banking system is sound. Whenever the banks
go down, whenever a bank closes in a Kansas town, the life of that
community is affected; communities disappear when the banks disappear. It seems to me we have to give all the attention that we
can give to focusing on the problem before us, which is maintaining
a zero rate of inflation, maintaining a stable commodity price level,
and preserving a sound banking system. I pledge myself to do those
things, and I welcome the support and comments of each of the
members here. I'm open for any questions that you might have.
DECISION ON NONBANK BANKS
The CHAIRMAN. Thank you very much, Dr. Angell. You jogged
my memory on something when you referred to banks' safety and
soundness. Before I ask you some questions I would like to comment on the Supreme Court decision that was made concerning
nonbank banks.
I have listened to the news media for 2 days now about an approaching vast expansion of nonbank banks. I would suggest that
the news media might read the decision before they report on it.
When I came to work yesterday I thought maybe we needed to do
something very quickly, but reading the decision I find that it is a
very narrow decision. On an 8-to-0 vote, that I totally agreed with,
the Supreme Court said the Federal Reserve does not have the
right to regulate those nonbank banks and with the defmition of a
bank currently in law. The Federal Reserve doesn't have the right
to change that definition. Only Congress can change the definition
of a bank.
Importantly, there is still an appellate court decision which has
created a moratorium, in effect, that prohibits the Comptroller of
the Currency from granting any final charters to nonbank banks.
So I would hope that the news media would report differently than
they have been on how narrow this decision is. It is a correct decision, but still the Comptroller of the Currency is prohibited by a
court decision from granting final charters. They have a very
narrow area under State jurisdiction where some State-chartered
institutions could expand the number of nonbank banks but there
is not going to be in the near future any great proliferation of nonbank banks.
Senator PROXMIRE. Would the chairman yield on that?
The CHAIRMAN. I'd be happy to.
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Senator PROXMIRE. AB long as the chairman has spoken out on
that, as usual, he's expressed the kind of responsibility the committee should have and I assume that he is not saying that we don't
need legislation. AB I understand it, he's saying we do need legislation and I think we need it quite urgently because while no nonbank banks can be chartered, the fact is that we have nonbank
banks now and in the judgment of many, many people the competition is grossly unfair. We have an unbalanced kind of situation
that calls out for action by the Congress. In fact, the Supreme
Court, as I understand it, encourages action by the Congress and
implied that in their judgment it was desirable. So I would hope we
get it.
The CHAIRMAN. The Senator is absolutely correct. That's why I
say the Supreme Court decision is correct in this area. It does require legislative action for us to change the definition of bank. AB a
matter of fact, the Senator was a cosponsor of my bill that passed
the Senate 89 to 5 in September 1984 that totally and completely
closed the nonbank bank loophole. It is not the fault of the Senate
that this has not been taken care of legislatively. We spoke rather
overwhelmingly with that kind of a vote. The House of Representatives was not willing to go to conference then and has not been
willing to act on it since, so your comments are appropriate and
absolutely accurate. We still need to take action on this. I wish we
had done so in September 1984.
Dr. Angell, it is my understanding that if confirmed you will
divest all of your bank stock, sell your interest in a financial consulting partnership, and cease all of your financial consulting relationships. Is that correct?
Dr. ANGELL. That is correct, Senator Garn.
The CHAIRMAN. You will also sell the savings and loan stock in
you personal 401-K pension plan as soon as the savings and loans
permits the stock to be traded?
Dr. ANGELL. That's correct, and I had word from them last night
that they will permit me to do that as soon as I get them a letter
requesting that be done.
The CHAIRMAN. It is my further understanding that you have
agreed to take all necessary steps to avoid even the appearance of
a conflict of interest, is that correct?
Dr. ANGELL. That is correct.
The CHAIRMAN. And do you agree to appear before this committee and any other duly constituted committee of the Congress when
requested to do so?
Dr. ANGELL. I would welcome the opportunity for any communication between us; between the Senate, the House, and the Federal
Reserve.
The CHAIRMAN. I'll guarantee you will have plenty of opportunity for that.
Proposals are regularly made to reduce or eliminate the independence of the Federal Reserve. I think I have seen all of them
over the last 10 or 11 years-proposals that we make the Chairman
of the Fed's term concurrent with that of the President, that we
havE:, Treasury Secretary be a member of the Federal Reserve
Board, that we have Members of Congress put on the Federal Reserve Board, and all sorts of other variations.
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I personally feel very strongly that one of the strengths of the
Federal Reserve has been its independence. I would hate to think
what would have happened over the last 10 or 12 years had Congress had the ability to control the money supply targets. We
would have had an inflation and demands to go far beyond what
the Fed has done. Whether I agree or disagree with particular
Presidents, I also feel strongly that a President should not be able
to dictate to a Federal Reserve Board. The Board should have an
objective viewpoint separate from the legislative and executive
branches.
INDEPENDENCE OF THE FED BOARD
How do you feel about the independence of the Federal Reserve
Board? Are you here to just carry out the policies of the President
who nominated you? Do you feel you're supposed to do what this
committee tells you to do? What are your attitudes on the independence of the Federal Reserve Board?
Dr. ANGELL. Senator Garn, I'm among those who strongly believe
that the Federal Reserve should remain independent. I believe the
Congress was very wise in its decision in the Federal Reserve Act
of 1913 to look toward the long-term independence for the Fed.
The problems of inflation quite often have a time lag attached to
them. We can institute policies in one period and then reap the
grain that we sowed in a later period. Quite often, the fact that
Members of Congress and the President do have the political process to deal with and do stand for election might tend to make the
executive and congressional branches take a more short-run view.
My view that the Federal Reserve's major responsibility is price
level stability implies that this arrangement of having the Fed be
independent is essential for that guarantee for the future.
With regard to the second part of your question, dealing with my
independence from the President or anyone else, I would suggest to
you that I have widespread support in regard to my nomination
and that the paper that you have before you I wrote on July 5,
1985, before I had spoken to any members of the executive branch
of Government; and I continue to hold those views. In fact, one of
the members of the administration asked me some questions about
that and I finally said, "I put down there those ideas against the
recommendation of many of my colleagues who su?.gested that all I
was doing was giving ammunition to my critics.' I suggested to
him that if I had to muzzle my ideas in regard to economic and
monetary policy in order to get the President's nomination, I did
not choose to serve on the Board. And I was very pleased that the
member of the administration seemed to think that was a very
good answer.
So I feel very confident that everyone supports this independence. In fact, the only question that was ever asked in regard to
any litmus test was can you be independent? And I think that
anyone who knows Wayne Angell certainly knows that I not only
can be independent, but that I am.
The CHAIRMAN. Well, I'm pleased to hear that. In the paper you
refer to, and I quote: "Discretionary monetary policy has a great
potential to do extensive harm and provide significant disruption to
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what might otherwise be a healthy growing economy." In the same
paper you support a monetary policy "focused on stabilizing the
commodity price level."
Could you elaborate on those views for me? You've made yourself
very clear here today in the statements you've made so far and yet
there appears to be a little confusion in the minds of some regarding this paper as compared with your very clearly stated views
today about the relationship of the Federal deficits, monetary
policy and this statement about discretionary monetary policy
which has a great potential to do extensive harm.
VIEWS ON COMMODITY PRICE LEVELS
Dr. ANGELL. Yes. I'm glad to have an opportunity to deal with
the question of my views on stable price levels and the role of commodity prices.
I never said in the paper and I never intended it to be interpreted that I was asking for commodity prices to be an intermediate
target. I was speaking for and advocated that the ultimate goal of
monetary policy should be stable prices, a stable price level, in
which commodities move up and down in price based upon their
relative scarcities, but not due to an overabunciancy or stringency
of money as a driving force in those prices.
I do not wish to substitute for an Ml target a commodity price
target, but I do believe that commodity prices, for which daily auctions are held, can provide a very important information variable
for monetary policy. Whenever we look at commodity prices and
see, as we have, that commodity prices have tended down over such
a long period of time, we note that the world better be prepared to
understand the Federal Reserve knows how to bring commodity
prices down.
Anyone who wishes to bet on owning gold or silver or precious
metals, or anything other than dollars should know it's our job to
make those commodity prices stable and thus to ensure that
they've made a poor bet.
Now I do not believe that it's appropriate in regard to these commodity prices to simply focus on an inflation rate target and then
to make cumulative errors. Because if we focus on a target and we
end up getting a 3-percent inflation, by goodness, the price level
doubles every 24 years. In that scenario, long-bond buyers are
going to look at an erosion of the purchasing power of those bonds
and interest rates on those long bonds will be much higher.
I advocate a policy of not only having a zero rate of inflation, but
also a policy that will correct for past mistakes and bring the price
level back, so that people can have a guaranty that the dollar will
have a purchasing power 10 years from now very similar to its purchasing power today.
Another reason that I focus on commodities is because of my experience in the agricultural sector. It seems to me that the service
sector of our economy, which is growing very rapidly, is not very
immediately responsive to monetary policy; that is, we can have
the very best monetary policy in the world yet we sometimes will
have a time lag where the service sector continues to have built-in
price increases. I do not believe that those service sector price in-
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creases are subject to immediate discipline by monetary policy, and
to try to bring the service sector inflation rate down in a very short
period of time would be a policy that would totally disrupt the
entire farming community worse than we have seen, disrupt the
entire oil-producing segment of our economy, and of other nations.
I believe it's appropriate to focus upon a commodity price stability so that then the consumers will learn, as they have learned, that
commodities don't rise in price as fast as services, and we will
begin to see consumers shift their purchases from the service sector
to the commodity sector until people in the service sector begin to
realize that they can't pass the price increases along.
So I believe that if we maintain stable commodity prices we take
away all of the speculative activity in our society, and we take
away the misdirection of economic activity from speculation and
direct it back to production. I want it to be in our market price
system that individuals make a profit because they produce something, not because they speculated with some accuracy.
The CHAIRMAN. Senator Proxmire.
NO. 1 PRIORITY-STOP INFLATION
Senator PROXMIRE. As I understand it, it's your intention to
make the stopping of inflation your No. 1 priority in the Federal
Reserve Board. That's excellent. I think almost everybody would
subscribe to that and I think it's right and you express it with
great sincerity and emphasis.
The question is not your sincerity or your convictions. The question is the policies that you advocate and whether they would actually stop inflation.
In your paper setting forth your views on monetary policy you
said:
The Federal Reserve Board should consider making it a first priority to select a
market basket of commodities that will not be permitted to increase or decrease
more than 10 percent from a base price level. Errors should not be allowed to
become cumulative.
Now as I understand your proposal, inflation would be stopped
dead in its tracks once the price index rose 10 percent. In other
words, the Fed would bring the ongoing rate of inflation down to
zero.
How do you think the Federal Reserve Board could accomplish
such a result, given the tools it now has, and wouldn't it have to
engineer a rather deep recession to squeeze all inflation out of
whatever price index was selected?
Dr. ANGELL. Senator Proxmire, as you know and understandand behind your question-is the indication that there are certain
periods of time, such as in the early 1970's when we had in a development of a cartel in oil prices; we had at the same time, certain
shortages in regard to commodities due to the new purchase of
grains by the Soviet Union and other countries.
My contention would be that it would have been far better
during that period of time in which the Ml growth path was not so
alarming compared to present numbers-that is, during that period
of time we're looking at maybe 6 and 7 percent Ml growth pathsin hindsight, to have been much more tight with monetary policy,
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because if we had been, the price of land in Iowa, Nebraska, and
Kansas, Oklahoma, and Ohio would not have risen as high as it
did. We would have stopped inflation then.
Senator PROXMIRE. Let me just interrupt to ask you, Dr. Angell,
if we had been much tighter, wouldn't interest rates have gone
even higher? As you know toward the end of the 1970's if this had
been able to work its course interest rates were at record highs.
How high would they have to go, 25 percent, 30 percent?
Dr. ANGELL. Senator Proxmire, it would be my estimation that if
a tighter monetary policy had been in place in 1972, 1973, 1974,
that we would not have had interest rates as high as we had them
in 1980 and 1981 and 1982; the failure was in not stopping the commodity inflation once it began.
I feel very strongly on this point, Senator Proxmire, but I would
also want you to recognize that as a member of the Board of Governors, if you confirm me and I achieve that position, then I would
also, of course, expect to listen to other people's views. I would not
expect, by myself, to be able to adopt such a shift in policy without
convincing other members of the Board, but I would expect that
collegial process to go on, and I would make it a personal responsibility to represent the agricultural community and its needs, and
not to misdirect economic activity toward the land speculation that
occurred between 1973 and 1982.
Senator PROXMIRE. Now let me ask you, what do you recommend
be included in your market basket and how would it differ from
current price indices such as the Consumer Price Index, the Producer Price Index, the GNP deflator, and so forth? How would your
market basket differ?
Dr. ANGELL. Senator Proxmire, the Federal Reserve no longer
publishes the commodity index, and so at this point in time we
have to choose between a lot of indices that are not really very
good. That is, there aren't any indices that would meet my standards of being-Senator PROXMIRE. You say they're not very good. They're good
for some purpose. They're not good for all purposes.
Dr. ANGELL. That's right.
Senator PROXMIRE. That is likely to be true. What you're suggesting is simply an additional index which would not necessarily be
better for all purposes or do you think it would be?
NEW INDEX ON A TRADE-WEIGHTED BASIS
Dr. ANGELL. I think it would be better for the purpose you and I
are discussing. It would be better if we put it on a trade-weighted
basis; that is, I believe that the United States and the Federal Reserve are not only responsible for domestic inflation, but I believe,
since the dollar is the primary means of payment in the world,
that we are responsible for the world inflation.
Senator PROXMIRE. What do you think should be included in
market basket?
Dr. ANGELL. I think items ought to be included on a tradeweighted basis.
Senator PROXMIRE. What should be included?
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Dr. ANGELL. Items ought to be included on a trade-weighted
basis. We ought to take an international trade-weighted basis.
Senator PROXMIRE. Would you include oil?
Dr. ANGELL. Yes.
Senator PROXMIRE. Would you include wheat? What would you
include?
Dr. ANGELL. I want to put them all in there on a trade-weighted
basis. I want to take all auction market commodities and say what
proportion of international trade takes place in these commodities.
We could argue about whether it should be an international tradeweighting or a national trade-weighting, but I would tend to opt
somewhat toward the international trade-weighting. I would like to
include all commodities on a trade-weighted basis, so that we could
have some auction results that might give us some early warning
signs.
Senator PROXMIRE. You're talking about crude commodities or
are you talking about finished goods?
Dr. ANGELL. I'm talking primarily about those traded in auctions, and those are primarily agriculturally based or crude products, not manufactured products.
Senator PROXMIRE. All right. If the Federal Reserve Board
should try to stabilize basic commodity prices, one measure is the
crude material index of the Producer Price Index. During the first
three quarters of 1985, this index fell by 11 percent. Under your
proposal, in order for the Fed to try to stabilize the index, it would
have been far more expansive than it actually was. During that
period the Fed allowed the money supply Ml to increase at an
annual rate of 13 percent. Presumably the actual rate of money
growth would have been far higher had the Fed been following the
Angell prescription.
So my question to you is twofold. Had you been on the Board
would you have pushed for a more expansive rate of money growth
than the 13 percent we had during that time to prevent commodity
prices from falling; and second, is there some upper limit in money
growth that you would not be willing to tolerate regardless of dedines ill commodity prices?
Dr. ANGELL. Senator Proxmire, the answer to that question is
that the Federal Reserve, since I wrote my paper on July 5, has
followed a policy almost identical to what I would have wanted
them to follow with regard to that price level rule. That is, it seems
to me that the Federal Reserve has done what I wanted, not only
with regard to commodity prices, but also in terms of exchange
rate intervention.
Senator PROXMIRE. Do you favor that 12 or 13 percent expansion
in the money supply over the last 11 months or so?
Dr. ANGELL. I always feel very concerned about looking very
carefully at any rates of Ml growth in that magnitude. I want to
be sure that we're not just engaging in rationalization, which
would result in our getting into another inflationary period. But I
am equally concerned that if we slow this economy down, and we
continue to experience international commodity inflation the way
we have, we are on the verge of disrupting the economy. We're certainly then going to make matters tremendously difficult for you
under Gramm-Rudman-that is, if we get the economy too soft or
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too slow, that's when we're most apt to engage in overstimulation
of Ml. I believe that accommodating, as the Federal Reserve has
accommodated, the Ml growth path has been pretty close to being
on target this last half of the year.
I was only critical during the periods when they were not responsive. I believe the Federal Reserve has properly been responsive
since July 5 to what I wrote on July 5. I'm not egotistical enough
to believe that they read my paper and decided to change policy
because of it, because they have many intelligent people who are
able to develop policy who were already there before I was nominated.
Senator PROXMIRE. Now you say:
Money aggregates in and of themselves indicate how well or how poorly the Fed is
doing in maintaining an appropriate supply of money.
You then go on to say:
Federal Reserve policy must not ignore the growth of the monetary aggregates
but a monetary rule cannot be the only intermediate monitor for achieving a stable
price level objective.
Dr. Angell, what other intermediate monitors would be used for
evaluating monetary policy? You seem to elsewhere in your statement discard real GNP, targeting unemployment. What measures
would you use?
Dr. ANGELL. It's largely a matter of semantics, it seems to me, as
to whether or not we use commodity auction prices as kind of feedback or information loop or whether we use them as an intermediate target. I never really specified using them as an intermediate
target, because if you do that then you end up with the difficulty of
having more than one intermediate target and when you end up
with more than one intermediate target, it really lets the Fed do
about whatever it wants to do. In that case, I believe we're not as
accountable to the marketplace or to the Congress as we should be.
Senator PROXMIRE. Dr. Angell, tell me what are the other intermediate targets? That was the question.
Dr. ANGELL. I suggest that Ml is still our best intermediate
target. I do not want to use interest rates as an intermediate
target.
Senator PROXMIRE. But you say it shouldn't be the only one.
What should be the others? That was my question.
Dr. ANGELL. I think I'm suggesting that I prefer that the commodity index be used as an information variable and feedback loop,
in order to adjust a single Ml target, rather than to have multiple
targets. I think multiple intermediate targets have some policy difficulties that make them not very accountable.
Senator PROXMIRE. My time is up, Mr. Chairman.
The CHAIRMAN. Senator Sasser.
OPENING STATEMENT OF SENATOR SASSER
Senator SASSER. Thank you, Mr. Chairman.
Dr. Angell, I want to welcome you before the committee this
morning and I want to commend you for answerin~ the questions
that have been propounded to you this morning. It s refreshing to
find someone coming before this committee for confirmation who
actually lets us know what their views are on the very important
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matters to be dealt with. I want to commend you for it and I find
myself in substantial agreement with what you said-not total
agreement-but the important thing is at least we know what your
perspectives are on some of the issues you will be grappling with in
the future.
I also want to say that for the past 4 years, every time we've had
a Federal Reserve Board nominee come before this committee, I've
had to point out that that individual had no agricultural expertise.
I joined with a number of other Senators some years ago in sponsoring a sense of the Senate resolution calling on the administration-at that time it was a Democratic administration-calling on
the administration to ensure that the next nominee to the Federal
Reserve Board had a background in agriculture, who could in some
way represent the interests of the agricultural sector of our economy, bringing those views into the board room when the Federal Reserve Board had a meeting. I'm delighted to note that you have
been engaged for 30 years in a farm partnership. You know something about the agricultural sector of our economy, which is in a
critical situation now, as you know-indeed, in a crisis situation, in
my judgment and in the judgment of most agricultural economists.
Over on~uarter of this country's commercial banks are agricultural banks. They play a vital role in rural communities all across
this country. They do in my State of Tennessee as I suspect they do
in your State of Kansas, and I hope they will continue to do so.
But, unfortunately, these farm-related banks have been distinguished significantly in the past year or two by representing a disproportionately large share of bank failures.
Now, troubles at this level in our farm banking system can spell
trouble nationwide. Nationally, commercial banks provide about
$40 billion of the operating debt to finance farm production expenses. These commercial banks are therefore a vital element in
farmers' ability to obtain financing for their farm operations. We
have seen, in some areas in the Southeast, that when the farm
bank goes under the farmers-the solvent farmers-have great difficulty finding financing.
Total farm debt now stands at $215 billion. Over 850,000 farmers,
roughly half of this country's farmers, accounting for 40 percent of
all food production, had negative cash-flows in 1984 and they
cannot meet operating expenses from farm earnings. Out of this
group of farmers, 215,000 have critically high debt-to-asset ratios
and face the likelihood of bankruptcy during the next year.
FAILURES OF AGRICULTURAL BANKS
Now we passed legislation last year to help the Farm Credit
System, but this bill does not address the problem of the small
rural banks. These small rural banks and farm banks are directly
linked to the overall health of the agricultural economy, and we
have seen these banks now starting to fall like flies. In 1984, of the
79 bank failures, 32 of them were agricultural banks. This has not
gone unnoticed. As you may know, a report prepared by econol!lists
at Wharton Econometrics this past summer suggests that this
trend of failures could have a ripple effect throughout the banking
community. The report concludes, "The continued failures of small
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farm banks could 'spread through the banking system like a contagious disease,' eventually causing the financial system to collapse."
So said Wharton Econometrics.
I'm interested, Dr. Angell, in what you see as the short- and
long-term future of these ag-related banks and how regulators
should respond to their difficulties? That's a big question.
Dr. ANGELL. Thank you, Senator Sasser.
I think it's very important-and I was taught this by my father
on the farm-that we ought always to prepare for the worst of
times and expect the worst of times and then be surprised when
things are better.
I think it would be irresponsible for us not to recognize the seriousness of the difficulties which you so well enumerated. Those difficulties are there.
I would point out to you that we do have many ag banks that
have been very well run and are continuing to supply credit and
have done a good job of discerning between those projects that
would have the cash-flow that would pay back the interest and the
principal. So I want to commend the rural bankers who have done
a good job.
But I want you to understand, as I know you do by your question, that business cycles and economic condition cycles are not just
due to monetary policy; we can have a perverse regulatory cycle.
That is, rather than the regulators being far-seeing-just because
they happen to be members of some Government agency-these
regulators were looking at these farm loans in their heyday, when
prices of farmland was going up at rapid paces and farm machinery prices were rising. The regulators were just as willing to say
those loans were fine and dandy at that time, and then, when the
farming community got into difficulty, all of a sudden the regulators and examiners thought that every farm loan out there must be
a bad loan.
We are now in a dangerous period in which we dwell upon the
farm credit that's not good and begin to assume that maybe some
other lending that might be workable is no longer workable. We
have regulators who are worried about their own butts; that is,
whenever we have a bank that fails, then somehow or other regulators think they messed up and the Congress may call them in and
say, "What did you do? Why weren't you looking at that? How did
you let Penn Square get where it was?" So then we have a swing
from being too gentle in our examination of banks to the extreme
of questioning every agricultural loan that's out there. In doing
this, the examiners could be duped into shutting off the entire
process of extending credit.
The Secretary of the Treasury seems to understand that the
world's economic development and the world's ability to repay debt
means that we cannot shut off all international credit. I understand that. We can't have the whole world economy go along with
an abundance of credit and then, all of a sudden, cut them all off
and think that those debts are going to be good. The Secretary of
the Treasury understands that.
But why doesn't he also understand, for our farm community,
that we can't go along with credit and then shut it all off and shut
it all down?
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I am most concerned, Senators, that we have many rural bankers out there who are tired and sick and want to give up. They
want to quit. They are sick of being bankers. Senator Gramm
talked to me and mentioned to me about having a banker run a
farm. Well, let me tell you, in our case, we borrowed money on our
farm machinery in order to buy the bank and that bank worked
kind of well, because we injected some money from the farm in it.
We've been very fortunate on our farm to be able to operate as we
have and to be able to have in a sense profits in our operation year
after year. But the fact of the matter is, we are just about to lose
people who want to be bankers. If we lose these people who take
private capital and risk capital and go into rural communities and
make loans, and we have such a perverse regulatory climate that
no one wants to be a banker, then I guarantee you that agriculture
is going to decline.
I think it's time for us to recognize that the Congress may want
to infuse credit into the Farm Credit System, which never did a
good job at all of looking at those debts, and ignored the commercial banking industry where private risk capital has been on the
line.
UNDUE PRF.SSURE ON BANKERS
I want to do everything I can to encourage people to understand
that regulators are not running the banks. I have bankers that tell
me that they spend one-third of their time answering questions
from the regulators.
Now I asked the members of the regulatory committee at the
Federal Reserve, I asked them, "Now do you have children? Do you
have teenage children?" And they said, "Yes." And I said, "Now
what would you do if you had a teenage child who got into a little
difficulty? Would you put him on regulatory supervision or would
you try to encourage and educate?"
We take adult bankers and we put them in the worst possible
light. Do you know what it's like to be examined by a bank examiner? Why it makes a highway patrolman's job look like child's
play. They're in there calling the shots and telling you to do this
and to do that. And I tell you our market system economy works
because we are people who make risk capital work, and we must.
not cut out the climate where people are ready to put risk capital
into the rural segment.
Thank you. I'm sorry I took that long to answer.
Senator SASSER. No, I'm delighted to hear that answer. It was
very good. My time is up, Mr. Chairman.
The CllAIRMAN. Senator Hecht.
Senator HECHT. Thank you very much. I've enjoyed your comments. I agree with you on your analysis of commodity prices. How
can we stabilize commodity prices with the world situation today in
minerals like in South Africa and so on and so forth? How would
you rationalize that? How can we control that?
Dr. ANGELL. Of course, we have some commodity prices in the
world that are subject to international cartels, such as OPEC. And,
when you have an international cartel, as Milton Friedman properly pointed out several years ago, these international cartels are
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bound not to work. But the reason international cartels and OPEC
didn't work is because the U.S. Federal Reserve System made dollars more scarce than oil.
What we're seeing now is that cartel was able to maintain prices
much longer than they would have been able to if there had been a
freely competitive market as we have for agricultural commodities.
Right now what we're seeing in oil prices is a time lag in oil price
decreases. But I want you to know, Senator, that the entire question of deflation is still a kind of ever-present danger. I've been
around a lot of entrepreneurial types who want to borrow money,
and I know during the 1960's they said, "You go borrow lots of
money and you make lots of money," and during the 1970's everybody wanted to borrow money, too. But today I don't know anybody
who wants to borrow money to try to drill oil wells at 28,000 feet
when the natural gas coming out would have to sell for $8 per million cubic feet. That won't work any more, and it won't work because the Federal Reserve made dollars more scarce than natural
gas.
What we have to do, I think, is to be conscious of the fact the
deflation does have a destructive impact upon an economy, and you
cannot have deflation at such a pace as to disrupt and break the
banking system and all the players in the game.
So I would say commodity prices have already reached their
lower limit, and we really ought not to think it's good public policy
to have the overall level of prices move down.
We welcome, of course, continued declines in oil prices that reflect their actual scarcity worldwide. They didn't come down when
we had the monopoly element there. But we must recognize, as
those commodity prices come down, that other prices aren't coming
down. We're not trying to use monetary policy to control oil prices.
We want to control the whole market basket of commodity prices,
not just one commodity.
Senator HECHT. Let's leave oil and go to gold and silver.
Dr. ANGELL. Gold and silver do seem to be rather responsive to
speculative notions as to how good the dollar is. I only warn speculators in gold and silver that they're taking a bet in putting their
money in such a commodity. Gold bars don't lay any gold coins,
and they don't pay any interest, and anyone who wants to own
gold is betting that the rate of inflation is going to be higher than
the rate of interest you can get on Treasury bills. I think they're
making a bad bet, but that's not up to me to decide. They're
making a bad bet if we maintain a stable price level.
Senator HECHT. The prime rate now has come down considerably
but in my opinion it's still too high if our inflation is 3 to 4 percent
which it's been the last 2 or 3 years.
Realistically, the prime rate has never over the last 3 or 4 years
been over 3 percent over inflation. Do you see the prime rate
coming down to let's say 7 percent?
Dr. ANGELL. I would think that it would be an excellent thing for
an economy if conditions justify and the market supports a lower
level of prices, and I would point out to the Senator that the prospect of Gramm-Rudman-Hollings was more responsible for a decline in market interest rates than anything the Federal Reserve
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could have done. I commend the Congress in showing their determination to enact that legislation.
I would suggest that further demonstration by the Congress that
they take the deficit seriously would be a big help in regard to getting the prime rate of interest and real interest rates down.
I would take the liberty, if I might, of suggesting to you that interest rates are much higher than they need to be also because of
loopholes in our tax system. The Congress, in 1981, did not just
pass the President's Tax Reduction Program. The President's Tax
Reduction Program was a program of reducing marginal tax rates.
The House Ways and Means Committee added to that another
round of tax reductions which were, by and large, what I would
call accelerated cost recovery, and that tax system is one which
leaves some of our corporations in this country paying a zero tax.
Now in that environment of high marginal tax rates, plus loopholes, you're going to have the prime rate of interest substantially
higher than it would be otherwise, so I support any moves that
broaden the tax base and close the loopholes.
It just doesn't make for good policy to have one corporation out
there paying zero income tax and have some other corporation in a
service sector that can't escape the tax. In that kind of atmosphere,
one corporation can go out and buy the other one and use it as a
tax shield; the assets of the one company become cheaper for the
other company.
I would suggest to you that our tax system is more responsible
than any other policy that I know of in regard to the high real rate
of interest, and I would recommend to you to consider that reduction. I would even suggest that going back to the Treasury-I proposal, in which we have the double taxation of dividends taken out,
would be a big help, because right now we give a tremendous incentive to debt financing of corporations versus equity financing.
And I believe the tax system ought to be neutral and let the
market decide how much ought to be in equity and how much
ought to be in debt. We are giving incentives to everyone to load up
with debt, and to takeovers by debt, and it's putting us in a position where our economy is not going to be able to go through tough
economic times of high interest rates as easily as when we had
more equity financing. I am quite concerned about these trends.
MA'M.'ER OF TAX BREAKS
Senator HECHT. There are two types of employers, the Federal
Government and private enterprise. You know and I know that not
everyone can run a business. But a company is able to expand and
create more jobs and put more people on the payroll. If they wish
to go out and expand and put more in plant and equipment, more
in plants, more in businesses, you don't think they should get a tax
break?
Dr. ANGELL. I don't understand why some corporation that is in
the position to expand gets a tax break, when we've got a farmer
out there who is going broke paying 13.5 percent interest rates and
who has zero income and whose aftertax rate is 13.5 percent. We
pass deals permitting someone else to engage in investment because of a tax gimmick.
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I favor a policy that creates a level playing field for the farmers
who have high incomes with the farmers that have low incomes. I
cannot accept it as a fair policy to have people burdened down with
debt because they have very little advantage from a tax system in
which Uncle Sam picks up a large part of the interest rate.
So, in a sense, I see this great inequity, and I would suggest to
the Congress that any tax rate reductions that take place of that
type, and any broadening of the tax base, is not going to lead to a
recession because the capital markets will take note of it and interest rates will come plummeting down and that will help to save
some farmers out there who ought to be saved. Not every farmer in
trouble needs to be in trouble. We don't want to lose all these
people. Everything we do to cause these tax rates to be high imposes an unnecessary burden upon a disadvantaged segment of our
society.
Senator HECHT. If we adopt the budgets required by GrammRudman, and I feel we will, and we keep inflation down to the 3,
3.5, 4 percent area, within 1 year what would you expect interest
rates to be, the prime rate?
Dr. ANGELL. I consider it unwise as a potential member of the
Board of Governors to make an interest-rate forecast. I have been
in the interest-rate forecasting business in my consulting business,
and my business seemed to double every year. Senator Proxmire, I
wasn't as wise as you, and when I ran for the U.S. Senate I borrowed $140,000 and ended up with that as debt, and there wasn't
anybody to come around and help me pay that off. As a professor
and as a farmer, I looked at my interest payments and they looked
like they were going to exceed my income as a farmer and my professor' s salary, and so it was necessary for me to get into the consulting business. In this consulting business, of course, I've learned
more than I ever would have learned otherwise. But if I had followed Senator Proxmire's advice, and not spent any money on the
campaign, then of course I wouldn't have had that difficulty.
But I would suggest to you that I think it's very, very important
that I now remove myself from the position of outside consultant
who tells people about interest rates, and that I not do that. That
is not, I think, appropriate. I think it's appropriate for me to tell
the market how I view the economy and how I go about the process
of economic analysis and what basis I would use for changing monetary policy, but I ought not to make an interest-rate forecast.
Senator HECHT. My time has expired, but on the second round
may I ask a couple more questions?
The CHAIRMAN. Yes. Senator Riegle.
Senator RIEGLE. Thank you, Mr. Chairman.
Let me welcome you today Dr. Angell. It's obvious from listening
to you that you have strong feelings about these issues and there is
a series of areas that I'd like to get into, so I'm going to ask you to
try to give me condensed answers if you would because I would like
to touch on a lot of areas and obviously I don't want you to summarize to the point where you don't think you're saying what you
need to say.
First of all, I'm interested in how you received the appointment.
Who interviewed you prior to your selection?
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Dr. ANGELL. Senator Riegle, I have always thought that my personal meetings with people were something that the other person
should reveal. I think I would prefer to say that I met with administration officials who were in a position to make this appointment.
Now, I'll be glad to answer your questions in regard to what took
place at those meetings. I'll be glad to answer them very precisely.
Senator RIEGLE. Well, at the moment I'm not so much concerned
about what was said at those sessions because I think that does fall
into the area of the nature of the conversation you may have had
with an individual, but I don't see any problem with you telling us
who you were interviewed by. In other words, I assume there was
some kind of a clearance process or some kind of a screening process.
Dr. ANGELL. Yes, there was.
Senator RIEGLE. So I assume you spoke to Donald Regan, for one.
Dr. ANGELL. That is correct.
Senator RIEGLE. Were you interviewed by Paul Volcker?
Dr. ANGELL. Of course I was. I was interviewed by Mr. Volcker.
In fact, Mr. Volcker called me on the phone while I was still in
Kansas, before I came back, and I had an interview with him as
soon as I crune back.
Senator RIEGLE. How long were you with Mr. Volcker?
·
Dr. ANGELL. Ample time.
Senator RIEGLE. An hour?
Dr. ANGELL. It was adequate to do the interchange that we
needed to do.
Senator RIEGLE. You seem reluctant to want to be very forthcoming about this. I've heard long answers on everything else, but all
of the sudden it sounds like you're running out of gas. I'm not
asking you what was said in the conversation. I just want to understand what the process was.
It's a very relevant question because there is a concern about the
independence of the Federal Reserve System and I happen to feel
very strongly about maintaining it. I don't want it politicized. I'm
not suggesting that your appointment necessarily does that, but
one of the ways we monitor that is to understand what kind of hurdles people have to jump in terms of who's chosen to come up here
to take these seats and it's very important at this point. So it's not
a casual question. I think the public has some right to know.
Dr. ANGELL. I understand. My answer is that I have had runple
meetings with Chairman Volcker-more than one meeting prior to
my nomination and after the nomination, and the meetings were
very productive from my point of view. If the Chairman wishes to
tell how they were from his point of view, I suggest you ask him.
Senator RIEGLE. Well, first of all, I think that by itself is a constructive fact because the last appointee that we had did not meet
with Chairman Volcker, as you may know, and I think that raised
a concern for many of us. So at least it sounds as if that base was
touched.
Let's get into some policy. When the Fed took this vote the other
day on the question of leveraged buyouts where there was some
controversy and there was a split vote on the Fed. What's your
view on that issue?
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Dr. ANGELL. Even though I wasn't there at the meetings, did not
have the benefit of the other Governors' discussion, did not have
the benefit of the staff input, I am somewhat of a hard-money populist, and I would like to see a level playing field, so without benefit of the discussion, I probably would have decided with the majority on that vote. I'm not sure that the mergers that are taking
place would take place due to market forces alone.
Senator RIEGLE. So I take it that that sort of ties in with some of
your earlier comments that very expansionary sort of credit activities multiplying in every direction are something that gives you
some concern I take it.
Dr. ANGELL. Yes; it does, but I don't have any stomach at all for
a case-by-case intervention by the Government sector in the private
market system. I don't like that at all. But this policy it seems to
me, is in place, and we ought to have a chance to see how it works
before someone sits around talking about changing it. It's a matter
of fact, and I think we need to have policy stability.
HUGE CREDIT BUILDUP
Senator RIEGLE. Let me ask you with respect to the credit buildup generally, there are some people around-and you've been in
the financial forecasting business so you're sort of a-I shouldn't
say forecasting, but financial consulting, so you've obviously been
paying very careful attention to these things. But when we look at
the runup of fiscal deficits and of course now the ballooning trade
deficit, which I think is as severe and even more severe than the
fiscal deficit because that's all money leaving the country-capital
leaving the country, if you will-then you've got the farm problem
which you've mentioned here. We've got problems with the savings
and loan industry and certainly a number of banks. We've got consumer credit at the highest level that it's been. We've got the large
increase in leveraged buyouts. There's an awful lot of credit extension, it seems to me, in every direction.
I'm wondering, if you step back and look at it in the aggregate,
do you have the sense that we're stretched out pretty far at the
moment, near our outer limits; or are you of the feeling that this
can be digested and managed and that we ought to just keep rolling ahead here?
Dr. ANGELL. We're stretched out pretty far, Senator, and I hope
it can be managed.
Senator RIEGLE. You hope it can be managed? So, I take it that
the choice of the word hope means that there is some real concern
here about man~g it and it's going to take some skill to manage
it so that it doesn t get away from us.
Dr. ANGELL. I am concerned.
EFFECTS OF GRAMM-RUDMAN
Senator RIEGLE. Now that Gramm-Rudman is in place and presumably we're going to get budget cuts one way or the other-or I
should say deficit reduction one way or the other, but presumably
budget cuts, as the deficit starts cranking down our target for the
coming fiscal year 1987 is $144 billion. Yesterday in the Budget
Committee when the Budget Director was there, he indicated that
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roughly $60 billion is going to have to come out one wa.r, or the
other of the deficit. The President is saying "No revenues,' and so
presumably it comes off the spending side but we'll see what the
mix is.
If, in fact, the Federal budget comes down by $60 billion and we
actually hit those targets which the law now mandates, what kind
of a monetary policy tradeoff would seem to make sense to you in
terms of how the Federal Reserve System might deal with that?
Because if it actually happens, that's withdrawing an awful lot of
fiscal stimulus and I'm wondering if in fact we're going to get or
are likely to get some major downward adjustment in interest rates
if it's feasible or desirable or if you see that kind of linkage.
Dr. ANGELL. I think there is a linkage. If the foreign trade drag
comes down more slowly than the fiscal stimulus, there will be a
tendency of course for the capital markets to recognize that, and
without Fed intervention long rates of interest will begin to move
down without any covert Federal Reserve action.
But, in that environment it would seem to me it would be far different for the Federal Reserve to accommodate what the marketplace is seeing on interest rates than it would be for the Federal
Reserve to be a lead on interest rates. That is, it's not as dangerous
in regard to inflation potentials to have the Federal Reserve note
and follow market forces. If the Congress could set those market
forces in play, there would be many farmers and other small businessmen who would benefit from that direction.
Senator RIEGLE. Well, if everything-if we had a perfect world
where everything adjusted the way we might like it to, we wouldn't
need a lot of the mechanisms we have, but it doesn't work that way
and you've given some illustrations yourself in farming. You've
seen it yourself as a working farm businessman.
What I'm concerned about here is that as we start down the
track of the automatic budget cuts that will reduce the deficits and
with a big bite on the front end here, not immediately but in the
coming fiscal year, the $60 billion reduction, many economists that
I've talked to across a broad philosophical range predict that if we
don't get some measure of lower interest rate that corresponds
with that fiscal change, we're going to run into real problems.
Maybe it comes automatically and maybe the market does it and
maybe the market leads it, but maybe the market doesn't. Maybe
there are a lot of other factors that intervene that cause the
market to not be able to do it that way and the Federal Reserve
System may well have to do it.
I'm wondering if it requires Federal Reserve action to in a sense
get some monetary response to the fiscal tightening, are you prepared to be a part of the effort to see that happen?
Dr. ANGELL. Senator Riegle, I do not lack the courage to be a
leader if conditions warrant such a move.
Senator RIEGLE. So I take it that you mean by that you're sensitive to that issue, you would watch it carefully, and you would
have no qualms about taking whatever actions you thought were
needed. And if lower interest rates seemed to be appropriate and if
the Federal Reserve System had to lead because market conditions
weren't able to, I take it that you would have the stomach for that?
Dr. ANGELL. That is correct.
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Senator RIEGLE. My time is up but I'll have other questions for
you later. Let me just say Senator Dodd, Mr. Chairman, had some
questions that he would like answered for the record and he had to
leave. So if I may, I would like to ask that those be submitted.
The CHAIRMAN. Yes, they certainly will be and there will be a
number of questions from other Senators as well that we will ask
you to respond to in writing.
Senator Gorton.
Senator GoRTON. Mr. Angell, in your opening statement you indicated a belief-and I think I'm quoting you correctly-that exchange rates are more important for inflation than has been appreciated.
I presume-and you can correct me if I'm in error-that this
means that you feel that a depreciating dollar is more inflationary
than most people have given it credit for and vice-versa. Is that
right?
Dr. ANGELL. That's not correct. I tend to believe that if we first
choose to stabilize commodity prices, then other countries will be
froo to follow us in pursuit to a stable price level by watching their
exehange rates vis-a-vis the dollar.
My experience in China, Indonesia, and India, from watching
thtse new countries begin to use incentive systems to increase production, is that the dollar hasn't come down against those commoditie;i. What we've had here is an adjustment of other countries' currercies upward against the dollar, because they have maintained
m~be somewhat different policies than they might.
NEED FOR A STABLE PRICE LEVEL
l believe it's our responsibility, as the world's means of payment
comtry, to have a stable price level and to let other countries
pu'"Sue their own exchange rates in a way that would be conducive
to chat.
Vhen we see, because of an international deflation, the dollar
risng against commodities, and also rising in value against all
these other currencies, that's a signal to us that we have been a
litile bit too stringent in regard to supplying money and in regard
to ~he international commodity basket.
Senator GoRTON. So the dollar can fall against other currencies
wi1hout falling against other commodities?
Dr. ANGELL. That seems to be correct, and I indicated that to the
petple that I talked to last year. I think the record indicates that
that has been the fact, that we haven't experienced inflationary
pressures by the declining dollar as the gloom and doom people
suggested when the dollar started down.
Senator GoRTON. Do you feel that would continue to be the case,
if the dollar declines against other currencies another 10 or 20 percent? How flexible is that course?
Dr. ANGELL. My guess would be that we are now entering into
the segment of the exchange rate where we will not get quite as
much protection from commodity price imports as we did formerly,
because during the period of voluntary import quotas it was sort of
an excuse for the Japanese carmakers to become kind of their own
voluntary cartel. They thereby had tremendous profit margins
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built into the cars we were importing. And, as the yen appreciated
against the dollar, we then found that those profit margins among
Japanese companies began to diminish. Those profit margins have
diminished and it would seem to me it would be more likely, if we
had another 20 percent appreciation of the yen that we would find
the Japanese cars would move up in price.
Senator Gorton, what I'm hoping-fervently hoping, as a
farmer-is that the United States automobile manufacturers will
understand that when the Japanese car prices begin to rise they
will understand the American people are not going to put up with
any kind of United States price collusion or any activity of spontaneous coordination in which the United States automobile makers
raise the prices of their automobiles.
I believe the American consumer in this environment will not respond. I congratulate the American consumers who understand
that when they buy cars they buy them because of price incentives,
and I don't understand why U.S. manufacturers do not recognue
the very elastic demand for their products. I don't understand it as
a farmer.
I'd like to ask them the question but I'm not in a position to do
so.
Senator GoRTON. I like your answer and I agree. That's the best
way that they can become competitive, more competitive, is to let
those price differentials go on and not to keep them at the s~e
they are now.
You did get me a little bit off. It was a very interesting point aid
I am happy that you made it. You got me a little off the directi.Dn
which I was pursuing.
I wanted to ask you what you thought of the recent G-5 effort to
lower the value of the dollar and whether or not it runs any risk of
reigniting inflation. I believe you partly answered that, but w:iy
don't you answer that question directly?
Dr. ANGELL. I'm delighted that we finally got around to doing it.
As you know, my paper of July 5 called for it, and Treasury Secretary Baker and the Chairman moved in that direction at that tine.
I just wish we had done it 12 months earlier.
Senator GoRTON. But you don't feel that that's an inflationa-y
move?
Dr. ANGELL. Of course not. I would never have supported a mo,e
that I thought was inflationary.
Senator GoRTON. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Sarbanes.
LABEL OF HARD-MONEY POPULIST
Senator SARBANES. Mr. An,ell, what does it mean to be a hardmoney populist? I think that s the phrase you used in responding
to Senator Riegle.
Dr. ANGELL. I don't really know. I've broken one of my rules.
One of my rules is never use labels on myself and here I invented
one. My family was part of the homesteaders who, 100 years ago,
went from North Carolina to Kansas. The declining prices of that
post-Civil War period that lasted for 21 years posed enormous burdens upon the farm community somewhat similar to what we're
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seeing today, and so I'm somewhat sympathetic to the populists,
but I'm a hard-money person in the sense that I do not want to use
reinflation as an antidote to those woes.
Senator SARBANES. Well, words ought to mean something. I had
always thought that at least historically and in perception being a
IiqpulIS
.· t did not encompass being for hard money. Is that an inacctliate view?
'
!>r. ANGELL. You have a very good sense of history. Let me suggest -that we, of course, had almost a 100-percent increase in commodity prices during the Civil War. After the Civil War, the
United States chose to turn gradually to a gold standard at the preCivil War exchange rates. Another alternative would have returned to a gold standard after the Civil War at a new gold parity,
rather than going back to the old one and not having to roll out
that inflation to get it clear back down.
Consequently, you could have been a hard-money populist at that
period of time, which would have meant you would have advocated
gold prices based upon the then appropriate equilibrium exchange
rate, rather than putting the U.S. economy through a long deflationary period.
Senator SARBANES. Was Bryant a spokesman for populism in this
country, would you say?
Dr. ANGELL. Yes, he was.
Senator SARBANES. Would Bryant have bought what you're telling us?
Dr. ANGELL. But Bryant didn't have the advantage of living in
1985 or the advantage of all the economic theory we have today.
He was an individual who was speaking out for a grievance as he
knew it, and I'm just saying that I understand that grievance.
Senator SARBANES. I think language ceases to mean anything
when you start putting together hard money and populism. I'll
leave it at that. I think we probably should not put labels on ourselves; we should just address the substantive issues.
Dr. ANGELL. Mr. Sarbanes, I take your correction as being very
well-intentioned and very correct and from here on I will not use
that phrase.
Senator SARBANES. Did I understand you to say to Senator
Gorton that you did not think the intervention in the exchange
markets by the group of five, which lowered the value of the dollar,
contributed to inflation?
Dr. ANGELL. I do not believe that it's had an impact upon the desirable price level stability goals that I seek.
Senator SARBANES. I think they should have intervened for other
reasons, but why wouldn't a lower value on the dollar mean an increase in the cost of imports and therefore contribute toward a
rising price level in this country?
Dr. ANGELL. Because of the diminution of credit in dollar terms
for countries of the world. We still have a scarcity of dollars in
international markets that prompts all the countries to use incentive systems to produce more goods in order to get those dollars.
So there is no sign of overabundance of dollars in the international markets. In fact, it seems to be somewhat the opposite case
and, under that environment, there is no ever-present inflation
process underway.
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Senator SARBANES. Are imports more expensive now than they
were?
Dr. ANGELL. Imports are not much more expensive than they
were. That's why we have such a long timelag with regard to the
,,foreign i~d~. Once the dollar rises to such heights that it begins to
take ~.··qiJ.rom Amei'!can farmers, American manufacturers, and
Amer1~ ·airplane ~ers those eJW)Ort markets, once those m~rkets are lost in a world in which every country needs more dollars
in order to make their deficit payments, there is not any danger of
·
inflation in that environment.
your
view
on the independence of the
Senator SARBANES. What's
1
Federal Reserve?
Dr. ANGELL. Senator Sarbanes, I strongly support the independence of the Federal Reserve.
Senator SARBANES. To what extent do you think the Fed should
coordinate its monetary policy with the view of an administration
in office as to what its policies should be?
Dr. ANGELL. I believe the Federal Reserve should use price level
stability as its primary goal, and I think the Federal Reserve
should be open to communications from the Senate, from the
House, and from the executive branch in regard to what policy priorities might be. There is no reason not to have communication
and open understanding and, if I might, I would like to go back to
a question I really missed-I'll do it on somebody else's time.
Senator SARBANES. No, go ahead.
FUNCTION BEST WITH OPENNESS
Dr. ANGELL. Someone asked me the question about whether or
not the Open Market Committee minutes ought to be made available. In my public life, I have always been on the side of openness.
I believe that in a democracy we function best when we have openness.
The only question in my mind with regard to the release of
FOMC minutes has to do with whether or not the Federal Reserve
gives better signals of what we're trying to do by what we do than
by what we say. As soon as I know the answer to that question, I'll
know whether or not the minutes ought to be published earlier or
later, but I would be open to hearing both sides of that issue.
Senator SARBANES. Pursuing this point of the independence of
the Fed, I'm interested in how your nomination to be a member of
the Board of Governors came about. Could you enlighten us on
that?
Dr. ANGELL. Mr. Sarbanes, I suppose since being a director of the
Kansas City Federal Reserve Bank I recognized that the Board of
Governors was more influential than a district director. I had some
aspirations to that, and when Lyle Gramley indicated in a news
story that he was not going to finish his term I recognized that
there might be an opportunity for someone with a farm background. I let it be made known to a friend of mine, who's a friend
of Senator Dole, and that was suggested to Senator Dole, and by
and large I was a welcomed rider in Senator Dole's car.
Senator SARBANES. For the enlightenment of others who might
have similar aspirations, why don't you sketch out for us how that
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proceeded? These are 14-year terms-not in your instance because
you've been nominated to an incompleted term-but these are 14year appointments. This is a very significant position and I think
it's helpful to get on the record how these things come about.
Dr. ANGELL. I guess I find it very strange that I would have pursued so many different vocations and not concentrated totally on
any one-economist, a farmer, politician, or banker, or an economic consultant. Then it just happened to be that at this moment in
time that wide background that I had seemed to be what some
people seemed to be looking for.
Senator SARBANES. After you expressed your interest to Senator
Dole, and of course you're from his State, and had him interested,
did you meet with administration officials with respect to going in
the Fed?
Dr. ANGELL. I met with all the people whom Senator Dole suggested I meet with. I just followed his wise leadership.
Senator SARBANES. Why don't we share that wisdom? Who would
they be?
Dr. ANGELL. We have been over this before. I have an integrity
question about personal meetings. I believe that if two people who
have met want to sit down side by side and tell the press about the
meeting that's perfectly sensible. I'll be glad to talk about the tone
of what was said at anr of the meetings. If you want to suggest-Senator SARBANES. I m not asking you for the substance of what
was said. I'm just inquiring as to whom you met with in the course
of seeking this nomination to the Federal Reserve Board.
Dr. ANGELL. My guess is that you would probably be pretty good
at guessing, and I'll tell you whether I met with anyone you ask
about.
Senator SARBANES. Did you meet with the President?
Dr. ANGELL. I did not.
Senator SARBANES. Did you meet with the Secretary of the Treasury?
Dr. ANGELL. I did.
Senator SARBANES. Did you meet with the chief of the White
House staff?
Dr. ANGELL. I did.
Senator SARBANES. And did you meet with the Chairman of the
Federal Reserve?
Dr. ANGELL. I did.
Senator SARBANF.S. Were there other officials of significant rank
with whom you met in the course of pursuing this position?
Dr. ANGELL. I met with Under Secretaries in the Treasury, and I
met with other E8()ple in the White House and I met with many
Members of the Senate. I met in July with Senator Garn and I am
most impressed as a citizen of the United States with the quality
and integrity of the people that I met with. I was most pleased.
Senator SARBANES. The question is obviously pertinent to the independence question and I don't see any problem with putting on
the record the extent of your contacts in seeking nomination to the
Federal Reserve. Others who may also aspire could probably use
that guidance.
Did you meet with members of the Federal Reserve Board other
than the Chairman?
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Dr. ANGELL. Yes, I did, and I met with Gov. Lyle Gramley who
was retiring and who happens to be an acquaintance of mine.
Senator SARBANES. Well, my time is up. I thank you, Mr. Chairman.
The CHAIRMAN. Senator Proxmire.
Senator PROXMIRE. Mr. Chairman, at the conclusion of my questioning I was asking Dr. Angell about intermediate targets. I just
have one quick question on that. I'm still not sure of your answer
on intermediate targets.
You say that the commodity prices should provide feedback information but should not be an intermediate target. You also say
the monetary aggregates should not be the only intermediate
target at the Fed.
My question is quite simple. What are the other intermediate
targets you recommend the Fed should follow in addition to the
monetary targets? What did you have in mind? Interest rates?
Dr. ANGELL. OK. No, I did not.
Senator PROXMIRE. You did not have in mind interest rates?
Dr. ANGELL. I would not have put down interest rates, but I
would say real interest rates would be a feedback or an information variable.
Senator, if I were rewriting the paper today, I would not have
said "other intermediate targets." On reflection, I believe that it's
better to have a single intermediate target. I want the commodity
basket auction prices to be a measurement of how well we are
doing on our ultimate goal.
Senator PROXMIRE. I think you answered the question in saying
that if you were writing it again you wouldn't refer to intermediate
targets. Does that mean that the only intermediate target would be
monetary aggregates? Is that right?
Dr. ANGELL. Well, yes, but the use of Ml target as an intermediate requires some procedure when Ml gets out of its target range,
as we did this last year. I don't like to deviate from targets without
a reason for suggesting why we should let them go. Why should Ml
be permitted to go above its target range? By and large, economists
typically focus on income velocity and it has a great deal of time
lag. That is, if the income velocity of money is falling, as it has
during 1985, then there's an indication that the demand for money
has been expanding faster than the supply of money has been expanding and, consequently, we don't have a problem. But doing
that, we're looking back over our shoulder at last quarter's data,
and I think that we would like to have some information or seek
out some information that would give us more precise explanations
as to why Ml targets should be permitted to be broken.
Senator PROXMIRE. All right. Let me go on to another one.
GANG OF FOUR
As you must know, there's been a lot of speculation in the press
about the Reagan majority on the Federal Reserve Board that's
going to happen after we confirm you and Mr. Johnson. You have
been dubbed, along with the other three, as the "Gang of Four."
Some of these articles implied that the so-called Gang of Four will
have their own separate agenda set in concert with officials of the
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Reagan administration and will seek to impose it on the rest of the
Board or Open Market Committee.
What can you say about the Gang of Four? Will it become a reality or is it just a product of the feverish imagination of the news
media?
Dr. ANGELL. I think it's the most preposterous statement of a
writers' imagination and expression that I've ever seen and there
is no substance whatsoever to it. I don't know why anyone would
ever even think such things.
Senator PROXMIRE. Suppose instead of calling it a Gang of Four
they called it the distinguished new intellectual elite. Would you
accept that?
Dr. ANGELL. No. I would accept it if they want to include all of
the Governors, but I don't want to include just four.
, Senator PROXMIRE. You would not expect to have a concerted
pro-Reagan administration policy then along with Governors
Martin and Seger?
Dr. ANGELL. I have a very long history of being a partisan in
seeking office when partisanship is called for. Once I became a
member of the Kansas House of Representatives I worked with
members of all parties to accomplish what I thought were appropriate ends in the public interest. In this case, I am entering a position that is written into law to be separated from the political process, and at this moment in time I no longer continue in a sense to
be a Republican. I have a responsibility to the people of this country and the people of the world to select the best policies we know.
And, in doing that in these dangerous times, we need to rely upon
the information, the expertise, and the intelligence of all members
of the Board of Governors.
Senator PROXMIRE. All right, sir. Now many economists are predicting substantially higher inflation this year. For example, the
Blue Chip forecast of 50 economists shows the CPI rising from its
current level of 3.6 to 4.2 percent by the end of 1986 and 4.7 percent by the end of 1987.
Given the rapid money growth in 1985 which you say you approve over 11 percent in Ml some economists are predicting even
higher inflation than the consensus forecast. One former member
of the Reagan administration, Larry Kudlow, says that because of
excessive monetary growth prices will soon be rising at the rate of
6 percent or more.
What's your own view of the possible resurgence of inflation in
1986 and do you think the Federal Reserve needs to change its
policy to head off higher prices?
Dr. ANGELL. I clearly do not anticipate the same inflation as
many forecasters do. I continue to be amazed, Senator Proxmire,
that the members of the press and the Members of Congress go
back to economists time and time again who have been wrong with
regard to the rate of inflation. We economists sometimes talk about
unbiased errors, and if we go back and take the last 5 years, take
all these economists and line them up, they all have had biased
errors, because they have all erred in the same direction for 5 consecutive years. I don't see any reason to believe those people that
have been wrong are going to be right in the future.
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Senator PROXMIRE. So you don't think there will be a resumption
of inflation.
Dr. ANGELL. Of course not, because I'm going to do all I can to
stop it.
Senator PROXMIRE. Well, you're a good man, but you have 1 vote
of 12 on the Open Market Committee which will set the policy with
respect to monetary policy.
REGULATION OF NONBANK BANKS
Now, yesterday the Supreme Court decided the Federal Reserve
does not have the power to regulate nonbank banks. The chairman
and I briefly discussed this at the beginning of the session today.
The Court said that if regulation was necessary Congress would
have to act.
Chairman Volcker has testified many times that all banks
should be regulated alike under the Bank Holding Company Act.
Do you agree with Chairman Volcker or do you think it is appropriate to have nonbank banks that operate outside the Bank Holding Company Act?
Dr. ANGELL. I agree with Chairman Volcker.
Senator PROXMIRE. All right, sir. Now recently the Fed moved to
apply margin requirements to bond-financed takeovers when the
takeover is accomplished by a shell corporation. I have two questions.
No. 1, do you think this is an appropriate use of the Board's
margin requirement authority; and No. 2, on a more general level,
do you think the current wave of hostile takeovers is on balance
doing more harm or more good for the economy?
Dr. ANGELL. I've kind of already answered those questions. Let
me indicate very briefly that I am quite concerned that the playing
field is not level. I do want market forces to determine capital
structures and control of corporations, but I want it to take place
on a level playing field.
Senator PROXMIRE. If I understand your answer, you're saying
that you think it is not an appropriate use of the Board's authority
to provide margin requirements in takeovers; is that right?
Dr. ANGELL. No; I think that a level playing field might require
that we have the same standards-that is, margin requirementsfor nonbank-financed takeovers that we have for bank-financed
takeovers. I want level playing fields in which the market forces
are most apt to function efficiently.
Senator PROXMIRE. Then as I understand your answer you favor
the margin requirement policy that was proposed by the Board recently. Is that correct?
Dr. ANGELL. Now that it's in place I want to at least give it a
chance to see how it works before we talk about it. I think it's a
policy action that took place before I was there, and I'm somewhat
inclined to think that it wasn't, based on my information, too significant a move.
Senator PROXMIRE. And I apologize for missing the answer that
you indicated you've already given, but do you on balance think
that the takeovers have been good for the economy or not?
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Dr. ANGELL. I think the takeovers have been so biased by our
lopsided tax system that there is no basis to judge whether efficiency is the cause.
Senator PROXMIRE. Now I'm a strong believer in our Nation's decentralized banking system, the fact that we have 11,000 independent banks in this country I think is a great advantage for our economy. It's unique, as you know, in the world. Other countries have
four, five, or six banks that do 95 percent of the business. We do
not have that. We have great dispersion of economic power and
competition.
I am troubled by the wave of interstate mergers which I think
will radically alter the character of our banking system and make
it more difficult for local businessmen to get credit.
What are your views on that issue? I think you're in an excellent
position to speak as a farmer, as a banker, as somebody who's studied this so carefully.
Dr. ANGELL. I prefer permitting States to make their own determination with regard to interstate banking. I do not believe that
all wisdom exists in Washington on these matters. I do believe that
it's entirely appropriate, and this Senate committee I think has
adopted a bill, which says, regarding some loophole to do interstate
banking, that it would be inappropriate for a State such as South
Dakota to allow within its State on an interstate basis what the
State law of South Dakota does not permit its own State.
Senator PROXMIRE. Well, I'm still not sure of your response to
my question on interstate banking. Do you think we should pass
Federal legislation legalizing interstate branching, regional branching, and interstate branching, or not?
Dr. ANGELL. No; I would favor that issue remaining with the
States.
Senator PROXMIRE. Very good. Thank you. My time is up, Mr.
Chairman.
The CHAIRMAN. I might just comment on that before we turn to
Senator Hecht, of how rapidly that marketplace is changing. Utah
is a small State insofar as number of banks go and certainly has no
really large banks relatively speaking to the money center banks. I
haven't even mentioned this to Senator Proxmire. I'm sure he's
aware over the years of the great opposition in my State to interstate banking.
A couple of years ago they passed a regional interstate compact
with 10 Western States, excluding California. But to my utter
amazement, one day last week both the house of representatives
and the senate passed a bill, signed by the Governor, with a 2-year
trigger. January 1, 1988, any bank that wants to come into Utah
can come in.
So I agree with your thinking. It surprises me that my own State
would have done that in such a relatively brief period of time. Nevertheless, that is their decision. Any State that wants to do that
should be able to. I would agree with you that we should not
impose that from the national level but I would expect, if my State
does something like that, you're going to see it happen a lot more
rapidly than people think on an individual State basis.
Senator Hecht.
Senator HECHT. I just have one further question, Mr. Chairman.
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You keep speaking about a level playing field. There's one problem I have in my mind the last couple of years which I cannot rationalize and I'll explain it to you and perhaps you can help me on
it.
A small bank that went under the last year or two, anyone over
$100,000 the Government did not take care of the customer, whereas in the large bank like Continental Illinois, the Government-the
Federal Reserve or whatever you might want to say-took care of
all the depositors. How can we rationalize that, the difference between the small banks and the large banks and the handling of
that?
Dr. ANGELL. I think it's difficult to rationalize, but I do believe
that when you examine it carefully the Federal Reserve's role in
Continental Illinois, for example, did not save the stockholders;
that is, the stockholders lost control of the bank and so I think
that's a very fundamental issue.
I think our present policy, in which we have $100,000 deposit insurance and in some bank failures we have individual losses above
$100,000 and in others individuals don't lose above $100,000 is very
difficult to explain. I think it's an inequity that has to be considered.
TWO-TIERED BANKING SYSTEM
Senator HECHT. Would you want to continue this policy as a twotiered system of banking?
Dr. ANGELL. I don't like a two-tiered system of banking, but we
do begin to have some innocent victims when a regional bank
begins to fail. Our two banks very close together, one in Missouri
and one in Kansas, would have a deposit in a Kansas City regional
bank which I will not name. In that regional bank we have sometimes Fed funds deposits of a huge amount; the payments mechanism necessitates rather large deposits by a rural bank in a regional bank. If a rural bank fails because of its own policies, that's one
thing, but I think it would be very difficult for us to let a regional
bank fail and take down with it a multitude of rural banks because
of that.
I don't consider that to be particularly a city-rural bias. In a
sense, the bias is that we kept alive the rural banks who would
have failed and stopped a domino effect if the large regional bank
were to go down. That's the reality of the payments mechanism,
and I think we ought to do all we can to alleviate any appearance
of unfairness, as the Senate committee has asked me to do in
regard to my finances.
Senator HECHT. But I feel we have roughly 14,500 commercial
banks in America, like Senator Proxmire mentioned. This has been
very important for the growth of America. Now if a depositor is determining whether he is going to put his money in a small bank or
a large bank he starts thinking, if the small bank goes under I'm
in trouble but if it's a large bank the Government is going to take
care of me. So obviously, if this continues, they would take their
accounts out of the small banks into the large banks.
Dr. ANGELL. You have hit on an iceberg and you have looked at
it and, frankly, I have so many more problems with this entire
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area. When we have, in a private enterprise economy, Government
guarantees of $100,000 on CD's and when we have banks and savings and loans who chose to issue CD's 130 basis points over the
Treasury bill yield curve, we begin to encourage speculative activity that's really very unfortunate.
I would like to look at that entire area and, as I do it, Senator
Hecht, I will keep in mind your feelings with regard to the level
playing field, which I share with you.
Senator HECHT. Thank you. No further questions, Mr. Chairman.
The CHAIRMAN. Senator Heinz.
Senator HEINZ. Thank you very much, Mr. Chairman.
First, I want to apologize for not being able to be here for all of
your testimony. I'm aware that you've covered a number of issues
of importance both to me and the members of the committee.
RESULTS OF A WWER DOLLAR
One question I understand you were asked earlier had to do with
whether the recent realignment of exchange rates, which resulted
in a lower dollar, a less strong dollar, would not be inflationary.
And I was wondering if you could go into a little greater depth as
to why this is so, when a currency depreciates by 30 percent, and
so many prices in fact are set at the margin by imports. This is
true with oil, with textiles, with steel, and almost any item. It's
hard to think of many that aren't set through international competition in trade-farm prices. Why do you feel that the 30-percent
drop or so in the dollar isn't going to result in a significant increase in inflation?
Dr. ANGELL. It will not result in a significant increase in inflation if the dollar at the same time that its value versus the yen
and the deutschemark is changing, continues to buy the same
quantity of commodities as it did previously; then clearly there has
been no inflationary impact.
For all the countries in the world except the United States, it is
true that a depreciation of their currency versus the dollar would
result immediately in more significant inflation problems for them
than we would have, because world commodity prices are priced in
dollar terms. The world is on a managed dollar standard, and when
those commodities are purchased with the same number of dollars
as they were previously, then we haven't had a deflation or depreciation of the dollar, but we've had an appreciation of these other
currencies against the dollar, which is tied to a stable level of commodity prices.
Senator HEINZ. Well, whether it's a depreciation of the dollar relative to other currencies or an appreciation of other currencies relative to the dollar, taking the yen and the dollar, won't Japanese
electronic equipment be more expensive?
Dr. ANGELL. After profit margins are pulled down until the economic profit is zero, we would expect that the import prices are
going to have to reflect those changing cost conditions, unless they
want to use them as loss leaders, and I presume they might run
into some problems if they began to do that with regard to our reciprocal trade agreements.
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Now that we have used up most of those profit margins there
would tend to be an increase in somebody's import prices with further appreciation of the yen, but if U.S. manufacturers are in a
competitive market and respond as competitors to that market
they will begin to gain some economies of scale as we begin to gear
up our own output. And if our manufacturers wisely recognize the
elastic demand for their commodities and try to gain profits by an
increase in output, then we will create many jobs and we're not
going to have any inflationary consequence, because the consumer
is not going to buy the Japanese import that rises in price if the
American-produced product doesn't rise in price. Let's hope in this
case that the American producers will understand that better than
they have in the past.
Senator HEINZ. That was a long sentence. But the reason I'm a
little concerned when I have someone explain to me the way everything is going to work is that sometimes it doesn't happen that
way. I think the dollar has been overvalued and I think there have
been some serious consequences to this country accordingly. There
have been some benefits to the country in pressures that have kept
prices low, but these in turn have exerted other costs on our economy.
I hear people saying to us, "Don't worry. There are no costs to
the dollar weakening vis-a-vis other currencies," but I remember
having this same discussion in this same hearing room back in
1977, and 1978, and 1979 with a fellow named Tony Solomon who
was then Under Secretary of the Treasury for International Economic Affairs. I kept saying, "The dollar is weakening. What does
it mean?" And he trotted out very thorough economic analyses and
said, "For every percentage point the dollar drops, it only means
0.00001 percent increase in inflation." And the next year Secretary
Solomon came back and said, "We've revised our estimate and it
may mean about a 0.1-percent increase in inflation." And the year
after that he said, "Well, we really have had to revise our estimate.
Inflation increased a lot more than that every time the dollar
dropped by 1 percentage point."
And we tend to forget that there are costs. Now why should we
care? There are ways of mitigating those costs, depending on what
other policies we adopt. I guess what I'm getting at is, if you knew
that in fact there were inflationary pressures being created by the
depreciation of the dollar-maybe you think that that's not going
to be the case-but if you were in fact convinced there were going
to be some serious inflationary pressures, what else would you do?
Dr. ANGELL. I would pursue a much more tight monetary policy,
sufficient to prevent the inflation from beginning. I certainly understand the Senator's skepticism and I certainly also remember
that same period. I would point out one difference. During that
period the world was primarily on a fixed exchange rate system
and the world is now primarily on a flexible exchange rate system.
A flexible exchange rate system-Senator HEINZ. Why was it on a fixed exchange rate system?
John Connolly floated the dollar back in 1972 or 1973 as I recollect.
Why were we still on a fixed rate exchange system back in 1978
and 1979?
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Dr. ANGELL. We were dismantling some of the fixed exchange
rate rules, but most of the countries of the world were still on a
relatively fixed exchange rate standard in that period of time, and
they had not experienced the discipline that floating exchange
rates puts upon them; that is, under a floating exchange rate
system, in any country other than the United States, the politicians are going to immediately experience expansionary policies
that are going to show up in the fall of their currency against the
dollar, and that disciplines those countries. Consequently, we have
today a world with more potential output expansion than we did at
that time. And that's why, Senator, we have not yet experienced
much inflation with the fall of the dollar from the level of 161
down to approximately 125.
But I share your concern, and I do not know at what point further adjustments of the dollar against these other currencies would
precipitate an inflationary course, and I will look carefully at that
as we go along.
Senator HEINZ. One apparent anomaly that's troubled me is this.
While the dollar has depreciated-or if you prefer, the currencies
of the G-5 have appreciated versus the dollar in the neighborhood
of 30 percent or so, including Japan-there has not been a similar
realignment of currencies with some of our other major trading
partners such as Korea, Taiwan, and I suspect Singapore. I haven't
looked at those numbers specifically.
What's the meaning of that?
Dr. ANGELL. The meaning of that is that we are living in a world
in which we have incentive systems that are increasing manufacturing outputs in many more countries, and that would mean that
as the yen appreciates, then Japanese automobiles will be relatively higher priced versus Korean automobiles, and the Japanese may
begin to lose their share of the import market vis-a-vis the Koreans.
Senator HEINZ. But what I meant is how is it possible for those
particular currency moves to take place without some kind of an
imbalance taking place someplace else? Has the Japanese yen remained stable versus Korea, Taiwan, Hong Kong, Singapore, or has
it appreciated or depreciated? What's going on out there?
Dr. ANGELL. My knowledge is somewhat limited in regard to all
of these currencies, but to the extent that I do know, it seems to
me the yen has appreciated against the dollar and against the
Korean currency as well as against the Hong Kong dollar and
against the Singapore dollar and others.
Senator RIEGLE. Would you yield on my time just at that point?
Senator HEINZ. My time has just about expired but I would be
happy to yield on my 1 second.
Senator RIEGLE. I appreciate that because I just recently have
seen the data on the market basket of currency value changes for
four countries, Korea, Singapore, Hong Kong, and one other which
is not Japan, and the net change in currency value so far is less
than 1 percent. So while we've seen some change, as the Senator
from Pennsylvania has pointed out is important here, we have not
seen it in these second-tier countries. So the data just isn't positive.
I thank the Senator.
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Senator HEINZ. I want to also commend Senator Riegle because I
only learned that from his international trade report which he
sends around to all our offices and I found that one of the more
fascinating pieces of information in it.
Dr. ANGELL. There may be some way I can get on his list of mailings so I can see that.
Senator RIEGLE. Consider yourself on the list.
Senator HEINZ. I think you've been signed up.
Mr. Chairman, I can think of plenty of other questions that I
could ask but I know that we're running late. I would like to
submit for the record and responses certain other questions for our
witness.
The CHAIRMAN. We would be happy to do that.
Senator Riegle.
Senator RIEGLE. Thank you, Mr. Chairman.
I don't know if you've had a chance yet to read today's New York
Times, but one of the lead stories on the front page is on the fact
that the U.S. economy grew at a rate of only 2.4 percent in the
fourth quarter and the initial estimates of course were higher than
that. So this is a somewhat depressing revision in terms of the
numbers and doesn't tell us what 1986 is going to look like but in
the subheadline here in the New York Times it says, "Trade gap
cited by analysts is being part of the reason that the numbers in
the fourth quarter were as low as they were," and this follows on
directly to what Senator Heinz was discussing with you and I want
to get into a serious discussion with you on trade in just a minute,
but I want to begin it by asking you one specific question which I'd
like to just touch on quickly and then move into the broader discussion.
JAPANESE IN THE GOVERNMENT SECURITIES BUSINESS
Recently a number of Japanese securities firms filed application
with the Federal Reserve Bank of New York to become primary
dealers in United States Government securities. I'm wondering if it
would be your view that Japanese securities firms should be allowed to become primary dealers in the United States Government
securities market before United States securities firms are accorded full national treatment in Japan, which they do not have and
have been prevented from having, and there is absolutely no sign
on the horizon that we're going to have any kind of access to their
market of that sort. This happens to be true in virtually every
other product area as well but we're just talking now about Government securities.
But would it be your view that we ought to move ahead to allow
the Japanese to come in and become primary dealers here in the
United States without some clear reciprocal arrangement on the
other side?
Dr. ANGELL. I do not prefer that the Federal Reserve System get
into the business of licensing and regulating securities dealers. I
believe that that market has worked very efficiently and I would
prefer not to have the Federal Reserve involved in doing that. I
prefer that that question be handled elsewhere.
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Consequently, I wouldn't think the Federal Reserve would be in
the position to engage in that activity.
I do understand that it seems reasonable that any time a foreign
firm has options in the United States that we ought to use the leverage of that entry to gain leverage for U.S. firms abroad.
Senator RIEGLE. Well, if you're on the Federal Reserve Board
your opinion on this issue counts for a lot. This application is
before the New York Federal Reserve Board, but I would hope you
would examine this and I would hope you would decide to oppose it
unless we got equal access arrangements .on the other side. In the
absence of equal access arrangements, I don't think we ought to
open one more door here, particularly in this area, and the Federal
Reserve System does have a bearing in terms of this question.
Dr. ANGELL. Then it must very well be then that what's happened here is that the Japanese firm involved is a bank holding
company and then it comes under the Federal Reserve Bank of
New York's regulation.
Senator RIEGLE. I'd like you to take a look at it.
Dr. ANGELL. OK.
Senator RIEGLE. I want to relate to a couple charts I'm going to
show you and I'll hold them up here so you can get the idea. I don't
think this problem is understandable if you don't see it in graphic
form. I want to show you two charts.
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FOR THE FIRST TIME SINCE 1914 THE U.S. IS A DEBTOR NATION
Dallan ID BIiii- -- U.S. Ket IDteniatlmal rm-tmaat .....U-
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lloaroe: lloaaamlo llapart el tbt Pnaldalt, 1111111
omc:D, "Socmailllo oatlook", , _ 1111111
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U.S. MERCHANDISE TRADE BALANCE IS DETERIORATING
AT AN HISTORIC RATE
Dollars In Blllloa.a
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total of all the trade surplw,es accumulated
since World War U.
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1967
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of _Senator Donald 'Ir. Rle1le, Ir.
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Source: Dopartmont of Commorco
46
One is what's happening to our trade defict over a period of
years and you can see that in about 1976-77 we moved into a more
adverse posture, but then about 1982 the thing really began to
hemorrhage and we have gone into this severe situation where our
trade deficit this year is approaching $150 billion and there is no
current sign it's going to be any less next year. People are hoping
because of the currency valuation changes and so forth that it will
happen, but as I've just pointed out with respect to the second-tier
trading companies out on the Pacific rim we have not seen any
measurable change in currency values after all of the drop in the
dollar that we've seen so far.
So in any event, this is what the trade pattern looks like in
terms of the trade deficit.
DEBTOR NATION STATUS
If you look at this from the point of view-can you think of that
as an income statement and you can think of this as the balance
sheet. We have been a creditor nation, as you know, the United
States has in the world economy since 1914 until just a few months
ago when we crossed the line and we became a debtor nation, joining Brazil and Poland and a lot of other countries in that status.
But we are moving into the debtor nation category so rapidly that
at the end of about another 6 months we're going to be the leading
debtor nation in the world.
Now, Mr. Corrigan, who is the head of the New York Federal Reserve Bank, has estimated that by 1990, 4 years from now, if these
trend lines continue, their prediction is that we're going to be a net
debtor nation to the tune of at least $500 billion and it could be as
high as $1 trillion. I mean, big money and an enormous reversal of
fortune in terms of our international balance sheet with other
countries.
Now we have not experienced this before and so there's not
much science that goes with the question of what this means, what
are the implications, can we service that kind of outside debt, what
does it mean in terms of foreign investors coming in and picking
off U.S. assets, and so forth and so on. But with the head of the
New York Federal Reserve Bank expressing concern about it from
the point of view of what this means if we move ourselves into that
kind of a debtor nation status, has gotten my attention I see it not
just in automobiles and heavy industry, but we've had the computer industry-we had a hearing in here that Senator Heinz conducted where we had Intel and the other companies that make the
computer chips who are in real trouble, as you may know, and they
feel they have been so adversely impaired in the international
trading system because tq.ey've been kept out of the Japanese
market that even if they got access today that wouldn't be sufficient to make them whole again, for they have been permanently
damaged. They weren't here to offer a corrective remedy except to
say that this problem is spreading coast to coast into virtually
every area of production that we have.
I might say it's even happening in agriculture. We are losing foreign markets partly because other agricultural countries have
come online and they've got certain other advantages that are
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helping them to give a cost advantage that doesn't necessarily
relate to the productivity of the farm units themselves. In Japan
today, the prime rate is 5.5 percent, at least the latest data that
I've seen is that the prime rate is 5.5 percent. Well, there's a 4-percentage-point premium here in the United States today, plus the
poor farmer out there as you well know is not borrowing at 9.5 percent, if he can borrow at all. He's not getting the prime rate. He's
paying something well above prime. So how does a United States
farmer or a United States manufacturer compete with a Japanese
farmer or a Japanese manufacturer who has the interest rate advantage, plus the closed markets, plus a whole host of other gimmicks and advantages that make us uncompetitive.
I'm not going to, at the moment, get into a long discussion on the
auto industry, but we may need to do that because it sounds to me
like you understand the farm problem better than you understand
the automobile problem and I think if you're going to be on the
Federal Reserve Board I want you to understand them both equally. So I hope we can talk about that.
But as you look at these numbers and as you watch us become a
debtor nation and you think in terms of how these official estimates that show us being a debtor nation to the tune of maybe
$500 billion to $1 trillion in just 4 years, what does this mean to
you and is this something that alarms you? Is this something that
you have some great sense of concern about as you come on the
Federal Reserve Board? Is there anything the Federal Reserve
Board can do about it? Does this fall within the purview of the
Board as you see it and the decisions that the Board might be
called upon to make?
Dr. ANGELL. First let me congratulate you for having such fine
charts that illustrate these areas. I'm very pleased a U.S. Senator
has the time to become so familiar with these pressing problems
which impose upon us changes and transitions.
We cannot go into the future as if this hadn't happened. It
means that interest payments are going to have to be going outward and at some point in the future we will have to become a net
exporter in merchandise in order to earn the money to pay the interest.
With an interest in agriculture and an interest in automobiles, I
think we have a lot of hope here, and that means we're really
going to have to become very good at exporting and that means we
have to become very good at exporting automobiles as well as exporting wheat. And, Senator, that means we're going to have to be
more efficient in producing wheat and corn and automobiles than
any one in the world.
I think it's a mistake for us not to have a sense of realization, of
hope, of what the American enterprise system can do. I am not
about to call off or cut off that sense that we can rise to meet this
challenge. With people like you understanding that, I think we will
be well on the way to improving the efficiency of American industry and that efficiency, as you point out, has an interest rate disadvantage in regard to the cost of capital and that disadvantage is a
rather severe one.
Senator RIEGLE. Well, I think that's an important point to take
up because if you take farming as an example, my sense for farm-
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ing today is that American farmers productionwise are the most efficient in the world. That's my perception, that in terms of workobviously you've got to adjust for differences in price level of imports and so forth, but in terms of being able to produce product
from labor, from their own labor and from the other production
inputs, American farmers are really at the top of the list in terms
of their efficiency.
But that isn't helping them at the moment and particularly as
we watch this international agricultural trading system change, as
it's changed very dramatically. The embargo had a big impact on
it. It closed out certain markets and let other people into the game.
Now they're into the game and so forth. And a lot of them are getting help-I'm talking about farmers in other countries-from
their national governments through a variety of policies, as are
their manufacturers, ranging from computers to video recorders to
cars to you name it.
So we are finding now that we're not just pitting the efficiency of
a farmer out in Kansas who may work from 4 in the morning until
midnight against some farmer in Japan, but that poor farmer out
in Kansas or that automobile company in the United States is
really up against Japan, Inc., which is sort of a national strategy
designed to help their producers and to crush ours, and ours are
being crushed bit by bit by bit and those ~aphs that I've just
shown you are an illustration of it. When you ve got a trade deficit
with one nation of $50 billion, as we do with Japan this year, and
which far and away heads the list, you've got a major problem.
But it goes broader than that. Here's the point that I'm getting
to. If you look at those costs of inputs with the prime rate-with
them having the advantage in Japan of just the 4 percentage point
difference-it's almost 100 percent improvement in terms of their
situation versus ours. With that kind of a low prime rate and ours
being that much higher, obviously they've got a much higher savings rate than we do and that's a problem in this country, how we
drive the savings rate up. But it seems to me that you can't ignore
the cost of capital-and I'm talking about interest rates now in
terms of availability of capital plus what you pay for it-when
you're running those kind of differentials, where does the Federal
Reserve System come into the act? In other words, when I hear you
say that the primary goal is controlling inflation-and I'm all for
controlling inflation, I think we've made great progress in that
area and I don't think we can afford to surrender it, but I worry a
little bit when I hear you say that and I don't hear you balancing
that with what you see as the other objectives of the Federal Reserve System. I can see us pursuing that approach in a way that
continues to give us high interest rates differentially with other nations that in turn create a cost of production advantage to these
foreign competitors who then just wipe us out steadily until they
put us in a debtor nation status where we're going to be working
day and night just to pay off the interest on money that used to
belong to us which we then exported to foreign countries in exchange for goods, and they're going to be our bankers. They're
going to be holding the mortgages on us and I haven't heard you
connect that yet. I haven't heard you somehow get beyond just the
question of holding down the inflation rate to the question of how
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we make this economy grow faster and what role the Fed has in
that area.
I guess I want to hear you say that. I want you to relate that to
this trade disaster that's overtaken us.
Dr. ANGELL. I appreciate very much your analysis. Let me suggest that I do believe there is a transmission mechanism between
monetary policy and real output. Now strict monetarists do not
hold that that takes place. I hold that it takes place in the following sequence: That whenever the expected inflation rate is higher
than the actual inflation rate, the real sector is going to have a decrease in output because the car manufacturers with the expected
rate of inflation are going to build into their cost structure and
that of their suppliers the expected inflation rate. When the actual
inflation rate turns out to be less than the expected inflation rate,
you have a depressing impact upon the U.S. economy and, by and
large, what we've failed to be able to do is to communicate with
credibility that we really are stopping inflation. We continue to
have unknowing forecasters predict higher rates of inflation than
we're going to have, and as long as that occurs we're going to have
slow growth rates, as were announced for the fourth quarter.
A 2.4-PERCENT GNP GROWTH RATE IS NO SURPRISE
A 2.4-percent real GNP growth rate does not surprise me at all. I
had some discussion with certain members of the Council of Economic Advisers who told me that the rate of real output in July
was going to be, for the second half, 4 percent, and I told them that
I thought it would be 2 percent, and so I'm not surprised at these
numbers. The reason for this is because we continue to expect a
higher rate of inflation than we have. It's very important that the
Federal Reserve have the credibility to bring down not just the
actual rate of inflation, but the expected rate of inflation, because
that has so much to do with output.
Economic efficiency will occur in automobile factories in Kansas
City; by the way, we are a rather substantial assembler of automobiles that your Detroit manufacturers wisely established in Kansas
City many, many years ago. We are not a johnny-come-lately in
automobile production. But if we pursue price level stability, then
the American ingenuity of our management and our labor force
can focus upon efficiency. I think that those two go hand in hand,
and that has to be the long-run solution to the problem, rather
than just a patchwork solution.
Senator RIEGLE. My time is up. Mr. Chairman, I've got a couple
of other things when it's appropriate.
The CHAIRMAN. Senator Hecht, do you have any additional questions?
Senator HECHT. No, Mr. Chairman.
The CHAIRMAN. I'll return to you. I hope you could proceed as
rapidly as possible.
Senator RIEGLE. I will, Mr. Chairman.
The CHAIRMAN. We have another nominee waiting in the wings.
Senator RIEGLE. I appreciate that and we're all busy and have
other things to do, but I think the job that you're being asked to
fill is one of the most important in the country. I view it today as
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probably more important than almost any Cabinet position because
of the critical role the Fed is going to play out over the next several years in working us through these enormous transitions in this
changing world economy, things we don't even understand yet. The
old textbooks I studied in good colleges not very long ago aren't
even relevant to the kinds of circumstances that we're seeing
today.
You made the point at least once-more than once actually
today-that you see price level stability as the primary goal of the
Federal Reserve Board. You made that clear and where you're
coming from.
What would you see as to what goes with that? I'm talking about
just the principal goals of the Federal Reserve Board or obligations
or responsibilities, if that is the primary one in your view, what
two or three or four or five others go with that to really comprise
your concept of what the Federal Reserve Board has to do for this
country?
Dr. ANGELL. By focusing upon this primary goal, the Federal Reserve creates a climate under which other improvements are most
apt to occur. In other words, the encouragement by having the unemployment rate fall as it has during this year-whereas the
famous Okuns law would have said that unemployment rate should
have risen during this period rather than fallen. The natural unemployment rate in the United States has fallen, I believe, for demographic reasons and because of impact upon the labor force-we
are now beginning to get through more flexibility in wage rates.
The natural rate of unemployment is falling, and the actual rate of
unemployment can thereby fall without engendering a labor shortage.
I believe in this market that we're going to expect to see-with
any improvement whatsoever in our real output, and if real output
could move up to the administration's hoped for target of around 4
percent-some real significant employment gains. They're going to
continue, and the unemployment rate, I believe, should be able to
fall rather substantially.
I think it's important to remember that the natural rate of unemployment is on the downswing because we have no longer had
the input of so many women who have decided to enter the working force all at once, and we now have fewer people in the high
school and college graduating classes, so that proportion of the population tends to bring down the number of entrants in the labor
force and that's very, very encouraging news.
But I believe that the Federal Reserve, if it does its one job well,
can help foster the other jobs that need to be done by other sectors.
UNEMPLOYMENT RATE
Now let's look at the unemployment rate again. Natural unemployment rates are due to microeconomic forces, not to macroeconomic forces, and we cannot lower the unemployment rate below
its natural rate without permanently increasing the rate of inflation. We've been through that many times before.
Senator RIEGLE. Well, on just that point, we're roughly at 7 percent now, just a little bit better than that, as we calculate the
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number and we've got a lot of things that have impacted this that
we haven't mentioned. Obviously, the major break in commodity
prices not unrelated to the improvement in the inflation outlook
but certainly this abrupt drop in the price of oil and a lot of other
commodities have had a major effect on how we've been able to
keep the inflation down and still get growth here as we go along.
But if the unemployment rate starts to go up-you know, we've
had sluggish growth around the world. Our number for the fourth
quarter isn't the only one. There are others, too. So you'v'lgot a lot
of slack in the system around the world which I think has caused
us to see less inflationary pressure and less demand on commodities and so forth. That can all change. But if we find at a later
point-let's say you're on the Federal Reserve Board and we're 1 or
2 or 3 years down the road and unemployment starts moving up
for whatever the combination of reasons, if we get up to 8, 9, 10, or
11 percent, where we've been not all that long ago, and it becomes
clear that-and interest rates are high and the high-interest rates
at that time are having the effect of in a sense starting to choke
the economy in certain ways and in a sense feeding into the growth
in the unemployment rate.
Would you be the kind of a Federal Reserve Board member that
at some point, even given the primacy of the goal for keeping your
main focus on the stability of price levels, might you start to feel at
some point if the unemployment rate got up into those ranges and
the deficit started climbing because we lose about a $30 billion
swing on the deficit for every 1 percent increase in national unemployment-we get up in the 9, 10, 11, or 12 percent unemployment
range, do you think you would be inclined, as a Federal Reserve
Board member, to want to pay more attention maybe to liquidity of
the money supply and making sure interest rates are lower and
that you're really inducing wheels to turn whether they're combine
wheels or factory machinery or whatever it is? At what point do
you start to shift off the question of keeping that zero inflation rate
to the point of saying I don't want this economy stalling out, I
want it to continue to function. Where would that be? Is it when
unemployment gets into the double digit range or where does that
start to cause you concern? I mean, you come from the breadbasket
of the country and I'm interested in how a Kansas perspective and
your background where you see that equation starting to change
and how that would affect your policy judgment?
Dr. ANGELL. Senator Riegle, I find it very difficult to answer
your question because-being a student of financial history-I just
can't perceive getting into the situation of rising unemployment if
we have stable price levels. I just do not know of any instance in
American history where we have ever had rising unemployment
rates following stable price levels.
If the Federal Reserve does its job of maintaining a stable price
level, we will not set in motion those forces that require us to
adopt policies that lead to higher interest rates and rising unemployment.
Senator RIEGLE. What about falling price levels? You've got falling price levels for land values today.
Dr. ANGELL. I understand that.
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Senator RIEGLE. So it isn't just a question of sort of rising prices
or stable prices. You can have a deflation. In fact, we've got a lot of
deflation in a lot of areas right now. But it seems to me that if you
go back, say, to the 1930's and to other periods later than that in
our history, we've had situations where we've had high-interest
rates and inflation hasn't necessarily been out of control but we've
had high unemployment.
Dr. ANGELL. Yes.
Senator RIEGLE. So you don't always get it in the same pattern. I
guess what I'm concerned about, I would be very reluctant-now
this is my own view-I would be very reluctant to see this country
take a hard long recession any time soon and I say that not just
because of the human suffering that would go with that but because I think there's a lot of structural weakness. We're seeing it
in the farm sector and we're seeing it in this credit expansion all
the way around. I don't want to test the lean-year proposition
today when I look at sort of the collective-balance sheets all the
way around the perimeter of what we have to work with. I just
don't want to do it. I don't think it would be wise to do it.
So if we found ourselves in a situation where we started to gravitate into a serious recession, Gramm-Rudman is going to kick in
here with automatic removal of fiscal stimulus which could help
drive the economy down faster. That was articulated in debate and
a lot of people are concerned about that. If we start going in that
direction and unemployment starts increasing rapidly and the deficit starts widening and we don't see any real improvement on the
trade front, I would hope the Fed at that point would say it is very
important to keep this system running; we don't want unemployment at 15 percent because that gives us more minuses by far than
any pluses on price stability, and at that point I would hope that
with the kind of flexibility that you say you have and the magnetism and independence, even if you're ~etting phone calls from
somebody in the White House who says, 'Hang in there, the price
level is the only thing," I would hope that at some point you might
from the populism side, the label iou gave yourself earlier, would
cause you to say if this system isn t humming we're going to trade
one set of problems for a much worse set of problems and we've got
to keep ~ple working and we've got to keep assets employed, not
fully, I can't get that down to zero, but I don't think we can afford
to see the unemployment rate up above 10 percent for any length
of time in this country in the financial condition that we're in, and
increasingly in a world economy situation.
So I stress that to you because I think if your bent is the other
way there I think you could send us right over the edge here without ever intending to and I don't want us going over the edge.
Dr. ANGELL. Senator Riegle, I aspire to be the kind of person that
you describe in regard to being flexible and a learner. All my life
has been involved in the learning sequence, and my formal college
education was not foremost among the learning experiences that
I've had. I would hope that I would not somehow or other cease to
be a learner once I enter the Washington scene. I would hope that
I would continue to be a learner, and I would hope I would continue to be responsive to new questions that you perceive, and I would
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be happy to continue this discussion with you in the years in the
future.
EFFECTS OF LOWER OIL PRICES
Senator RIEGLE. One final thing and that is, here the oil prices
have dropped below $20 a barrel and nobody quite knows where
they're going, but there are a lot of sophisticated people who think
there's no particular reason why they can't go lower, maybe to $15
a barrel, and if that were to happen, if we were to see oil getting
down closer to $15 than to $20 a barrel, and as you look at the
imfact of that in terms of the international financial situationwe ve got cases like Mexico that probably stands out foremost but
there are others-how much of a cause for concern would that be
in your mind in terms of this being profouncly destabilizing to the
banking system, to the oil-related sectors in our economy, and the
regions in our country and so forth? What would be your view of
the implications of oil at close to $15 a barrel?
Dr. ANGELL. Senator Riegle, for 2 years I have felt that a $15 per
barrel oil price is very likely. Now my difficulty, sometimes, is I get
premature in regard to how soon these events may take place, and
it's because of this concern and belief that forces are at work in a
deflationary manner that I have been willing to take a somewhat
more independent view as to what monetary policy should do.
Senator RIEGLE. But I guess my question is: What are the implications? What follows if that happens? Does that create huge new
problems that we'd better really start to get ready for or not?
Dr. ANGELL. It adds to problems we already have because in
many ways, of course. In our Midwest we have not only grain production and red meat production but we also have a very heavy industry in oil and energy, so we are very adversely affected by that
industry in the Tenth Federal Reserve District and are very conscious of that. And I believe at every level of Federal Reserve activity there is a very clear discussion-at least we had it at Kansas
City-concerning oil prices at about every meeting that I attended
before voting on the discount rate.
Senator RIEGLE. If some extraneous factor like that comes careening into the picture, a break in oil prices that creates a lot of
secondary instability in banking institutions and international financial relationships and so forth, does that kind of thing-are you
flexible enough again in your decisionmaking that you are prepared to have the Fed take whatever actions are needed to sort of
stabilize things and to maintain some kind of equilibrium?
What I don't want to see on the Federal Reserve Board is a true
believer that says we've got to hold to this even if we've got a terrible disequilibrium on here that's sending everything cascading over
the side and we're going to hold to this goal come hell or high
water. I don't think we're into that kind of situation here and I
think we're going to have to be very intelligent, flexible, pragmatic,
and I think cautious and wise. I think it's a whole new assignment.
I think probably being on the Fed 10 years ago was a lot easier job
than it is today.
So I guess I want to assure myself that you are prepared to
adjust as necessary here and help the Fed maybe search its way
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54
through some new ground and policies that it might have to develop that maybe it hasn't had to have in quite the same way before.
Dr. ANGELL. Senator, your point is well taken, and I hope that I
would be wise enough to understand the flexibility and have it
there when it's needed.
Senator RIEGLE. I thank you. I appreciate the time, Mr. Chairman, and the witness' answers.
The CHAIRMAN. May I say that the Senator from Michigan has
certainly outlined the trade deficit problem very well as he has
often in the past and I want to assure him once again I still drive
an American car. I would not not buy one under those circumstances.
In closing, I want to say there is one more issue that is developing very rapidly beyond the issues that Senator Riegle is talking
about. That is in the internationalization of capital markets and
the explosion of the zero-bond market. I don't think too many
people understand the implications for the financial services industry.
So the committee is going to hold hearings next month. We have
invited many different organizations and international witnesses to
start to explore this area, because it's had very little attention in
the press and I don't think we have answers to those questions. All
these others at least we've talked about for a long time. But the
internationalization of the capital markets is a very great concern
to me.
We appreciate your testimony very much, Dr. Angell. Senator
Sasser outlined my feelings very well earlier today. We appreciate
the candor of your answers. We have too many witnesses who seem
to be either intimidated or afraid when they appear before a
Senate committee to express their opinions. The important function of nomination hearings is for us to determine how those witnesses feel, and whether we agree with you or not on all points is
not nearly as important as the fact that you have been candid and
straight with us so that we can make that determination. I echo
what Senator Sasser said, speaking on behalf of the committee; we
appreciate the directness of your answers very much.
Dr. ANGELL. Thank you, Senator. I appreciate very much the
manner in which I have been treated by your committee. It's a
pleasure to be here. I hope to come back again.
The CHAIRMAN. Thank you. You will be back. We guarantee it.
[Biographical sketch of nominee and response to questions of
Senators Heinz, D' Amato, Mattingly, Proxmire, Dodd, and Dixon
follow:]
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STATEMENT FOR COMPLETION BY PRESIDENTIAL NOMINEES
US S1111tt l1nldn9 CH•ittu Sht111nt , ll1yn1 Aftgtll
Mam....,,,lpo:
Fo=to~ ,. ,.~
Name:
UGCU
- - - • - • ~ "-' _ _ _ _ _ _
...,
Otteofblrth:
Marital atatua:
Namtandalfl
ofchUdr.n:
:JAh
=-
0,
lftllJ)
,f ionrnora of th, f1d1r1l Rnerv, S11tt1Det~natlon:
1~
larchd
P1tric1A . Pitkering- J2
llynne Den iu Ang e ll -
a
Institution
Euno ■ iu
.
, ...,,
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Anociation
1155-
-
Urban F11lo111hip Advilory Co11 i ttu
U. S. DtpartHnt of No111hg
, Urben D,ulop•~!'L . _
1970 - 1972
ll1n111 Shh Ch11btr of Co11er n
E•eeutivt Co11ittu
1911 - 1961
OttanCh11berofC011tret
Board of Oirutort
1965 - 1961
Ry1nL.Ang1ll-21
-
Dates
rocolved
attended
9/,.,. to 5/U
Ph ins Hi gh Sthool
Auriun
Uiubllh (lttty) JuR Ange ll
lliltyD . AnQlll • 22
Educatlon:
--
October 10, 1985
PlaceDfbirth:_~L~ib~"~•~l,_,"''"°'""-'--------full name of spouse:
Ult below all memberships and offices hald in profa»lonal, fratllffill, bulineu, scholarly,
civic, chlritablt and other orpnluUons.
.....
0.tuof
~
OiploH
Illy, l91tl
Ott•~• University
9/0toS/ 52
B, A,
Jun, I, IH2
Uniursitr of hnus
9/ 52to5/5l
II . A.
Juntl, IISJ
Uni vtrsity of K1nu1
9/53to6/56
Ph . D.
June 3, 1951
ltentH Council for
Eeono ■ ict
lduulion lueutivt Co11itht
Pro9r11 Co11ittu, A11riun Baptist Churehu
Kauas Ba.f!.t-ist Convention
Chainan
Pr es ident
1!61 - 1175
ltH
!!!_g_
Employment r.eord: Ust below 111 posltk>ns held since coll-.., lncludin1 the tit'- or description of Job, name of
employment, location of work,, and dates of lncluslve ,mp,oymtnt.
InttcetCtnr
Oninraitr cf h1111
Anittfnt f r ofn19r
fa reno
15
9095/t ta 5'1951
0tttn Uniuc1ilx Otho IS - 7O9M to :VUM
Auoeiatt l'rohnor, Ott1111 Uniur1ity, Ottawa, ltS - 9/1951 to 5/U!O
Proft1tor of Eeonoalcs, Otta111 Un i v1r1it1, Otta'!!.!_ 115 - 9/1960 to 12/1115_
Oun of th, Collt9t, Ottawa Uni ur1lty, Ottawt, ~ -:- •fil~l___!!_J[ll1l
Yiu Pr11id1nt and Director, N1111 Bink, HuH, NO- I0/1971 to 12/IHS
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Honors and awards: Ust below all schollrlhlps. fenowlhlps, honor11ry delrMI. mllttary fflldatl. honorary society
mombotlhlPo, and any athor apocial - - for - . d l n a - or achlowmanl
P~i Itta leppt, Uninr1ity of 1&11111 - 1953
Mell Str~tt_Journal Stlldtnt Aehitv111nt l11ard - 1151
hn11 llnktr1 Auoe latio11 flllo111hlp I~ Co111r'dal Bankint - 1955
_Nuttrt _!IJ_...!!..!!_11111 !,1thr1 1 Ottawa Uni unity - Stpltltbtr 1 1 1111
Sibyl luti• Ol1tin91i1 i1htd Proftuor 1 Ott1111 Univtr1itr - )185
Di,tin911i1htd Str•it• A111rd
Ott1111 J11ni or Chubtr of _Co_1_1_~r<:L- 11111
Mk '• Who in AH rl un Politiu
O.t1ta• dl n11 Eduutor1 of Aaerie,
of tht Soard , Fir1t Statt lank, Pltannton, IS - 11/1975 to 12/1115
P1rtn,r , An!!II 8~01,, f~r•__P•f'_tntrJ~ip - 5/1953 to 12/1915
~
---
11S S.Htt luU111 C1Hlttu Sht1H11t, •••••
11S S11111tt l111kht C111IUu l tatuut , ll1r 11 , Alllttll
k>c:al ~ ·· In•
Utt lltY uperlenct kl or dlrtet NSOClltlon with Fedtf'al, Si.It,
ckKflnc 1111 MfvilOr'J, conaullaUw, honorary or oth« part-lima MfVlct or po&Ulon,.
Of
Poeltkal
contributions:
lltu u Sta ll h ,r,u 11 t1 tl u , IHh 01, t rl ct - I/IH I lt l/1111
Cllt lr, ..
a.,,11
lltmlzt 111 politlal contributions ol $500 or more to any lndivldu.l, c-,npai,n or11nlu •
lion, politicel part,, pollUcel action commlttN or ahnl l•r entll)' durln1 the l11t tiaht
the reclpltnta.
)"Nl'I and Identify tht specific 1moun11, dltn, 111d namH
°'
Angell h r lllll tt • Stttn s. .. tt - l tJI
h1ll11 etr l 1I On, h,1t1t C111 lttu , Yiu Chli n111 1111\lr l n 111rc n ,
Sub C111 ltt n, Ch 1ln111 , ••r• "' ' lliuo ( A,1,re,ri • tiM) C111ltt u .
All,lur! C1H llt 11 lt t h, SteH , , t he lur• 1f C.ner11or1 , ,,, .,,.1 lhun,
re 111111 ll1U l119 Cu p111r l ttlt h 1h11 111• l 11u h ti 1111 .
Dl ruttr, r.,,r a l ~,uru 1111~ 1< h11u 1 Cil r . 6/ 1961 t t ll/llU
Publl"""
writlnp:
U•I lht 1111.. , pubU1htr1 and d11H of boob, artkle1, repo,t1 Of other pubtlthlld mat.rills
1G'IMY'lwritttn.
Qualif!QIUOnt:
Stat, lully JOUr q1.6allliCIUons to """ in tht posHlon to which )'OU NW bttn named.
(ltlMh .,_,
··~·future employment
relatlonahlpa:
1, Indicate whether ~ wlll ""'" 111 connections with )'OUr pr9Mnt tmp6orlr, budne11
firm, 1noct.tlon Of or11nlullon II you art confirmed by the Senate.
.
,
.._her
10'! MW IIIY p&lnt after comp6etlna: IO¥lfflo
2. Al tar as can bt torNMn. stat,
menl Mf"Ykt to re.ume emp4oyment, affillltlon or pqcUc, wtth )'IMlr PNVlou• em•
~ ,. butlntM firm, 1110Clatlon oro,pnl.tatlon,
I hn, Ill u ,h '""' ·
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Political
1ffllla1lon1
and KtlviUN:
3 . HH anybody made 10'! • commitment to • }ob
Litt 111 m.mbtr1hlp1 and otlictt held In and Mf"Ylcts rtndtred to 111 polltlul partlH or
lltctlon commlltNS durln1 lhl IHt 10 )'IUI.
,.1,.
Yiu Chtl l'tlll ,, th• ,.,.. .. .. ,.1111c,11 Shh L-, l, h tl u c..
c, .. Ht u •
lliuhr tf thf lla11111 lh pwbl\011 St .i t Plt thr 1 ~111ltttt - I HZ 1 I H \ 1 1961
Chalr ■ u 1
ltpubllcM
)f-. Olatrlct
C111 u11ti111 1 l•111u - 11141
,re_! l•c. t c, .. i uu ..11, lruHl11 CtwlllJ Ntp,,Aliu11 CHt r •I c, .. 1u .. - IHO
11,.
,ft., 10'! 5-w .,.,_mmenU
_!,
.
4. Do )'OU expect to ltfVt tht full term for which
,
you hafl bttn a~ntedl
~
--lcb
IIS S11u1tt ltnki111 CtNitht Stlh ■ tnt. ll17n1 Angell
us S.uh lanld111 c ... 1u .. ShttHllt, ••r11• ... ,,u
of lnllN'Nt:
°'
4. List any lobbyln1 activity durin1 the past 10 yuir, In which you have enppd for the
purpose of directly or Indirectly influencln1 the passage, dtfNl or modific■tton of
any leaislaUon at the national leval of 1overnment or affectln1 the admlnlstraUon and
execution of national law or public policy.
other
1. O.Cribe any financial arranpment1 or defer19CI compensation a1reement1
cont1nuin1 dealinp with business a110ei.tes, cl'-"ts or customers who will be af•
ftcted by polld• which you will lnllUflnee in the po1ltlon to whkh you have been
nomlnated.
Non,
10111
2. Lill any investments, obligations, liabilities, or other relationships which mi1ht involY11
potential conflicts of Interest with the politk>n to which you hlwi bNn nominated.
rlr1tFln111u & lnnst ■ enh, Inc, - Sale 11ill llt co ■ pl1t.dprlor to u11,11ing office .
Hu•e hnuh1r11 , Inc, - Sale 11ill b1 co.pitted prior to
uu■ in!
off i ce ,
5. Explain how you will resolve any potenti•I conflict of intel'9st that may be disclosed by
your responses to the above items.
Aft911l riun d ll llan1gu1nt - Sale 11ill be co ■pltttd prhr to u1u11In1 office.
Sale oror ttroination ,, bu1ineu u ducribedin quution 2, page S.
1117111 Angtll & Auoci1tu - lu1inn1 11 ill bt ter•inated ,rior h auu•ing orfict.
1117111 Angtll, Fhanchl [co110.id - l111i111u 11ill bt ttr•inattd prior to 1111111"1 office .
3. Dncrlbe any business relationship, delllin1 or flnanclal tranuctlon (other than tax•
paylnl) which you have hid durin, the Int 10 ,ears with the Federal Govwnment,
whether for yourself, on behalf of a client, or 1Ctln1 as an apnt, that mllht In any
_., constitute or result In a poUlt)•e confUct of lni.r..t with the J)OMHon to which you
....
have been nomtnated.
Civil, Crimin.. Ind
invfltlpto,y
action~:
l. Give the full details of any civil or criminal proceedlna In which you were• defendant
any Inquiry or lnvntlptlon by ■ Federal, State, or locll 1pncy In whk:h YoU were
the subitcl of the Inquiry or lnY11stlptlon.
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2. Give tha full details of any proceedin&, Inquiry or lnvestlption tr, any profluk»nal
the aub)ect of U. pro,
anoclatlon lncludln1 any bar association In whkh
ceedin1, Inquiry or investigation.
you..,.,
lone
~
QuPstions Submitted by Senator Heinz to l-!r. Angell
Nocination Hearing -- Ji:muary 23, 1986
-?-
Question 1. Despite cany signs of c:ontinuing health in
the U.S. economy, a number of disturbing il'lbalenccs clouc'I the
horizon.
Ouestion 2. Concerns have bc1>!'l expressed that the
□assive c!ehcit position of th€> 11 .S. vis a vis thc> rest of the
,,orld could lend to a loss of confidence in the U.S. econocy,
resultinp: in a rapid drop !n the value oi the dollar and cop!tnl
inflows, and to a rise in inflation. Actual experience over the
la&t year haf! been of a gradunl ly fall i.rig exchange rote anc1
modest infh1tion. \That do you believe Are thr. prospects !<"!r a
continued steady decline in the dol lor with(!ut a notAble
increase ii"' inflation or the drying up of foreier. capital
inflovs--a so-cnlled "soft landing"? Fnw should c;onetary pnlic-: ~·
be user! tn Address a more rapid <lrcline in the dollar or
increase in ir.flatior,?
The trade deficit is at recC'rd levels and still
risiq;.
The value of the d('lllar, although below the peak
level of early 1985 in part duP to a more actiVP.
inte.rvention polic:y, is still at a level cnTT'l!lensurate \11th continuing larp.E' current account
deficits .
And the federal budget defid.t, although now subject
to limi to icposcc! by Gnnmn-Ruc!r,;m, remains enormous.
The U.S. is a net debtor nation and U.S. mtpC'lrtP.rs fnce tremendous competitive odds. ~ow urgent fnr the continued. health o4'
the overall econorny ,md the U. S . t:-nr.e positiof" are these r.tPps
to correct fineT'.cial imbalances? Are the steps being taken
sufficirnt?
~-
P.igh priorf.ty should be a&f-ip.ned to correcting
the imbalAnces in our econocy.
ThP &teps that heve been tal-.cn
so far are movPments in the right direction.
It is important tC'
follov thr('IU&h on these cff('lrtR if further progrf'ss is to br
g
cg
N
(1)
made .
>-nswer.
I cannnt preclict whnt will happer, t<" the!
exchanr.e rate of thE: dollar.
It depends nr r-c,licies hf'rt' And
abro,,cl end on other c!evelopr.rrts in our economy, in ot:her
econooics, and in ir,tcrnational narkets.
,: do not bclicvr. that
thr. decline in the dollar no fr.r will hnve a signifit:r,T'tly
c!dvc-rse effect. on our inflation rate.
If
R
f urther, r;:.pid
decline in the dollar threatencc! to reignite ir.flati('lr- t-:f'rP:, T
vould be inc-lined u : pu r sue a tighter nonet,-iry policy
t C>
l:f'.' ep
in."lation ur1der control.
However, we t!lUSt recognize thl't even i.n the best of
circumstancPs, it vill toke sor:1.e tirnr before our trade dC!fici !,
Q.
~
and the other icbA.ls:ro.ces in our P.cr.ror:,y arc sir,nificnntly
C')
:-educed.
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Question 3. A more actl.ve inter,,cr,tior. noi. i cy has bctinstitutf'l"li"v""tlie"G-5 countries t('I C'ror.u:-e that tl--~- '-'.tlues 0f t}
mejor cur:-PnCies accurately rcflF-ct the reli•tive strenr;t-hs of
their econonies. H('I"' inportant d('I you belif'V<: 0x change ric, rket
intrrv ention is to the v,1:!.uc of the do1 lsr, and hfJl·.' rlo vou SP.P.
this tr.ore• nc:tive appr. 0a ch affectittr, U.S . monetary polic'y?
t.ns~.
Intervent:lon can M.: t~nes be use~ul .
Pow<.'!VP:
!'or intervention to h ~"e a significPtit, la~t"tii; l'ffect on
cxchangP. r,1t e s it must be :q:pportcd by i.pprop!"i::tr 1T1acrnPcnnor-,.
policies.
For that :-P.ason, I hr?l ieve that the <.'!XChPr.r,r. :~;ite
r.hr\ ;lt" l -e giver. F'"F--'1tP r wr : 11 -1 ir
c .P;h•· .. · · •
;-~· ! ic·-· 1·l;~!<.i ,, .
&l
I
Question i.. The Or.mibuP Trade Bill introduced in thP.
Senatr. contRins e nuobcr of provisions intended to further
reduc-e the value c,f the dnl!nr. These include:
-- A possible [!lc,nctary conf P.rence to consider itJl:flrovcments to the world oonetary system,
Enhanced coorclination of G-5 monetary ,md fiscal
polic:irs to pro[!lote converg•mce of key r.conomic
fnctors such as inflati"'n, interest rates and r,nncy
y.rowth; nnd
EstabliPhment of a Strategic EY.c-h,:mgc RP.11erve in
which forrign currrncies woulcl be accumulAted to
increase the value of non•d('lllar currencies and r:wke
U. S. pr.rtic:ipation in foreign P.xchange markets nore
effective an<! crf!~ible.
With regard to these prov:f cions, do you br.lieve ,my significant
changes nre needed in the monetary system an<! tJ-oat a monr.t11ry
con~erence should be ccinsidered? How important to future
econonic health is corvergencP. of G-5 policir.s, and ho\l w"'uld
you seP. such coopeution affr.r:ting the conduct of U. S . fiscal
and rionetary polic:y? Do you believe thot 11ccumulation of a
foreign exchange reserve would t,,- nn effective t:onl for fC"r.cign
exchange intr.rvention?
~-
I share ~oce of the concerns about the func-
tioning of the intr.rnational monetary system, particulitrly about
the C('IPts a11snciated with ocrlium-terc swings in exchange rates,
0
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w~ich have given rise to talk about an internation11l raone.tary
conference.
However, modifications in selrcted aspects of the
international monetary sy11tem are t'lore likely to be achieve-cl. by
pragmatic 11.djuatments in current 11rranget'lenta than by convening
11. conference.
-~-
•· 4•
A conference runs the risk of raising unrealistic
expect11.tiona about a caeieive overhaul of the international monetary ayateri, which I c!o not believe is required.
After all ie said and done for, there is no substitute
for sound, non-inflationary policies by all major countrit"fl on a
sustained basis as the way to achieve ~reater exchange-r1.1te
stability.
Consultations within existing international
forUt.J.s-•the Group of Five, the Group of Ten and the IMF's
Interim Comnittee--provide avenuP.o for countries to purFue
policiP.s that are mutually reinforcing.
Discussions in these
forums also provide n means of assuring that policymakers take
int:n account the international inplications of each others'
dot:1estic policies.
While a core mutually con~istent set of
pnlicieA aoong the major ec('lnomies would be desirable, each
country's policies oust be designed to suit its particular
economic c ircums tan cc&.
The U.S. Treasury and the Federal Reserve currently
possess adequ11.te means with which to intervene in foreign
exchange markets, and such intervention can at tiDtCn be useful .
However, it does not appear necessary to establish a special
Strategic Exchange Resr.rve for this purpose.
$
-6·
Questio n 5 . Despit e the decline
in the value of the
doll.er during l9BS, the U.S.
andise trcl.de defici t remain s
at record levcl r.. Export -led tnP!:'ch
and
have bornP. the brunt :of the high ir.iport -sensit i•,r. ir.dust rir.s
has been an:• rerl!la nent weaken ing dollar . Do you believ e then~
of the U.S. nar,ufa cturint
sector ~ue to the high dollar ,
ho\J soon do you forupr .
inprove r.ient in the trodr. rlefici end
t as n r!'t:t?lt of dnclin es in the
dollar during the last yea r ?
~
- The nnnufA cturin@ sector ccrtl'lin
l y has been
hurt by the high value of th£' d<1llar
, as have other sec tors ,
includi ng the farn &PC'tor . Sone
firns are pcTl!lB nently out of
buainr. ss. Howeve r, chose th~t remain
have been forced by coopetitio n to aJopt. more efficie nt
produc tion techniq ues, the
entire U.S. Pconom y should benefi
t fror:l this enhanc ed proctuc- tivity .
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I U("!Uld hope to see SOt'l(! iuprove
T'lent in our trade
positio n i n ~ tercs quite quickl
y. Howeve r, it coulc.' v"U
be lat.e thiA yr.ar or even nc:"<t year
before we see a sir.nif icant
decline in the value of our tr:tde
defici t.
.7.
Questi on 6. Given the size of the
U.S. trade defici t,
th(!re is strong suppor t 11.cross
improv e the compe titive positio nthe United States for measur es to
of U.S. export ers . One such
step was passag e of the Export Tradin
g Company Act in 1982.
What are your views of the export
trading compan y concep t ?
Answer . Export trading compan ies
can be usP.ful in
proctot ing export s, but the compe
titive positi(" ln of a countr y's
export s will depend pririar ily on
fundam ental econoa ic factor s-notabl y, a non-in flation ary econort
ic environ ment that profT\ot es
saving s and i nvestm ent and a realis
tic, sustain able exchan ge
rate.
Questio n 7. Since the nri.~in al
legisla tion paSFed , it
has become clear that A nur.iber
effecti ver,ess of the lnu 11r.d theof impcc!i oents have liciteL I the
have introdu ced lP.giel ation (S. icipact of tradin c coe.pan ies. I
1934)
to
provic!
c furthe r
p.uidan cc to the Federn l P.eserv e
on the approp riate relatio nship
bP.twee n b,mks and affilia ted export
trading conpani e11. These
anendr: ients 1muld clRrify the definit
i.on
of
ETC6
and relax
certa in rC'f;tri ctions on acnber
action s with ETCs beini a pplied bsnk investm ent in and trar.r.by the Federa l P.E"serv e, u hil f'
;~~~~n ::! n~;i ~!:fe~ e~:;:!. P.e~~~r
~ ;~~h~~~!n ~o o~r~~= ~! ;~~visions ?
Answer . The provis ions of S. 1934
sppear to be quite
techni cal, and I cannot cor.c,en t
at this time. I would expect t("I
study thesP i,isues at a later date.
~
V,
00
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WC'uld not apply if there iR <'!Videncc that purcha!lrra of the
C"uestion l. On January 8, 1986, the Fedenl Reaerve
Board (FED) adopted an intP.rpretation of Regulation C. Thia
interpretation applies the t'l8.rgin requirP.menu of Rer,ulation C
to the finandng of corporate takeovP.ra through the use of .1unk
bonds. The interpr~tation represents a departure fron the FED' a
earlier position ('lft thh subject.
a) Do you agree uith the FED',: .Tl'.nuary 8, 1986 interpretation?
Answer.
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Questions Submitted hy Senator D'Amato to ltr. Angell
Uocination Hearing -- January 23, 1986
securities could rely on assets other than oarr,in stock as
cr,llateral; thst h. if the debt 1a issued or guarr.nteed by an
operating coopany vith flubat11ntial asset,;; or cash flov or if the
debt securities are only issued upon the cor:ipletion of the
rierger.
Although l have not hnc! the benefit of the
Federal Reserve Board staff studies on the questlon or the
benefit of the Board discussion, I probably would have sided
with the majority on the vote to adopt the interpretation .
d) Do you think a dhtil'ction should havP been osde
between the application of the Januar~· R, 1986
interpr~tetion to hostile takeovers and friendly
:~~~!:~t~~~a u~~ ~fvj~;[c~r,~~!~uts that are fir.r.nced
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b) If you take issue vith the January 8, 1986 interpretation, could you please state your position?
~-
As I just noted, I have no reason to take
It :!.cn't clear that such a c\iatinction vr,uld
be easy to make as a general ctot.ter.
But, r,ore fundaC"1c11tally,
would have reservations about using the r.,echttniso of margin
regulation to shape "the narket for corporate cortrol."
excP.ption.
To the
extent tha:t this is a concern . other instruoents of p;nvernment
c) The interpretation was !luppoaedly linitf'ld to certain
traneactiona. What do you perceive tn be the licits
of the interpretation?
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Answer .
to a specific, narrow class of transactions thet fall within the
0.
The interpretAtion
scope of existing market regulations .
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applies Nrgin requirements to debt securities hsued by shell
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priate approaches ,
I believe that the interpretation 1a lir,ited
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regulation--for e:r.aopl~ , securitieo law--wnuld seeo More apprn-
corporations to finance acquisitions of m11rgin stock.
As I
understand the interpretation, the Board's margin requirements
e) At present, foreign investors who finance acquisitions through foreign borrowing are not subject to
the requirel!lent• of Resulation C. Should legislation be enacted that would require the application
of the Mrgin rules to these forei~ investon?
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Regulation of borrowing from foreign lenders
is s complex issue , and I would not want to suggest that
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Col'!grcss enact any specific lc&islation until I hAvf! had the
opportunity to study the issues involved .
In concept, I believe
that regulations should be applied unifomly and evenhandedly.
Applying margin regulations to foreign lenders. howevP.r, does
raise sensitive issues regarding jurisdictional authority and
rel11tions with other governments, a tl&tter requiring care.
I
would like to point out that the Federal Reserve's margin regulations do apply when U.S. borrowers obtPin credit fron forctcn
lenders, either directly or indirectly.
f)
I.Ast year a FED Study reconnended thP repeal or
nodification of the 50% nnrgin requireoent. DCI you
support the recocanendations of this report?
Answer .
As I unden1tand it, that study focused on the
broader issue of the need for federal nargin re(:ulation and the
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Elppropriate regulatory body, rather than on the 5('\ percent
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cargin requirement per se.
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in securities rnarkets--and the role of onrgin rrcdit--over the
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past h.ilf r.entury, such
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appropriate.
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Given t~e changco that have occurred
fundacP.ntal reasscs&l'lent would oeem
I hAvP.n't hac! Pn opportunity to study the staff
report yet. though, And would uont to do so before taking a
position on this issue.
Question 2. The B,mking CcitllDittee hao hP.en exa.r.iining
the hsue of depotdt insuUl"IC'~ refon!l for srve ral 100rths. Part
of this inquiry has focused upon the aJefJt!rc-y of the cintmum
c apital resprves maint11ined by barl~s. Last week thP Cnaptroller
of the Cur::-r.rcy proposed a plan that would elininate the current
nandatory requirement th11t banks maintain a nJnirnum 6% capitalto-aesets ratio . The Conptroller recom1Dended promulgating new
rules thAt would set bank•' cinir.,un. capital reserves solely by
the riskines6 <"f their investments. Hy contrast, FED Chairnnn
Volckcr proposed cP.lculating capital resP.rvcs accordinr, to rislr.
but rf"taining the 6% requirPr-iPnt as A b11.se.
a) Do you bt>,liev.- that the cinimun c.itpitel adequacy
rese rves of bankc should be increas"?d?
b) Do yc>u bcliP.ve the plan proposed by ChAi rMBn Volcker
or thnt cf the Cornptrcller p1·cvides a ""re appropriate solut:l.on:
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a)
I am in favor of Rupervisory Rtandards
thet requir(' hanking organizationF to aaintain strong capitn:
positions in view of the risks to ,:hich banking organi211t.1C\ns
are exposed .
As you know, the lloarc! haF rr.tablished i;,ininun
capitcl R~equ,u:.y ratios and hn11 tightened these sta.n<lr.rds for
the laq;er hAnks c>Ver the last several yP.ars.
R~ccntly, thP
Bonr~ propo~cd a &upple1:1er.t2l rir.l-:-based capita! t>PosurP. that is
deaiirP.c! to cncour~ge those banlr.ing organizations with higher
risk profiles tr, strengther. their cnp!t11.l hasi~.
I support the
thrust of th:f r. effort and bdie'le thPt honking orF,P.nizatic>ni>
should back their rir.k-bear i n& P.r:tiviticr. ,.,:ith adequ11tP capital.
ThP support of risl:-takinp l-:, a strong capital posir!on promote£
the safety of dcpositorB' func!s, serves ac. t1r additional buffer
to the FDIC insurance fund, ar<l can better enable a bar.}, to
withstand a perir,C of serious asset or cr.rrings problet:is .
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b)
The risk-based ccasure at th:!.11 fttage ii:i a propoaal
on which the Board is seeking connent and which may change in
light of the coments re ceived .
However, I agree with the
general direction of the proposal, and that, at least initially,
we should not replacP. the existing ninirmrn guidelines sincP. the
cuidelines have been instruniental in encouraging banking organi-
~~~k~ ~~d
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Guaranty
Ci tt~o~~•h:~! :;;~~~:tI~~:t p;~~~ybe~~~~•~he
FED that would pemit theae inetitutf.01'8 to undertake non-
~::k~:~•~!~;.!!!d'
p~I~c~:a!~;~n:: ' f~:~"fn t~:cii~n t~l :e:::!;;aph
7 of the Glass•Steagall Act . Do you believe that the FED \lould
be acting within its ■ tatutory authority by granting these
l'.pplications end, by doin~ so, euentit1lly re~.f'!fining the tC':rn
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;:~~:t~~itr~~c~~•~ir: te~
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or
b!"~:}t
Ans~ .
u.tions to strengthen their capital position11t.
g~!!~!~!~"
The undenn-:!..ting propos11b now before the
However, over
FedP.ral R.ese?Ve Board concern the. applicability of section 20 of
time, P.s we gain greater experience with a risk-based r1easure ,
the Banking Act of 1933 which prohibit-.fl bank affiliates fron
it r,ay be appropriate to place greater enphasis--and perhaps
being "engaged principally" in the underwriting and public sale
eventually rely entirely--on such a measure.
of sccuritiee .
Congress gavr the Federal Reserve B011rd the
responsibility to r.drliniater and enforce section 20 which of
necessity includes the authority to interpret thP. tneaning of
~rn:~:: ;1~~=~ :!!~f.:!~~r~~
t!i~!;~c~h,.~"~~~u!.!~~:r~;k:~
!:cg~:e~e:~1~~~;!it;::~1o~~r
should be invested in the FED, the Treasury DepartMent or a
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legislati~e;~~~~s~is ~~~fr:~~1~
1
;~~
self•regulatory organization?
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I ao not really convinced that an adequate
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case has yet been made for governr,ent regulation in thh markP.t.
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':'hie is a very liquid and efficient rutrket and it ■cfl'm1 unvi1e
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to disturb it unle11 serious and per ■ istent failures have been
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eophi,-ticated.
Moat participant, in this market are quite
To be 1ure, aor1e, generally lees sophf.oticated,
psrtiee were injured in episode ■ in the recent peat, but I think
those episodes have had a aalutary educational effect that
1:houlc! significantly reduce the likelihood of new probleae.
"engnged principally" in
11.
of the Act and its purpose .
way that is consistent uith the terms
With regard to the particular caaee
now before the Board, I am generally familiar with the proposals
but I have not had the opportunity to ,;tudy the o.pplicationa r.fl:d
accompanying docunent• in detail.
Because of this and becau•e
of the possibility that, if confirned, I could be involved in
Board
decision ■
concerning these cases, it would not be appro-
priate for ce to express an opinion on the
application ■•
Of
C'OUrse, if the law 1• not effectively serving the public
interest, it h
the respon1ibility of Congreee not the Federal
Reserve Board to make the necP.ssary change• or amendmentl.
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Ouestion 5. Last year the Suprer:ie CouTt held that
comcrcial paper was included within the scope of the definition
of a security under the federnl securitiP.e laws. However ,
certain bank i ng ins.ti tut ions continue to ur,dcrwrite and distri -
Question 6. Many comentators contend that America has
becoce over-leveraged and that corporationB and individuals face
a debt crisis of huge proportions . Do you believe that such a
r.risia situation exists? If so, what action shC1uld the FED take
to discourage the growth of corporate and perf'onal debt?
t~~k ~~:i~!e inp:t!~ ·er~~ ~~~n1;~~~da~~r~!~ti~~t t~~mi:~!~~;l
Answer.
Answer .
Debt growth has been extrecely rapid recently,
The Suprene Court r uled that corar.erc-ial paper
and is, I believe, a cause for concern.
I think it would be a
is a security for purpo~en of the Glass-Steeg11 l l Act, which
mt stake to suggest that
WE'
are faced with an itrtinent, general
~enerally prohibits benks fron underwriting r,r dealing in
econot!lic crisis, but certainly many individ\lsl firms and housesecurities .
The Supreme Court expressed no opinion, however, on
holds ha.ve nf':'IB. s sed debts that reduce their financial root'I to
whether thP. meth<'d!I banks u s e in placing the cOT'lClercial paper of
caneuver and could expose thet!I to serious difficulty if their
third partieR with sophisticated invei::tors constitute undercash flow expectations are not realized.
writing or dealing ir the commercial paper s e curities.
Jn June
Sooe of the leveraging we are currently witnessing b
1985, the Board ruled that the methods of plAcing cot:miP.rci a l
stimulated by features in our tax code that favor debt
piipcr used by the Bankers Truet Company, a New York bank, do not
financing--features which I hope will b£' reconsidered as part of
involve underwriting or de11H.ng in col'lr!lerr.ial paper for purposes
Congress' work c,n tax reform .
of the Glass-Steagall Act.
has to hf' with t11eeting general nonetary needs in line wi.th the
reviewed in the courts and, a c cordingly, further comment on this
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riatter does r,ot appear appropriate.
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The Fed's chief concern , however,
This ruling is currently being
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goal of pronoting price stability in the long run.
:f
Queationa Submitted by Senator Mattingly to Mr. Angell
Nonination Hearing -- January 23, 1986
Queetion 1. What h your attitude ttenerally toward the
Claes-Steagall Act, and what. in your opinion, should thf"
Federal Reserve Board do in this area to prohibit bank• fron
engaging in nonbank activitiel?
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I 'a in general agreement with the propoaah of
the Board (and the Treaaury) to ler,islate some widening of the
2
Guaranty t~ktR~~e ~pp~~~!~~~~~ ~~~:!~dI~•~ef~~eM~~~a~ederal
Reserve 8oard that would redefine the tern 11 engaged pr!nr.ipally"
ao aa to allow the1e COf!'l'lereial banks to engap;e in securities
ond other nonbanking activitieR , In light of yesterday's decision on the l>iaension Case before the Supreme Court, which
struck down the Fed's redefinition of a bank, Hhat action (if
any) do you believe should hr. taken by the Fed to redrfine the
tera "engaged principally?"
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The proposals you t!lentlon concern the
o:
powers of banking organizations, into such areas as municipal
applicability of section ?O
revenue bond underwriting .
prohibits bank affiliatP.fl from being "ens11re-d ?)rincipally" in
I believe that it uould be desirable
the Banking Act of 1933, which
to require that such nontraditional activities be conducted
the underwTiting and public sale of securities.
outside the bank, by other affiliates within a holding company
a lawyer, it iA not clear to me that thf" Dh:1ensior. decision
1tructure1 while I appreciate the limitations of thia Approach
would alter the picture- in these case,:; Congress gave the &c11rd
\!bile I ar. not
ln sheltering the bank fror.i the impacts of potential risks in
the respon11ibility to adaiiniater and enforce section 20, vl>ich
new activities, I do 1ee aot:1e benefits .
of necessity includes the authority to interpret the meanine of
Jn addressing the issue
of which activities to pemit, I believe consideration should bf'
"engaged principally" in tt way that is conaietent with the terl!la
given to the degree of risk involved and whether therr. ,ire pos-
of the Act and its purpoae .
sible conflicts of interest.
Of course, if it i8 detenii.ned that
the law ie not serving the public interest effectively in
today'• oarket environcent, then it would be approprhte for the
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Federal Reserve to ask. the Congreu for leghlation that woult!
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clarify it1 desires regarding the separation of cotll!lercial and
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investnent banking,
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the Board, while I am generally f'amili"r with them, I have nC1t
With regard to the particular casPs before
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had an opportunity to study the applications or legel considera-
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in deciaiona on these cases as a Board meober. I feel it would
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tions in detail.
Because of this and because I aay p11rticipate
not be appropri11te for me to expreu an opinion on these
applications at this ti.De.
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merger an~u=~~~£:dionW:~~i!:ti~~r i~t~~;u~~o~~~;~a!~~
should the Federal Reserve Board do in this area?
Answer.
~~=~
rd th
e
Questions Submitted by Senator Proxnire to Mr. Angell
Nonination HP.aring -- January 23, 1986
If merger and acquisition activity takes place
in the context of a "level playing field" where it reflects
efforts to achieve, for exaople , gains in efficiency or improveC
management and where shareholders and others are treRted fairly,
there is no strong case for government intervention--apart from
normal anti-trust considerations.
distorted in a number of WRys by
Question 1. Fiscal/nonetary policy r-iix. I You] d like
to get your view on the interplay between ff.Etcal and monetary
policy. Onr. view suggests that oonetary policy should be
influenced by fiscsl policy . That h, if thP President and the
Congress are pursuing a loosf' fiscal policy, the FF.D needs to
teeper the effect with n tighter money policy . Those who hold
this view argue that if the federal deficit can indeed be cut
through Gra~-Rudman, that the FED can then loosen up on the
moretary reins.
However, the narket today is
A
tax code that provides
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The opposite vieu suggests thnt nonetar:, policy shou\<!
be conducted with a. view towards long-term price stability 11.nd
stable growth And should not be influP.nccd by fiscal pol:J.cy.
nunber of artificial incentives and aids to those involved in
\lhat is your view on this ione7
mergers, including the favorable treatncnt given debt financing
Answer.
Indeed, over the lonr. ten:1 the Federal Reserve
which has the undesirable aide-effect of encouraging the aesunpshould focus on achieving and maintaining r.table prices.
Uith
tion of highly-leveraged--and thus riskier--financial postures.
monetary policy directed at that goal, reductions !r. the feder11.l
The Congress should address this question as it considers the
general issue of tax reforn.
bud~et deficit would lower interest and cxchangP rntcs as the
federal governnent reduced its competition with the private
sector for credit.
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uestion 4. Will it be your intent to seek reopening
of the recent un
ond liciitationa imposed by the Fed on
hostile mergers; if so, why?
(1)
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Answer.
No I I probRbly would have sided vith the
majority to adopt the interpretation which applies the margin
requirement to a narrow rnnge of financing arrangPments involving the use of shell corporations.
Credit-s•maitivf' nnd foreign tr,,de-ser.i::itive
sectors \1ould grow faster, an<l thuEt help to naintain economic
expansion.
I think we need to be c~utious Ett-oout atter.lptini any
"fine-tuning" by rionetary pol icy, but I would cert::inly want to
monitor developnents carefully to mke i::ure that sof'"!e short-run
adjustments are not needed to keep the economy on an even keel
as the fiscal direction h
altF.red.
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Ouestion 2. Stabilizing the ExchAnge llate of the
Dollar. 1ou Gay that one of your chief critichms o!: r.,onetary
policy over the last several years ia that it 4llowed the
exchange value of the dollar to appreciate by over 70 percent,
thereby destroying r1any nf our export markets. You recocimend
that the Federal Reserve intervene 11.ctively in foreign exchange
1:111rkt>ts to stabilize the value of the dollar again,1t foreign
currencies. I hf!IV<' SOt"le trouble "11th your proposal on two
counts:
(1) Pegging the dolh.r to some arbitrary exchange rate
could require a ~flsive increase in the coney aupply to prevent
the dollar from risint, thereby laying the scPds of rar.i.pant
inflation 1
(2) In the view of Nlny P.conomiats including Preflident
Reagan ' s former chief Econonic Adviaer Feldstein, the principal
reason for the rise of the dollar ie due to our uncontrolled
budget deficits. If we eay the value of the dollar on foreign
exchange markets iB ndnly the responsib111.ty of the Federal
Reserve . don't we give a frr.c ride to the Preaident P.nd the
Cong::-e s s to continue their irresponaible ff seal policies that
got us into so ouch trouhlc?
~-
I do not believe that we should t~ to peg the
dollar to soae Arbitrary e xchange rote, or th11t the exchange
r11.te should be the sole objfl:ctive of monetary policy .
R11.ther,
bPlieve that the exchan(tf' TAte is one factor amonr; nany that
should be taken into 11ccount in deten:,,ining policy .
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When it
seeins too high, aome interventi<m and aomewhAt easier nonetary
policy would seem appropriate .
However, the Federal Reserve iR
not the only body that ahould be concerne('I about exchange rate1 .
The icq>Act on the exchange ratf! of the large federal
budget deficits h
r1•~uced.
only one r@1.u1on for those deficits
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be
Other it"lbalancefl in our econoriy and the world economy
.,l:10 havl! beP.n generated by our deficits1 these other itnbahn r.ea
provide anple cause to act promptly to reduce our budget
~Lf icita .
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carried aau:;~t~lc ~ntrc1;~ 7.li~t~a;::~ ~~~ ~~i~o~~b~~Cl!~ which
it is stBted that ceny banlts with Latin Al!lerican debt,; nre
finding relief by selling thtt1 in a SC'condary mrket. The
article noted that aeveral of the bi'- ooney center banks havP.
refused to discuso this development . It then said, "One reASOfl
for the reticence of the banker• and brokers is that the trana .:ictions provide t,m,ible evidence that many Third Uorld loans
1tre not worth their face value and the big banks f~ar that the
regulators would citr. that as a reason to require loan lose
reserves."
In May of 1985 the bsnkinE c01mnittee of the American
Institute of Certified Public Accountants ruled that honks that
svap loans must discount the loans on thPir books if they
received le Rs than fac-.r. value.
Do you agree with that ruling by the account.ants? Do
you think if the oarket is say ing that various of the third
world loons are not worth their face value this is a good reason
for the regulators to require additional rP.servea against such
loons? Do you think that the rr:r,ulators should JDake the banks
set aside reserves aiainst any loans that 11re swapped for leos
than their face value?
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The ruling by Certified Public Accountants
ar,pcara reasonable, I ur.derstand it applies only to those portions of loans that are actually swapped ,
Banks may ewap loana
for many rea1ons, and the market for such loan swap, is
rPportedly thin.
Bank regulators should require reserves (either general
loan loss re1ervPs or allocated transfer risk reserves) on the
basiR c,f thorough evaluation of the loans and of the oltuatlona
of the debtor countries, rather than solely on the baai1 of a
relativfl:ly few transactions .
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~~~:t;~~g!~te~8 ~~=~i~~g~~~ie~~p
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watcher&
o,r~~~~- th~ ~~DF~~YR it
is tnrgeting, it is really targeting real G?lP grovth . That is ,
when the FED thinks . the econony is growing too fast in real
terns, it steps on the t'lonet11ry brakes, and when it thinks the
econot:1y is growing tno slow, it steps on the □onetary gl'.S
peddle . My question to you is tuo-fold:
(l) Do you think this is an accurate de11cription of how
oonetary pol icy is actually t!lade?
(2) Do you think the real rate of GNP growth is an
e,ppropriate target for the FED?
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Alth0ugh I haven't yet p a rticipated in FOl1C
deliberatior-s, 1 can say th11t, as a director of the Federal
Reserve Bank of Kansas City and a longtime observer of monetary
uestion 5. Rules vs. Discretion in monPtary policy.
There has been considerable debate in the last few yPors about
whether the Federal Reserve ought to be allowed any discretion
in the conduct of monetary policy. n\ose against discretion
argue that a dhcretionary policy is inherently destabilizing
and that monetary policy ought to be conducted according to a
strict rule. The nature of the rule varies from soce measure of
money to some measure of price such as gold , foreign exchange
rates or co'l!ll'Dodity prices .
Those against a rule-based monetary policy argue the
econony is too cotlplcx to be run in accordance with a simple
rule . They say that any rule will not cover all the situations
arising in a dynarnically changing econoMy and that the monetary
authorities must be allowed discretion .
Without getting into the question of what is an appropriate rule, where do you stand on the question of discretion
versus a rule? Should the Federal Reserve be allowed discretion, or should we seek to constrain its policies with a rule?
policy, it is my percepticm that nnnetary policy is not t;irgeted
on re11l activity.
In view of the t!lany uncertainties in recent
yeAra about the· nonPy stock Ard other financial guides to
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policy, though, it is evident to me that the FOMC has, of necessity, placed nor c rmphssis on the underlyinr, course C1f economic
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expansion
Al:.'
well as other ecClnot'lic w~riables in asscssin(l the
stance o! r<'licy.
In my view, because monetary policy influ-
cr.ccs the econc,ny only over a span of tine, an effort to "fine
tune" GtlP p.rowth could actuall!' prove destabili z ing.
P.ather, I
believe th11t the appropriate policy objective should be to
steb5lizf' the price level ovPr the lony. run.
Answer.
In concept, then'! is much to he said for a
rule that would govern the cor,duct of r10netary pol 1.c.y.
Ideally,
such a rule would guide polic!' action consistently fr, the direction of achieving the goal for which the conetary authority has
unique respC"T'sibility--dot:testic price stability--and \,tould
minimize the possibility of errors in judgr.ient and reduce
uncertsinties on the pArt of the public as to the stance of
nonetary policy.
Over the years, many rules have been held out
as offrring such benefits, but given the nany changes affectini
our financial systeo and econC"ny they all he.ve serious shortcocings and run the risk of being destabilizing if pursued
ritirlly.
Therefore, like it or not, given the currcr.t state of
the world, judgment in nonetary policy is a necessary fact of
life.
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expre,u;ed°'J~~~!~ :bou~
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~h~r;;:. D~~t ~orC::!~~.~~~ck;~rhaa
exacple, in 1984 rnd 198~ nP.arly $80 biflinn of corporate equity
waa exchanged for debt. As a result, the cnrporate debt /equity
ratio ha ft rhen aherply .
Some suggest the rising levels of corporate debt are
aaking the economy far core vulnerable in the next econoMic
dow-dovn.
Other11 suggest that lllOrc corporate debt. is a good
thing--that it keep• corporate r:iana~ers on their toes since thf!y
must mef't the interest payments.
Where do you stand on this iuue. h the rising level
of corporate debt a threat to the econDr!l.y, or is it a blcssintt
in disguiee7
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Huge amounts of equity havf> been retired by a
relatively smll nUD1ber of fima.
tlh.Ue the added debt c!oea in
general act as a disciplinary force on corporate canagement, in
tome. cases the r•11ulting increases in leverage may leave firms
vulnerable to a &f!:riou1 weakening of the economy or a eharp rise
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in interest rates .
Giv•n the credit problem, we have already,
such leveraging makes
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uncomfortable, and I think that. in
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particular, the incentive, for debt finance contained in our tax
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code need to be exRlllined closely.
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Que1tion 7 . Bank-Deregulation. There ti.re sone who
argue that bank rlere,ulation ha1 run its full course and t.hat
b1mk11 should not be granted any neu powers.
Others continue to argue that banks need new powerr. in
the Area of real estate, insur1tnce, and aecuri ties if t hey are
to coopete wit.h other finan cial services conglot:terates.
banks and~=~k·~~l~~~;
~
.
:~:~1:: ~~u R~~~l~
::p~~f~d t~~w!r~c~or
In con cept, I favnr r.,:.panded powcrfi for banks .
However. I bel ieve steps in t.his direction shnulri he taken in a
cautic,us and orderly eianner becRuse the rial:,: f'f such Act.ivitic.e, especiall:,, when cw.bined with trAditional h anking
activities, are larcely unknown.
Caution is especially icpor•
tant today g i ven the strains on the bankin(I: aystcr.i .
$
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Question 8 . Herser of FDIC and FSI.IC. There has been
1cme talk about aerging the FDIC and the FSLIC in order to
Question 9 . Agricultural Credit. Congreu has before
it a number of propoaal111 for casing the agricultural credit
crhin. One idea is to er.tend the net worth certHicate program
provided to thrift institutiona to agricultural banke . Another
thrift• could exceed $15 billion while the FSLIC has leas than
~~~~o:•io~=e~ p:!1~: ~fr~~~!t~~:~e~ ~~:n t~a::~:r c~~a~n~t~!P.~it
when the loRn ie writ te-n down . Hany banks h11ve urged that
agricultural banks be afforded th!'! oame relief Congreu Mnde
available last year to the Farm CrC!.dit SysteC\.
:!!knl~::d' !h:c!f}~c~h!";~~!~~~:~· 10!~~:r1!~ ~~d:~u!!~!rby the
$4 billion in un-encunbered re,ervP.a.
What are your viev1 on this iaaue? Should we l'lerge the
twn inatitution,i, or 1hC1uld we try to keep thee aep11rate?
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Merger of the FDIC and FSLIC insurance funds
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How seri ous is the fenn credit probleo, and what
proposals , if eny, would you recomncnd for dealing with it?
would, in principle, be appropriate if the depository institution, involved had to adhere to equivalent regulatory and
eupcrvhory standard,, and particularly if their pO\lera broadly
coincided.
While there haa been crmsiderable movecent in this
direction, therP. still are substantial
difference ■
Until
these conditions are aiet there are major doubts as to whether
MOniea contributed by coanercbl banks and mutual 11avinga banks
ahould he made available to protect the depositors of sRvings
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and loan auocb.tiona.
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FSI.IC .
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Answer.
In the interic the Congress &hould
perhaps conaider other means of bolatering the aiu o f the
Fam loan difficulties have been 1r,creASfng
for severnl yrar•, and have been serious enough to cause the
failure
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scores of agr iculturnl banks and tn pose najC'lr
prob lees for nr.ny other hanks as well a£ o ther fAn:1 lenders.
in thc-ae
areftll between the classes of depository inatituti<'na.
0
In crn ai dering wayo in which f:trn borrovcrs 11nd leru1PTS
might be auisted, it is inportant to recOf.1"'.ize th• nature of
their diff:l.cultiea and the ir prosp~ e. ts for financial recC\vcry.
The farnen in financial stress arr ,. 1:1inority, dbeit
one, most of vhori borrowed heavily at
A
for fom income seemed very fn,.C\r11.ble .
H
s!.7.ablP.
tine when the outlook
But the expectP rl income
r,rovth did not aaterial ize, ttnd thus a groving nuT"ber of farmers
have been unable to service their debt.
Nor can they 111ell their
lnnd to pay off their debt, becauae farr:i hnd priru have
fallen .
Because pro sprcta SP.en rather dim for inprovenent in
the ffr11ncial c ondition of l-f>nvily-indebted farr:iP.rl'. nvt!r the
next several y ear& , I ar.i socewhat skcpt icP.l of the 11dvi&ability
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of allovint lender, to prolong the pP.riod over vhich they recog-
h11.ve s ~ cone.e m that people vill look to the tooh of regula-
nize the ir.tpact of exiet i nr, lC'lan losses, or uaing t•chnical
11ccounting dcwicea auch os net vort.h
their financial condition.
certificete ■
to dhguiae
These strategies NY be useful in
tion and 1upervilion for a long run solution, to be aure ,
regulation and supervhion have a role to play in preventing
r.xcessea, but we muat be careful not to hamstring our financial
cr,pinr. with some well-defined cyclical difficult.lea which appear
institutions in vaya that in the end vill make it unattrnctive
relativel:, <'.~rtain tC'I be resolved in the near-tem, but the £Arm
for investors to eupply then with capital 1md thus will reduce
credit problem dcea
their ability to serve the rural coD'lUnity.
t'IOt
fit this mold.
W•
1'JU ■ t
face the unfor-
tunatr. fact that . in ciany cascR, fatlll loan difficulties
repreaent funda pen.,anently loat .
Under the circumatancea , rwTe
fUJ'ldar.tental actions ainerl at recovery and revit,'llization in the
rural con:runity oey be of greater help .
Az>onc the poui1'11itiea
are prograne to 11uht bankrupt faroers in re-entering fanaing,
faciliUtinr, c11pitftl infusion, into agricultural banks, and I for
thf' long run , proi,oting rural econot'lic developr.ient .
I d" v11nt to &treas that I to a conlidcrable degree , the
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credit problL'ffla in a(C:riculture tod1ty had their r oots in a basic
aacro-econocic dbtortion, naaely the inflfttion that gripped the
:i
economy aa a whole in the 19701.
~
when expectationfl lost contact vith fundanental econocic
(;
rea!.itiea, that ao many of the financial coaaitmentfl were made
0
that are the source of the present dielocation1.
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It waa during that period,
And in the
long run. the key to avoidin~ a recurrence of the rf!cent esperir.nce h
to be found in the NLintenance of price atnbility .
....
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,uestion 10. DelsyPd Funds. The 1-'ouse is about to
pass legich.tlon requiring banks to make chP.cks deposited by
consuroero available in two or three business days. As you knou,
sone banks restrict availability for ten days or P.ven longer.
Many consuriers have CoMplained about this prActice.
Question 11. Credit Card lnterest Rates. Consumer
groups have charged that the rate of interest charged by banks
on credit cards is way out of line with the bank's cost of
funds . They point out that while all other interest rates hl!:ve
come down, credit card interest rates have stayed the sar,e or
gone up.
I am told that SOffle bankfl charge as ouch as 24
percent.
\Jhat are your views on this issue. Do you support the
passage of legislation such as the bill being considered by the
House?
~-
1 believe that it is inportant !or banks to
c!eal fairly with their custotr1ers.
Senator D'Amato has introduced a bill to put a federal
ceiling on credit card interest rates. Do you agree that credit
card interest rates are too high, and if so, do you favor
federal legislation to cC"lntrol theri?
Generally, coopetitive prr-:1•
~-
Over tine, credit card interest rates are
sures \lilt result in bank custoncrs receiving equitable at'ld
likely to be relatively sluggish, in pert because administrative
rE'-a[l.onahle tre11tnent, but in sone cases it may be necessary for
the Federal governcent to a~fli.et the consumer by prohibiting
expenflcs 11re a mAjor share of t.he cost of such accounts And
these costs do not move in line vith mr.rket interest rates.
certain bank practicei:: that are inequitable ,:,r unfair to con-
With regard to the role of federal legislation. I agree
sumers .
with the posit:ion previously taken by the Federal Reserve BO11.rd
Blanket hold poliC'ies un«!t'r which all cC"lr.aumer checks
that would leave any such decision to regulat.e rates to the
are he lrl for predeternined periods of time vithout rep,11rd to the
states.
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ceilings--be they federal or state iriposed--can have distortinr,
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detricental to the consumer and are not necessary to protect the
Q.
bank.
effects on credit flows, channel in& funds to alternate uses
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Nonetheless, past experience has shown that usury
creditworthinPss of the dra\ter of the check or the depositor are
While I have not had the bepefit of review of all the
where yields are unconstrnined and limiting credit to borro\lers
infornation 11.v11.ilable to the rouse or the Board on this issue,
who in many cases may not have access to other sources of
to the cYtent that i::uch practicf'i;i persist 1:teps should he taken
finance.
to correct this inequity .
Such steps night include disclosure
requirerients to allow corisumers to choose amonc banks ,md
therefore to correct these practicefl through cocpetitive
p!'essures.
::: c!o not believe that nandatory availnbility
sche<lules, such 11s those contained in the P.ouse bill, Etrc
dc-i:;i~nble to correct this prot'llem .
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Questions Subnitted by SenatC1r Dodd to ?Ir. Angell
ttonination Rearing -- January 23. 1986
Question 1.
In yesterday's Hew York Times, Lester
a~~~i~ ~~~~ ~;~i~i~:~c~~!
~~~o:e
£!~:~~~a!r;.~~c!r~fi~~e tr~2b. •
and the great depression of the 1930's.
For example, he said that: "The loon portfolios of
American banks include oore than $500 billion in farm ani!
third-world debt, where default is easily il'I.Rgined. As oil
prices fall, what were good oil loam1 are rapidly becomint bAd
ones. Major h«Tike are sinking under the weight of falling real
estate values. Mergers and leveraged buyouts lead to firms that
can barely meet inte:rest obligations in boot!!. periods and that
could not meet them in a recession."
How fragile do you think the financial systet!l is?
What would you plan to do to elleviate the problems &fl
a member of the Fed?
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by puraufog a responsible monetary policy aimed at the Pchievcnent and maintenance 0£ price level stability.
Fiscal policy
should be directed decisively towardfl balancing the ff'deral
budget.
As the st?"ong posicive oorket reaction to the Grnnn-
Rudman-Hollings leghlation has demonstr11tP.d, there is substantial scope for easing pressures on financial nnrkets by reducing
thf' deficit.
Even with appropriate 1!1onetory and fi seal
policies, it mRy take some tine before present strains or. our
financial syster.i are relieved.
If you could control both rionetary and fiscal policy,
what would you do about these problems?
Answer.
Looked at broadly, the financial sys tern
clearly is somewhat fragile now, J!lOre fragile than one would
like, but not precarious.
It seems quite unlikely tone that,
with proper monetary and fiscal policies, we will experience a
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generalized financial crisis.
Many present financial problems--including difficulties
related to the agricultural sector, the energy narket, and
third-world borrowers--can be traced to the inflationary binge
of the 1970s and ita subsequent unwinding1 contributing to these
problems have been large federal budget deficits that have
placed upward pressures on real interest rates.
Monetary
polic)'t'Ulkers can beat contribute to a solution of these problems
concern w?~hs~~:~ t~dg~~ ~~fi~r;; ~~~~it~~e i~ ~~~~;.~;::iudmanHollinga legislation . To rneet next year's target deficit of
$144 billiori, we will probably have to cut about $60 hillier,.
won't ask v('lu whether we can do that without increasing
revenues, because that ia a question for us, but what I would
0
~!~!cI~u~yo§!~i~~l~~o!~ r~e;~e~a~t t~o~!fs~e .~:~t~:v~~u!e:~c:o tl"
it, or reduce it by sorm lesser amount--111ay, $40 billion--with
only revenue cuts?
~deficit down .
It is very ir.iportant to get the fedcrs1
I believe it would be beat to achieve that objec--
tive by lower spending, to the naximurn extent posaiblP, before
con,iidering tax increaee11 that can distort incentives and redu,,
economic efficiency.
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Qu<" stions Subnitted by Senator Dixon t" Mr . Angell
Nonination Hearing -- January 23, 1986
Question 3. What do you think we should do to
strengthen our deposit insurance funds?
Answer.
Proposal s to strengthen the deposit insurance
funds deserve serious attention.
Question 1 . Do you favor restricting the ,mounts of
preferrP-d stock 11:nd t:l.andatory convert:t.hle instrurn.ents inclu<'flble
in pr:f.n11ry ba1'k capital, as proposed by the Board o f Gove rnorR
in NnvP.cber of 1985?
Whatever is done should preAnswer .
In general I ngree with the loric undP.rl y ing
serve the dual goals of protecting the small or unsophiRticated
the pr<'po s ed restrictions .
As indicated in n y respon!'le to the
depositor and of insulating banks and the payments riechanism
next question, however, I b e lieve that i::nflll, independently-
frOf!:I systemic risk.
Reform proposals which hold aoce promise of
owned bankn and bank holding cor.,pnnies should be subject t.o
aucceu and which should be studied further include strengthened
fewer restrictions regarding the conposition of capital thar
supervision and regulation, increased capital standards, risklarger institutions because the sources of capit a l on which they
based capital standards based on the riskiness of nontraditional
can clraw are norr. limited.
banking activities, some liriits on insured deposit brokeraie
activities , and perhaps incrc11sed uae o f narket disc i rl ine by,
for example, inc.reasing the risk exposure of large depositors .
9
cg
h a ve cotnC1~-¥,fiJi~ha~ th~o;~o;~:; ~- :~f / ~tig~~~~~: ~ ~~~\ cn r,
principle source of pernanent equit y end curtai 1 the use o~
advantageous estate and tax planning tools. Do you believe the
proposed regulatory limitationr, could hnve such an advers e
effect or wheth£>r r.losely held cor.ip&nie ~ could be excnpt fror,,
its prC1visiona?
Answer.
I believ e that it is !.np<"'rtant to fc,ster an
environmer.t that is conduc:lve tCI thP mmership C1f srnAll banl--.s by
N
~
individuah .
~
tory restrictions that uould unden:iine that objective or hind e r
Therefore, I would s e riously question any rPr,ola-
C;
the ability of small bnt'l~· s to access the liait<-c! i::curces of
0
capital nO\I availabhi to them.
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But I underst1u-.d the Federel
Reserve hes in place scpArate and nore liberal capital stan dards
for snall bank holding ccmpanies thnt are designl"d to faci1:!.t.atc
the independent ownership of small hE"nks and that the propr.i;;ed
restrictions
ori
preferred s tock and r.'IAJ"ldatory convertible
instrUl"!er.ts vould not apply to bAnk holding coa.panie::; Pith
cs r.et s of lerr; than $150 Pillion .
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Question 3 . DoP.s the proposed limitation or. the
compor.ents of bank c1tpital improve the rey,ulation of capital
adefl.u.!cy which 1s currently P.nalyzed on a subjecti·v f', bank-byl:iank bash?
~-
5
iuuc- of ~=s~~:t!~1 u ~fu~~n;.~:s c~~~!~~~g r~~!::. t~~c~n!!r!tiat
Rome argue are in effect cases where there fa de facto control
by non-votiTlg security holders and holding company creditors?
Answer .
The propo11al should iqrrovc thP. re~ulation cf
Mrital because it will auure that a large proporticn of the
The Bank Holding Cottpany Act provides that n
company may not acquire dirP.ct or incl i rect ownerahip of morP
prinary capital bnr-E' will be in the £om of Corl!"On stt:icl;holders'
than 5 percent of the voting sharco of a bank, or otherwise
r.quity--thf' kind of pririary capi tnl that provides the higJ-,.f' s t
eAtablieh effective control ovP.r a bank, without the pri:lr
level of pr<'tection during periodr: of financial stress.
approval of thP. Bc,ard of Governors .
In my
view, the proposal vill make the deternination of capital
adequacy
J.P.Rfl
subjective .
This is ,ill to the good becausr.
In order to provide greatP.r
guidance on the question of control, thf"' Board issued a policy
statement in 1982 setting forth a fraMework for evaluating
believe thE.t nll rules and regulattons should be as clear,
whether the acquisition of non-voting aec,uritiea of a banking
tlirect, and t!f'l&l'lhiguous as possiblP. .
organization is consistent with the control provisions of the
Markets uork best whc,-, the
rules nnd regulrtions are understoo-:1 b y all participants.
Act.
Amol"g other things, the poltc~, statement describe11
11.
number of provision a that would leave an organization' a canagement free to conduct its banking buAineu ,md, therefore, that
would generally preclude a finding of de facto control.
The
statement also describes the type of provisions that would raise
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serious question a of C'ontrol under the Act .
creditors.
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The policy does not
address the issue of control exercised by a holding company's
While I have not yet had an opportunity to study this
matter in depth, upon first review the Bonrd' s policy atatement
appetirP: to be a sensible approach to iuuP.s relating to the
exercise of col'ltrol.
A• a general rule, I am open to recon-
sidering supervisory and regulatory approache• if warranted by
changing
time ■
or circumstance•.
TherefC'lre. I would welcome the
opportunity t:o cooperate with this Coanittee in reviewing iseuea
relating to the exercise of control over hanking organization,.
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76
The CHAIRMAN. Next we'd like to continue the hearing with the
nomination by the President of Manuel Johnson to be a member of
the Federal Reserve Board. We see in our midst the distinguished
Senator from Virginia. Senator Warner, we would be happy to recognize you at this time.
STATEMENT OF SENATOR JOHN WARNER, U.S. SENATOR FROM
THE STATE OF VIRGINIA
Senator WARNER. Mr. Chairman, I shall be very brief because
brevity is in order. This is one of the more outstanding persons to
come before the Senate in my judgment to fill this important position on the Board.
The President's nominee, Mr. Manuel Johnson, is accompanied
today by his wife, Mary Johnson.
As the chairman knows, he's presently Assistant Secretary for
Economic Policy at the Treasury. He's been at the Treasury since
1981 and prior thereto he was a professor of economics at George
Mason University, one of Virginia's most distinguished educational
institutions.
The full biography is before the committee. Mr. Chairman, knowing you and other members of the committee and their interest in
the various aspects of the person's background, I thought I would
select today to emphasize the unusual and diverse number of the
recognitions that this nominee has achieved in his lifetime.
As a member of the U.S. Army he was a green beret, completed
ranger training, qualified parachutist, jungle expert-The CHAIRMAN. If I may stop you to say that I noticed his being
a jungle expert, and that's very important here in Washington.
Senator WARNER. Mr. Chairman, I think you have a note of sincerity in those remarks because I know you and all the diverse
things that you have done.
The CHAIRMAN. I have had jungle experience here in Washington
but I came with none, so it was harder for me when I first got here.
Senator WARNER. He went on to achieve a degree with honors;
Omicron Delta Epsilon, economics honor society; doctoral dissertation; Nuclear Regulatory Commission; Labor Economics Prize, best
research paper in labor economics; honorary president, Troy State
University; Alumnus of the Year in 1982, Troy State University;
Honor Award for Outstanding Contributions to Public Policy, Florida State University; Secretary's Honor Award for contribution to
first foreign-targeted securities issue, U.S. Treasury Department,
and on and on goes this most distinguished biography.
I'm privileged to be here today to recommend to this committee
this outstanding American public servant. I thank the chairman
and members of the committee.
The CHAIRMAN. We appreciate your willingness to be here.
Dr. Johnson, I'm pleased to have you come before the committee
and I welcome you to the committee today. You have been nominated to the Board of Governors of the Federal Reserve System to
fill a full 14-year term that runs until January 31, 2000. It sounds
like an awfully long time, but my experience is that it will rush by
rather rapidly. It seems like I arrived yesterday and this is my
12th year.
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You have already had very extensive experience in economic policymaking. You currently serve as Assistant Secretary of the
Treasury for Economic Policy. Prior to joining the Treasury Department in 1981, Dr. Johnson was a professor of economics at
George Mason University in Virginia. He did graduate work at
Florida State University. During his academic tenure he was a prolific publisher on a wide range of economic issues in a wide variety
of professional journals. As Assistant Secretary of the Treasury for
Economic Policy, Dr. Johnson has advised the Treasury Secretary
on all monetary affairs, has developed first-hand experience with
the operation of Federal Government debt financing and its relationship with monetary policy.
Dr. Johnson has also been involved at the Treasury in the development of administration policies on the financial sector of regulation and supervision, international lending and exchange rate.
I would also add that Dr. Johnson certainly fits what we have
been trying to do, as I mentioned earlier in the first hearing, being
from the proper geographical area.
Dr. Johnson, before you testify, could I have you stand and be
sworn.
[Whereupon, the witness was duly sworn.]
The CHAIRMAN. Senator Hecht, do you have any comments you
wish to make before we start?
Senator HECHT. No; thank you, Mr. Chairman.
The CHAIRMAN. Senator Riegle, any opening comments?
Senator RIEGLE. No, Mr. Chairman.
The CHAIRMAN. Please proceed, Dr. Johnson.
STATEMENT OF DR. MANUEL H. JOHNSON, JR., ASSISTANT
SECRETARY OF THE TREASURY FOR ECONOMIC POLICY
Dr. JOHNSON. Thank you, Mr. Chairman.
I don't have a prepared statement to submit, but I would like to
make a brief remark before I answer any questions.
First, it's both a pleasure and an honor for me to appear before
this distinguished committee for consideration as a Governor of the
Federal Reserve System and, if confirmed, I will try my very best
to pursue monetary policies that result in sustained economic
growth and employment consistent with stable prices.
This is obviously a difficult task in such a complex and interdependent world, and monetary policy alone cannot guarantee such
an outcome. I don't profess to have all the solutions to this economic puzzle, therefore I look forward to working with the members of
this committee and other Members of Congress to try and resolve
an_}'~ problems that may arise in the future.
Thank you.
The CHAIRMAN. Dr. Johnson, do you agree to appear before this
committee and any other duly constituted committees of the Congress as requested?
Dr. JOHNSON. Yes, sir; I do.
The CHAIRMAN. And do you agree to not only avoid any actual
conflict of interest in your service on the Board but even the appearance of conflicts of interest?
Dr. JOHNSON. Yes, Mr. Chairman.
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The CHAIRMAN. Dr. Johnson, my first question to you would be
the same as to Dr. Angell. That is that I personally feel very
strongly about the independence of the Federal Reserve Board.
Over the years, we have had a large number of suggestions about
how the Board should be reconstituted from, on the one hand,
those who proposed bills that would make the term of the Chairman of the Federal Reserve concurrent with that of the President
so the President could pick his man and put him in there for his
term. We've had suggestions that going beyond the geographical requirements of the law that we have a farmer, a small businessman,
a Member of Congress, the Secretary of the Treasury-all sorts of
different categories, and that we divide it up on the basis of, well,
this will be a seat for small business and this will be a seat for
farmers and so on.
We have also had proposals since I have been here to actually
pass a law to set the monetary targets by Congress. I would hate to
think what would have happened back in 1975 or 1976 when that
was proposed if we had had Congress arbitrarily setting inflexible
targets, coupled with the irresponsible fiscal policy we've had in
Congress for so many years.
I give that same background to you that I did to Dr. Angell because I think that the Fed must remain independent and members
of the Board should express their views. If they agree with an administration or a Congress, fine. But if they don't, they should
have the willingness to state that regardless of what the political
consequences may be. I think this has been one of the real benefits
of the Federal Reserve System.
So I certainly have outlined to you how I feel. I'd like to know
how you feel about being a member of the Federal Reserve Board
of Governors. You were appointed by President Reagan. Do you
have the independence to steer your course regardless of your
background in this administration and Treasury?
VIEWS ON THE CENTRAL BANK
Dr. JOHNSON. Yes, Mr. Chairman. First, I totally agree with your
opinion about the independence of the Federal Reserve Board. As
an economist who's studied the actions of central banks throughout
history and looked at their performance, I think that from an economic perspective the major factor that separates the developed
countries with stable economies and relatively lower inflation rates
and better economic performance from some of the developing
countries or those who have had highly unstable economies, both
in terms of hyperinflations and roller coaster-type changes in real
output, has been the independence of the central bank and I think
that you're absolutely right, insulating the actions and decisions of
the central bank from political pressures I think is extremely important and it allows the tough decisions necessary to maintain stability in prices but at the same time keeping a watchful eye on the
real growth performance of the economy.
I think that if you really study the record you will find that
those banks that are highly subordinated to the political process
have relatively unstable economies and have experienced extremely rapid inflation rates at various points in time. I don't need to
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cite countries who still experience that today. They're all fairly obvious. But I do feel very strongly about the independence of the
Fed.
Now there are some areas in which I think improvements can be
made that I think are important. I do think that the central bank
should be forthcoming on providing information to the public and
the financial markets about its policy actions, and it's well known
that the Treasury has supported the idea of coterminus terms between the Chairman and the President but very similar to what
Chairman Volcker has voiced support for himself, coterminus
terms with a 1-year lag.
I would also possibly support earlier provision of the FOMC minutes that gave more accurate and timely information about policy
changes to the financial markets, the public, the administration,
and Congress. But it's absolutely imperative that the independence
of the central bank be maintained.
The CHAIRMAN. Well, I would agree with you on earlier information. Chairman Volcker and I have talked about that in this forum
over a number of years and his usual answer is, "Well, we don't
like to signal this or that"; and yet, the game playing that goes on
out there waiting for those figures-I don't understand the other
side of it. When we're trying to put more certainty into a marketplace, information, rather than guessing about what the information might be, I think would provide some more stability. So I'm
glad you feel that way.
In the Treasury Department you conducted studies which concluded that higher Federal deficits cannot always be expected to
push up interest rates and drive up the value of the dollar. A lot of
critics of your studies say that your conclusions are incompatible
with common sense.
How would you respond to those critics of your reports?
Dr. JOHNSON. Well, Mr. Chairman, it's true that during my
tenure at Treasury we did perform a number of studies, one in particular that was published which concluded that you couldn't statistically verify a systematic relationship between Federal budget
deficits and interest rates.
RESULTS OF TREASURY'S STUDY
However, there were a number of qualifications and the report
was very technical and went through quite a bit of theoretical reasoning and empirical research. It pointed out that if in fact you
were able to hold all the other economic variables in the economy
constant and realize a large Federal budget deficit, that indeed you
would expect interest rates to rise. It is commonsensical to think
that if you have a fixed pool of private savings and the Federal
Government is borrowing large amounts of that and draining that
pool of private savings that it's going to leave less available in the
private sector for private participants seeking credit for their investment purposes.
It's only natural to reason that way and expect interest rates to
rise as a result and, indeed, if nothing else in the world were to
change, that in fact is what would happen. I think the reports and
the studies that we've done at Treasury point out that theoretically
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under those conditions interest rates would be expected to rise.
However, in the real world, a number of things happen and our
statistical studies have tried to isolate the effects of deficits from
interest rates given all the changes that have taken place in the
world and are not able to pick up this systematic relationship that
commonsensical reasoning comes up with.
That doesn't mean that deficits don't put some pressure on the
interest rate. All it means is that there are other things changing
at the same time that we realize large deficits. For example, because we live in an open economy we have seen large capital inflows in the United States from abroad which has supplemented
domestic savings. So at the same time the Federal Government
may be taking a larger supply of domestic savings, there are also
additional capital flows into the U.S. economy from abroad which
offset that effect.
It's also true that if you were to increase the deficit by cutting
taxes where the marginal tax rate was lowered substantially on
income earned from savings, you would expect a savings response
as a result of those lower taxes on savings. Therefore, at the same
time that Government borrowing would reduce savings in the private sector, it's also true that savings would increase as a result of
the incentive measures of the tax changes. So, the net effect is not
totally clear.
Even though Government borrows large amounts, it's quite possible that people don't use only their private savings to purchase
Federal Government bonds. In fact, it's quite possible that private
purchasers of Federal securities cut back partially on their consumption in order to purchase Federal Government securities. So
it's not necessarily true that financing the Government debt comes
entirely out of private savings.
All of these things complicate the issue and make it fairly ambiguous when you try to empirically measure the relationship between the deficit and interest rates. I think the point that we tried
to make with that study was that if the deficit per se is not systematically related to the interest rate we should be careful in trying
to cut the deficit in a way that does not clearly improve net savings
and the economy.
For instance, if we raise taxes to solve the deficit we extract private savings from individuals just as if the Government continued
to borrow to finance Government spending.
So, the point we tried to make was that the only clearly unambiguous way to cut the deficit would be to cut the rate of growth of
Federal spending because that would eliminate the additional financing requirements that put pressure on raising taxes, that put
pressure on further Federal borrowing, or put pressure on the central bank to monetize the debt.
The CHAIRMAN. Well, for those of us who are not trained economists and getting away from all the technicalities of the study
then, and I understand how you've explained it, but getting back to
the commonsense quote of one of your critics, common sense does
tell us that deficits, however you try to solve them-obviously
there are some differences-but deficits are an important factor in
interest rates.
Dr. JOHNSON. Absolutely, Mr. Chairman.
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The CHAIRMAN. So you're not saying they're not important?
Dr. JOHNSON. We are not saying that they are not an important
factor, by any means. We are saying they are very important.
There are a lot of other things going on in the world, too, that we
also should concern ourselves with and that · makes it important
how we deal with the deficit to avoid any other side effects as a
result of dealing with the problem.
The CHAIRMAN. Senator Proxmire.
Senator PROXMIRE. Thank you, Mr. Chairman.
Dr. Johnson, I want to get on the same subject the chairman was
just asking about in a little different way. You have a deserved reputation as an extraordinarily brilliant young man and you're going
to be on the Board of Governors of the Federal Reserve Board for a
long, long time, into the next century, the year 2000. Most of us
will be long gone and 6 feet under by the time-The CHAIRMAN. Speak for yourself.
Senator PROXMIRE. Well, we have a very youthful chairman here.
He'll be around, if he's not out in space somewhere.
In March 1984, the Treasury Department released a study which
concluded: "that high-Federal deficits have had at most a negligible
effect in raising real interest rates."
You were the principal author of that study. In testifying on that
issue before the Joint Economic Committee in October 1983, you
suggested one possible explanation for this result. Here's what you
said and I quote.
One framework of analysis notes that when taxes are cut Government borrowing
is increased by an equal amount. Some, perhaps all, of the tax cut will be spent on
new Government bonds. The total amount of the tax cut will be used to purchase
new bonds if the taxpayer-bondbuyer perceives that the bond interest he receives
will be used to pay the future tax required to service the Government debt and that
the return of the principal of the bond will be used to pay the future tax required to
retire the bond.
It seems to me, Mr. Johnson, that the notion that people deliberately increase their purchases of Government bonds because they
anticipate a future tax increase seems very, very far fetched. In
fact, it seems to me to be almost bizarre.
Here's what the CBO said about that theory:
Most-economists consider this theoretical view excessively abstract and the evidence in its support unconvincing.
What are your views on this? Do you agree with the CBO assessment or do you seriously believe that people are buying more Government bonds because they anticipate future tax increases?
Dr. JOHNSON. Well, if I remember right, when I read that in my
statement, you responded in the JEC by saying that that was one
of the most complicated explanations you had ever heard and you
can't imagine any member of a household going out and increasing
their savings because they expect future tax increases.
Senator PROXMIRE. You've got a much better memory than I
have. I didn't remember I even said that.
Dr. JOHNSON. You made a very interesting comment. I have to
admit that that is an extremely cumbersome theoretical explanation. What I was trying to say there was that one explanation of
how the deficit does not totally preempt private saving is that
when a deficit is incurred, people expect some future action by
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Government to offset that deficit at some point in the future,
whether it be by taxes, whether it be by excessive money growth,
or any other means, there's going to be some harm done to their
income in the future so that they choose to save more in the current period-to sort of put aside savings for a rainy day-to avoid
this future outcome or to pad their savings to offset this future outcome.
Now it sounds abstract to me too, and I'll admit that, in fact, I
think this is strained reasoning to expect when a deficit is incurred
from a tax cut or any other means that people say, "Oh, well,
there's going to be a future cost to that and I'm going to start
saving today to make sure that I have that savings when the Government decides to tax it away in the future."
However, researchers in the academic profession who have tried
to reject this theoretical notion by doing statistical work have not
been able to totally reject this. I'm not sure that the theoretical
reasoning is why they haven't been able to -:-eject it.
Senator PROXMIRE. But the practical development since the big
tax cut in 1981 is that savings have dropped sharply. Now, as you
know, there have been months when they have been below 2 percent, an astonishing low figure. They seem to be going in the opposite direction.
Dr. JOHNSON. Well, Senator, it's absolutely true that personal
savings as a percent of personal income is down and that is a
reason for some concern. However, total savings in the economy is
up substantially, and by total savings I mean net foreign capital inflows as well as business saving from both depreciation and retained earnings and the surpluses run by State and local governments. All of these factors added up together, even when you sort
out the Federal Government deficit, lead to fairly large levels of
total saving. It is true that personal savings is low.
Senator PROXMIRE. I challenge you on that figure that there are
large levels of total savings. The figures that I've seen is that in
relationship to income and in relationship to gross national product
and so forth, the savings have not increased over the last several
years.
GROSS PRIVATE SAVINGS UP 19 PERCENT
Dr. JOHNSON. Well, I think if you will look at gross private
saving you will find that it is at very high levels. I think as high as
19 percent.
Senator PROXMIRE. Well, everything is at a high level now of
course because of the inflation and so forth.
Dr. JOHNSON. Well, I should say, as a percent of the GNP, total
gross saving I think is running around 19 percent.
Senator PROXMIRE. Let me follow up by asking you this. If people
really purchased more Government bonds in anticipation of a
future tax increase, then according to the rational expectations
theory of economic behavior the Reagan economic program has no
credibility with the public. That is, a rational person does not believe it is possible to vastly increase defense spending, cut taxes,
and balance the budget all at the same time.
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If we accept your theory about deficits and interest rates,
wouldn't we also have to acknowledge that President Reagan's economic policies, which you helped to design, are fundamentally irrational?
Dr. JOHNSON. Well, I'm sorry.
Senator PROXMIRE. I don't expect you to answer yes to that.
Dr. JOHNSON. No; I certainly can't agree with that and I think
they are highly rational. I think that when we put the economic
program together back before the beginning of the administration
and even the first stages of the administration, there was never
any intention to run a deficit by any means. As a matter of fact, no
one is comfortable with the deficit, even though some of the research conducted at Treasury doesn't find a systematic relationship
between deficits and interest rates doesn't mean that we are
pleased about the deficit. As I said from the beginning, the deficit
does preempt private savings and makes less available and obviously if you cut the Federal deficit and cut back on the amount of Federal borrowing, that would mean more capital available for private
expansion and investment.
So I certainly would like to reduce it. I think it's very important
now. When we started this program we proposed maintaining
budget balance at the same time that we cut tax rates by substantially reducing the rate of growth of Federal spending. We have
continued to make proposals to try and deal with the deficit problem on the spending side, not always with success, but we continue
to insist that we deal with the deficit primarily by those means and
we think that this will add to the economic health of the country
and sustain economic expansion.
We clearly want to deal with the deficit, but we think it's important how we do it.
Senator PROXMIRE. I read with considerable interest your speech
you made on our trade problem in July in which you criticize,
"those who emphasize the U.S. budget deficits have pushed up interest rates and therefore caused the dollar to appreciate." You
said then you found it very curious that people could believe that
large budget deficits would reduce the world's strongest currency.
It was your view, you stated, that the strong dollar results primarily from improvement of the productive potential of the U.S. economy brought on by the 1981 Reagan tax cuts.
Now this puts you at odds with most other economists who have
looked at this issue, including the former Chairman of the Council
of Economic Advisers and President's former Special Trade Representative. Martin Feldstein said, for example, in an article in the
summer 1985 edition of Foreign Affairs, and I quote:
Some commentators have tried to explain the sustained rise in the value of the
dollar by pointing to dynamism and profitability of the American economy. I believe
that these factors have had relatively little direct effect on the value of the dollar.
The vast bulk of foreign funds coming into the United States have come as bank
deposits or as purchases of fixed-income securities and have not been investment in
corporate stock or direct investment in American business. Thus, the profitability
and dynamism of the American economy have attracted foreign funds primarily by
contributing to the rise of U.S. real interest rates.
What is your reaction to that?
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Dr. JOHNSON. Well, I would disagree with that. I stand by what I
said earlier. I think that the primary reason why we have attracted capital into the United States is not because the deficit has
pushed up interest rates higher relative to other countries. If you
look, as a matter of fact, at relative interest rates between the
United States and our trading partners, you will not find them especially high in a relative sense or that they have dramatically diverged from each other over the last several years.
Senator PROXMIRE. If it's a matter of increased productivity, why
don't they invest in American corporations and so forth and bul
stock which would reflect that kind of efficiency? They haven t
done that.
FOREIGN FUNDS HAVE HELPED CORPORATE EXPANSION
Dr. JOHNSON. Well, in fact, through the financial intermediation
process, they do, even though they may be buying bank CD's or
other types of paper-type securities or savings instruments. The financial intermediation process obviously invests these funds directly by lending those funds that were put in financial institutions to
U.S. corporations or other firms who are purchasing capital assets
and in building plants and machinery and I think a good example
of what's happened is just to look at the data on gross private investment since 1982. Gross private investment, domestic investment, has grown at over two times the rate of GNP growth, which
is very extraordinary for any postwar expansion period.
So I think that the capital has been attracted into the United
States for a couple of reasons. I think clearly capital wouldn't flow
to the United States-I don't think investors would put their
money into the United States because of a large deficit in the
United States. I would think that people would consider the deficit
to be somewhat of a risk to their investment. So I think that if
people are choosing to invest in the United States by moving their
capital here, it's for other reasons. The deficit I think adds to the
riskiness of the investment and it must mean that adjusted for this
risk there are other reasons.
Senator PROXMIRE. My time is up, but it seems to me the obvious
reason is because they get relatively higher interest rates given the
fact that they can buy U.S. Treasury securities and other similar
securities with no risk at all.
Dr. JOHNSON. But they can get similar interest rates in other
countries, too.
Senator PROXMIRE. Not without any risk.
Dr. JOHNSON. Well, that's a good point. I think that one of the
major reasons why the dollar is strong and capital has flowed in
has been the dramatically higher risk involved in investing in
Third World countries because of the debt problems that they have
faced and, therefore, commercial banks, money center banks, have
pulled back their lending to these countries and left funds in the
United States.
So certainly the higher risk abroad in Third World countries because of debt problems and other reasons have caused a lot of the
capital to flow here. But that means on a risk-adjusted basis it
must be that the returns are higher in the United States. I agree
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with that. I think once you adjust for the lower tax rates that have
been introduced at the Federal level, plus the lower risk involved
in investing in the United States versus debtor nations and other
countries that are growing at a slower rate, you will find that in
fact the rate of return on investment is higher in the United
States.
Senator PROXMIRE. Thank you. My time is up.
The CHAIRMAN. Senator Riegle.
Senator RIEGLE. Thank you, Mr. Chairman.
You've got a birthday coming up here on February 10 and so it's
significant I think that you're here for such an important job at a
key time in our Nation's history and at a relatively tender age, and
I can appreciate how that feels, having come to the Congress
myself at a rather young age.
But I guess I want to just reflect on that for a minute before getting into the questions and I gather you were in the room for the
previous discussion with Dr. Angell?
Dr. JOHNSON. No, sir; I was not.
Senator RIEGLE. Because I want to cover some of the same things
and I just wanted to know if you heard that discussion or not. You
are about to be 37 years old and is it your intention to serve the
full 14-year term?
Dr. JOHNSON. Yes, sir.
Senator RIEGLE. I think that coming in now into this job in my
view is as important, say, as being appointed to the Supreme Court.
I mean, that's a lifetime appointment and that also comes at a
time when there are a lot of very profound questions before the
Court, and I make the analogy because I think that what is happening with respect to the economic system and the profound economic changes that are underway and we will likely continue the
trend lines that we say that in many cases are accelerating, what
happens out over the next 14 years with respect to financial management decisions in this country, private and public together, I
think will really tell the story as to where America is 14 years
from now. Are we still a preeminent world leader? Do we have the
capacity to carry out our very expensive defense obligations? Are
we able to educate our people? Can we pay our medical bills? Can
we modernize and remain at the state-of-the-art level with respect
to world competition, particularly when we see what's been developing there and where we've really been I think not doing so well
relative to others, which the Presidential Commission on Productivity laid out very starkly.
So it seems to me that the decisions that are going to be made-
and you may be part of them more than anybody else that's on the
Board. One doesn't foresee probably most of the other members
necessarily serving that long and it's your intention, with good
health and so forth, to serve for that length of time, and well
beyond this administration, presumably into the next two administrations, whoever they happen to be headed by.
So I guess what I want to say to you-and as I've gone through
your list of accomplishments and you're obviously a prodigious
worker and I really salute you for that kind of effort, and you've
written a number of things and you've expressed a lot of opinions
on a lot of things and yet I guess what I'm concerned about is that
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things are changing so fast that I suspect that even some of the
articles that you may have written 5, 10 years ago, even 2 or 3
years ago, you might not write the same way today because things
have changed, your thinking has changed, and so forth and so on.
I guess what I would like to just say-and I'd be happy to have
you respond in any way you like, but my hope for you would be
that you could give a distinguished period of service and could be
able to help sort of guide policy and guide the country through
some new questions, some very difficult choices, where I for one
think that a lot of the economics textbooks that are several years
old aren't particularly relevant to us as road maps as to where we
go from here. There are some basic underlying principles about the
stable dollar and economic growth and open markets and so forth
which are sort of bedrock ideas, but the question of how you
manage this economy publicly and privately in the midst of the
changing world economy it seems to me is a new puzzle and a very
complex one.
So I would hope that you would be the kind of person that would
be able to give the kind of fresh thinking and intellectual leadership to the role that you would play that might have you in fact
even taking different views 3 years from now from something you
thought 3 years ago simply because circumstances have changed
and that you're the kind of person that's capable of not being so
locked and so rigid that you can't make those changes in your own
thinking and help the country both understand and respond to
some of these profound changing economic realities. That's my
hope for you and I don't know whether you want to comment on
that at all or not.
Dr. JOHNSON. Sure, I would like to. I like to think that I keep an
open mind on issues. I have convictions about things that I've studied very carefully, but I am also an empiricist so that over time, if
the facts that I see don't fit the ideas that I have and I can't reconcile them in my mind, I'm certainly willing to rethink the problem
and I certainly hope that I'm able to evolve with events as thel'
occur if in fact the information that develops in the future doesn t
fit the theories or views that I have. I'm not the kind of person
that would continue to make claims about views that I have if in
fact there is no supporting evidence whatsoever.
Senator RIEGLE. Do you consider yourself a supply-sider?
Dr. JOHNSON. Well, I wish I could say absolutely what that
means todal' I'm not sure. There are a number of different definitions that I ve seen so I'm not sure that I fit into every definition of
what a supply-sider is. The way I have always interpreted it is that
I do generally feel that free markets lead to the most efficient outcomes and I sueport free-market-related types of policies.
But it doesn t necessarily mean that I think that tax cuts will
pay for themselves overnight. So in a free market sense, I am a
supply-sider.
Senator RIEGLE. Do you believe in the Laffer curve?
Dr. JOHNSON. Well, I think, first of all, there are different truths
to a Laffer curve. I think for the top income tax brackets that get
very high, there's a good bit of evidence to show that cutting the
top capital gains rate or the top income tax rate may yield you
more revenues because you would have people in such high tax
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brackets that they would pursue heavy sheltering in their income,
but I think that you will find that the evidence suggests that a general reduction in taxes given the current U.S. tax structure doesn't
lead to a full recovery of revenue and that you have to make up
the difference in some other way.
Now eventually, as the income base improves over the long run,
it may be possible to produce enough GNP to raise the tax base to
higher levels, but I've never been able to find solid empirical evidence that across-the-board tax cuts pay for themselves in the
short term.
Senator RIEGLE. Now I want to move into the trade question with
you and I talked about this with Dr. Angell and because you were
not present I'll say some of the things again that you were not able
to hear.
I don't know if you saw the story on the front page of the New
York Times today. The headline reads, "U.S. Economy Grew at a
Slow 2.4 Percent Rate in the Final Quarter," which was a fairly
substantial downward revision from what the estimates had been.
But then the subheadline says, "Trade r;,ap cited by analysts, 3-year
GNP rise 2.3 percent worse since 1982 ' and then the article goes
on in that vein.
I wonder, if I may, just show you a couple of charts that are derivatives of work of President Reagan's Commission on Productivity, and you may be familiar with these charts, but I just want to
use them as the point of reference for a discussion I'm going to
have with you on that issue.
I'm just going to cover two of them right now. One looks at our
merchandise trade deficit over a period of time just to help illustrate in a more vivid way how fundamentally this has changed and
how we've sort of gotten ourselves on an exploding curve of deficits, and we're going to run close to $150 billion this year based on
the evidence I've seen, even on the change in currency values, I'm
not convinced based on what I've seen now that we're going to get
a miraculous change next year based on that. I think we're likely
to run about the same way. As I watch the automobile thing, for
example, I think we're going to get a lot more import penetration
this year from Korea and other things which will help drive this in
the same direction.
$500 BILLION DEBT BY 1990
In any event, we were making pretty good progress and then a
problem developed but it's broken out in a very extreme way. But
if you think of this as the income statement and balance sheet
looking like this, and I'm asking you to think about this if you can
from your own professional background and training. As you know,
we've been in a creditor nation status since 1914 until just a few
months ago when we crossed the line and became a debtor nation,
but we're becoming a debtor nation at a very fast rate. The head of
the New York Federal Reserve Bank has estimated officially now
that by 1990, as this builds up, we become the leading debtor
nation in the world. It looks like in about 6 or 7 months from now
that will occur and we will surpass Brazil, Mexico, Poland, and
other countries. But that by 1990, they're estimating a net debtor
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status for the United States of maybe a half a trillion dollars, $500
billion up to $1 trillion. That's a brandnew development. It's obviously a fundamental change from what the historic trends have
been and it's very difficult to know precisely what that means. I'm
trying to understand what it means and I'm sure you are, too.
And the reason that I show you those two is because when we
talk about, in response to Senator Proxmire's questions-when we
talk about capital flows and net capital inflows and so forth, and
having studied economics myself, I'm trying to understand the difference between money and capital which is in our possession
which we've earned in this country and which we spend for a foreign product, be it a car, or video recorder, or computer, or whatever it is, and we exchange the money, our capital, savings, which
are in a sense not as large as we'd like them to be, and we get a
durable good whatever it is and it comes over here and it has a
useful life and it ends and it's gone, but we've transferred dollar
wealth out and we've gotten a physical good in return and, of
course, that's basically what underlies this pattern.
Now when the foreigner who sold us the ~ood, whether it's Japan
or whoever it is, they take the dollars they ve exchanged the goods,
now they can lend us back the money and they're doing a lot of
that. Of course, they don't have to do it and if we ever get to a
point where we desperately need the capital, then we might have
to pay a lot more for it than we mi~ht want to pay for it simply
because we've got to have it and they ve got it and we haven't. But
it starts out being our money, it becomes their money, it comes
back if they loan it to us. Of course, they can invest it here too, but
as Senator Proxmire points out, they have invested far less in manufacturing assets or physical assets than they have in debt instruments. So we owe that money.
And I must tell you that I am getting alarmed about the degree
to which we owe that money and as that burden rises and if we get
out to 1990 and we're a net debtor nation to the level that the New
York Federal Reserve Bank anticipates and we've got that claim in
terms of interest payments to pay that foreign debt, presuming
they are willing to leave it here, because they're certainly not obligated to-they can pull that money out, they can sell the instruments or when they mature they don't have to roll them over, they
can put the money somewhere else. So I must tell you I've got a
very uneasy feeling about getting hooked on both this degree of foreign lending which we have to rely on, No. 1, and whether or not
it's going to be there when we need it and what price we're going
to have to pay for it, but I'm just as alarmed about the degree of
our future national income that's going to be pledged to service
that debt held by others coming off an adverse trade relationship
that seems to now have established itself in a very adverse way
with no signs of improving. In fact, it's staying where it is if not
worsening. In fact, I think I could make a pretty convincing case
that it will not be materially better in the next year. You might
argue, but I think I can make that case.
So my question to you is: What does this mean in your mind? If
we find ourselves in 1990, if these trend lines continue and if we're
a net debtor nation to the tune of half a trillion dollars by 1990,
what are the implications of this? I mean, you might argue that
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we're not going to get there and if you want to say that, fine; but
I'm saying if in fact we should get there, what are the financial implications of that and is that an alarming prospect and is it something that we should try to forestall?
Dr. JOHNSON. First, Senator, I think it's very important in assessing the outcome of becoming a debtor nation how the debt was incurred and for what purpose. You have explained some of what it's
going for and you're accurate in some of your description.
DEBTOR NATION FOR 200 YEARS
I think one thing you have to remember is that being a debtor
nation is not necessarily bad. It depends on what you do with the
borrowed funds. For about 200 years before the time we became a
country until the turn of this last century, we were a debtor country and the reason why this didn't destabilize us economically was
because the money that we were borrowing was used for developing our private economy, financing our rising capital stock. The
amount of borrowing that was done and the amount of foreign investment in the United States went toward fundamental capital
formation in general.
Senator RIEGLE. Let me just say parenthetically at that point, we
had very little role externally in the world. We were basically an
insular country. We certainly weren't carrying anything like the
multibillion-dollar defense obligations for the world that we do
today. So I think it's important to note that we were very much an
insular developing country at that time.
Dr. JOHNSON. You're right. But the principle still holds that if in
fact the borrowing that you do from abroad is used to invest in a
capital asset that has a rate of return on it that produces income
that is able to service both the principal and interest of that debt
and return of profit, then in fact the debt is self-liquidating. In
other words, even though you may continue to build debt, as long
as it's income generating debt that creates an earnings stream like
a capital asset, you will be able to service the debt.
Senator RIEGLE. But where does the earnings stream go? Who
gets the earnings?
Dr. JOHNSON. Well, if it's invested in expanding the capital stock,
then entrepreneurs, capitalists, who in fact earn profits off of the
capital investments that they make are able to pay back the lender
and earn a profit. Of course, that's part of our system. I mean,
that's how we create wealth to some extent.
And I think that that is a difference between the debt that we
incur today and the debt in the Latin American countries. Now I'm
not saying they are totally different. To the extent that public borrowing consumes a lot of this capital and doesn't add to the capital
stock and does not generate any future income flow, we have a
problem.
Senator RIEGLE. Can we manage a $500 billion net debtor status
in 1990 handily and is that something that we don't have to worry
about getting into, or is that something that we ought to try to
avoid?
Dr. JOHNSON. Well, . principally, if in fact, as I said, the debt is
incurred for reasons that generate rates of return that exceed the
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debt-and that would be the case for any capital investment that
has a positive rate of return-then, in fact, this can theoretically
go on indefinitely. However, I am not suggesting that is in fact
what's happening. That's partially what's going on because we've
seen an investment boom in this country.
However, to the extent that public borrowing is the result of the
capital inflow and it's being consumed in a way that does not generate any increase in the future capital stock or generate income
that will help retire the debt, then you have a problem.
Senator RIEGLE. Well, that's part of it. I mean, part of it is going
into financing the deficit.
Dr. JOHNSON. So I'm saying, partially we have a problem that we
need to deal with. But in fact, if you take the Brazils and the Argentinas and the countries who cannot service their external debt,
if you look at those situations, almost the entirety of the external
debt they have created for themselves has been the result of borrowing to invest in state projects or other types of projects that
have generated no future income, and so they cannot service the
debt because the borrowing that they undertook does not generate
income.
ENORMOUS WORLD LEADERSHIP BURDEN
Senator RIEGLE. Let me tell you my concern with that analysis
and I'm following what you're saying. That is, it seems to me that I
think distant historical citations in the past are not terribly relevant to now. I think we're in a world economy. I think we've got an
enormous world leadership burden that we've taken on for ourselves that's very expensive to handle and so forth. And I don't see
that changing.
It seems to me that if we get out into 1990 and we're a debtor
nation to the extent of a half a trillion dollars or more and we've
got that debt burden to service periodically, we've got our internal
debt burden to service, we've doubled the national debt in 5 years,
certainly not an insignificant item. It's a very big item. The fastest
growing item in the Federal budget is interest on the national debt
and that alarms me enormously.
Dr. JOHNSON. Sure.
Senator RIEGLE. And what I'm concerned about is what you
think of in a finance course as the lean-year test. You know, if the
economy is rolling along and you've got the income and you can
sort of meet your creditors' payments and so forth, that's one
thing. If all of a sudden things become quite adverse economically,
your income drops substantially and suddenly your Federal fiscal
deficit widens out because maybe unemployment has gone up,
whatever the set of reasons, to some high level, double digit level.
And all of a sudden you find that you've got an enormous lean-year
debt-service burden to have to meet and you've got to pay it because you owe it to foreigners and to the extent that payments are
due I expect that they are going to want to get their money, just
like we're trying to squeeze our money out of people today that
we've loaned money to.
But I guess I'm surprised that you don't seem to express a sense
of concern about working into that posture. Now if that isn't a
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problem at a $500 billion debtor nation status 4 years from now,
would it be if we were at a $1 trillion level or a $1 ½ trillion level?
I mean, is there any outer limit here that we have to worry about
or not? If so, where is it?
Dr. JOHNSON. Absolutely. I can't give you a number and a time.
Senator RIEGLE. Give me a range. Give me a sense of your thinking.
Dr. JOHNSON. What I can say is, as I said before, if the reason for
the growth in the debt is borrowing that is for pure consumption
purposes, our Federal borrowing does not make any kind of infrastructure improvements or anything that increases future GNP,
then you've got a problem. Now I don't know when the time bomb
actually explodes in a situation like that. If you take a theoretical
case where you're borrowing constantly and not generating any
future income as a result of that, I would say very quickly you're
going to have a serious problem. If you generate income but it
doesn't fully service the debt, then it's going to take longer for you
to have a problem.
Senator RIEGLE. Doesn't that put you in a bind if it's a proprietary investment, if it's a foreign company coming in and making
an investment in the United States and they withdraw the profits-in other words, the profits are earned but the profits are taken
out of the country because profits belong to the foreign investorthey don't really accrue to this country.
Dr. JOHNSON. They do partially. They take the profits from the
capital investment to some extent, but they also improve labor productivity and hire American workers and they make wage payments on the basis of that. So part of the investment ends up improving domestic income as American workers earn more. So I'm
saying, to some extent, it benefits the domestic economy even if
they take the profits out of the country because they have to use
that capital and they have to pay labor to actually perform the production function with the capital.
Senator RIEGLE. My time is up for this round, but wouldn't we be
better off if we could keep and retain the ownership of the capital
ourselves, the $500 billion, if we're at that point in 1990? Wouldn't
we be better off as a nation, other things equal, if that capital continued to be our capital rather than money that's left this country
and became some other nation's capital?
Dr. JOHNSON. Well, I think having the capital invested in the
United States is beneficial.
Senator RIEGLE. The ownership of the capital you don't think is
critical?
Dr. JOHNSON. Not necessarily, as long as it's reinvested domestically. If it goes out and it's permanently withdrawn and doesn't
come back, then you have the wage payments and the things that
benefit the American workers.
Senator RIEGLE. But you can shut a plant down overnight.
The CHAIRMAN. Gentlemen, excuse me. I've just got to interrupt
you as a courtesy to Senator Proxmire.
BAKER'S THREE POINT PLAN
Senator
PROXMIRE.
I'll take as brief a time as I can.
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Dr. Johnson, in October at the IMF-World Bank meeting in
Seoul, Secretary Baker announced a new initiative to deal with the
international debt problem. One key element of the Baker threepoint plan is to have the commercial banks put $20 billion more in
new money into the debtor countries over the next 3 years. I know
that some banks are complaining that the recent emphasis by bank
regulators on increasing the capital levels of our banks will make
it more difficult for them to come up with the new money for the
debtor nations. Still others complain that the bank regulators are
being too strict in administering the special reserves provision.
Those reserves, as you know, must be established by a charge
against income and they are not considered capital by the regula.to~ agencies.
I ve heard reports that some high-ranking Treasury officials have
said there would be a sympathetic review of such complaints by the
relevant regulatory authorities in order to encourage new lending
to debtor countries who cooperate in carrying out the Baker plan.
So my question is this. If confirmed, will you support efforts by
the bank regulators to have the banks increase their overall capital
levels and their special reserves against questionable foreign assets
despite complaints by banks that such actions make it more difficult for them to put more money into debtor nations?
Dr. JOHNSON. First, I do support the notion of reserving against
troublesome loans or bad loans and I certainly would support reserve capital in order to offset bad loans. As a matter of fact, I support the Fed's recent findings for some sort of risk-based capital requirements.
Senator PROXMIRE. So you favor a higher capital requirements in
spite of-Dr. JOHNSON. I think that you should be required to hold higher
levels of capital reserves the more risky the investments that you
undertake.
Senator PROXMIRE. I appreciate that. I agree with you.
Second, as a followup to the question I just asked, there was an
article in the December 23 issue of Fortune magazine entitled
"Why Baker's Debt Plan Won't Work."
That article contends:
The deep down truth about the debt problem is that the debt is too big for the
debtors to handle on a sustained basis. Their burden must be lightened. That can
only happen if the banks holding the countries' debt agree to take less from the
debtors than they are now demanding. Taking less will mean write downs of the
bank loans, the excruciating steps the banks have been avoiding for years.
The article goes on to say:
In private, some bankers concede the countries can't live with their debt, but in
public many are busy lining up behind Baker's plan which would throw more
money at the problem. It will simply increase the amount of pain and it will eventually have to be distributed.
Do you share the view that U.S. banks will eventually have to
write down at least some of their loans? Are you aware whether it
is true that the European banks have already written down or reserved against a larger proportion of their Third World debt exposure than American banks?
Dr. JOHNSON. Well, I think it is true that European banks have
reserved more and written down more of their debt. Whether in
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fact American banks will have to experience further writedowns in
the future is not clear yet. I think the Baker initiative is one effort
that tries to stabilize the growth rates and improve the ability of
Third World nations to service their debt and possibly avoid any
future restructuring of debts by U.S. commercial banks, and this is
not just something that would benefit U.S. commercial banks obviously. This has repercussions throughout the entire economy.
So I think that the initiative that Secretary Baker has undertaken is definitely the right direction and we have a significant chance
to avoid any major restructuring in the future and allow Third
World nations to improve their capital investments and their d~
mestic economies.
Senator PROXMIRE. What about the private view of many of the
bankers that the debtors can't live with the debt they have now
and that this makes it worse?
Dr. JOHNSON. Well, I think that we've seen improvement since
1982. I think that when we really had a problem obviously was
1982. Since that time we have had domestic growth. Assets have
diversified within the major banks' portfolios.
Senator PROXMIRE. But let me just interrupt to say that that improvement has been spotty, hasn't it, erratic? There are some countries where the situation is worse, particularly countries that rely
on oil production?
Dr. JOHNSON. In some cases that's true, but now some of the
same lenders to oil-producing countries are also lending to oil-consumer countries in large scale, so it's not clear what the net effect
is on the bank balance sheet because even though loans to Mexico
may look weaker, loans to energy-consuming countries like Brazil
and Argentina may look better.
GROWTH OF Ml
Senator PROXMIRE. Now in testimony before this committee last
July you criticized what you termed "the erratic short-term pattern of monetary growth in recent years." You went on to deplore
the fact that quarterly Ml growth ranged from a minus 1.3 to 17.7
percent annual rate since 1980.
Given your views, I assume that if you become a member of the
Federal Reserve Board, you will push for less quarterly variability
in money growth. What is an acceptable range for quarterly
growth? If it is achieved, how long will it take to reduce real interest rates by the 2 to 3 percentage points that you attribute to excessive volatility?
Dr. JOHNSON. Well, back when I made some of those statements
there seemed to be relatively better stability in monetary velocity
and the demand for money so that the targets seemed appropriate
and to the extent that volatility in money growth exceeded the
target ranges and the demand for money appeared to be relatively
stable, it was my feeling that the variability in money growth was
adding to uncertainty about the future course of Federal Reserve
monetary policy and that this might be adding a risk premium to
interest rates.
However, since that time, we've seen a fairly significant weakening of monetary velocity and a dramatic increase in the demand
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for money which has made it necessary for the Federal Reserve to
revise up its money targets and, in some cases, to simply relax its
monitoring of Ml relative to its Ml target because of the huge explosion in the demand for money that caused such a weakness in
velocity, which simply meant that even to sustain real GNP growth
at stable price levels at reasonably low inflation, a lot more money
was needed in the system. This would not necessarily have inflationary consequences because of the tremendous demand for money
that was going into checking balances in the form of savings like
super NOW accounts that earn interest.
Senator PROXMIRE. I take it your criticism of the Fed at that
time no longer applies, is that right, because of the change in the
velocity?
Dr. JOHNSON. I think under the current circumstances where it's
been necessary to revise up the targets and to some extent even
allow Ml to drift above target and the fact that the Fed has made
it very clear and provided accurate information to the financial
sector that it intends to continue not trying to restrict Ml relative
to its targets because of this velocity problem, that that takes away
the risk premium.
I think what you've seen is the financial markets relax on that
information and we've seen interest rates actually decline as a
result.
Senator PROXMIRE. I have one final question. As you look back
over the conduct of monetary policy over the last 5 years, what are
the major changes you would have pushed for if you had been a
member of the Federal Reserve Board compared to the policies actually followed under Chairman Volcker?
Dr. JOHNSON. Well, I have a lot of admiration for the Chairman.
I think he's been very courageous in his fight against inflation. I'm
on record as not agreeing with every single policy move he's made.
There were times when I thought money growth was too restrained, times when in fact I thought it as moving too rapidly. But
in general, I think it's been a good record.
Now I think that all I can say at this point is that I would support stable policies and accurate information to the financial markets and oversight groups like this Banking Committee and Congress in general and the administration so that there's a clear understanding of why the Federal Reserve is pursuing the monetary
policy it does. As I mentioned, I support earlier disclosure of the
FOMC minutes so that financial markets and other observers will
get responsive more accurate information about the upcoming
course of monetary policy and that this might avoid bidirectional
movement in the securities market and the bond market that takes
place. I think that if people knew in advance or immediately after
a decision by the Federal Reserve Board the direction of monetary
policy over the next few weeks that you would get unidirectional
movement in the bond market instead of-Senator PROXMIRE. I was just going to say, you seem to have
changed your position vis-a-vis the Federal Reserve Board in general. You say now that in general you think it was a good record,
that the Chairman was courageous, he did the right thing. But in
testimony just last July, 6 months ago, you termed, as I say, "the
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erratic short-term run pattern of the monetary growth in recent
years" you found deplorable.
Dr. JOHNSON. That was referring mainly to 1981 and 1982 which
I still have concerns about. I mean, I did think that Ml growth was
too slow in 1981 when it undershot the target range and in 1982
when it appeared that the velocity of money was more stable.
Senator PRoxMIRE. Wasn't that exactly the time when the Federal Reserve Board took steps which were severe-I admit they were
slow, but I thought they were right because they had the effect of
stopping the worst inflation we've had in a long, long time.
Dr. JOHNSON. Well, I think that certainly it has dealt very effectively with inflation. There was an economic cost to the GNP and
employment. There's no doubt about it. I don't think this was intentional on the part of the central bank by any means. I think
that there was plenty of room for disagreement over what the appropriate monetary policy was at that time. There was a lot of fear
that very loose fiscal policy was feeding the inflation that was running at double digit rates in 1981. There was concern that that
would have to be offset and so you could rationally come to the
conclusion that you needed a tighter monetary policy and might
want to undershoot your targets, but I happen to disagree. I think
that at the time they should have avoided overtightness during
that period, but there's plenty of room for disagreement. Inflation
was running at double digit rates and there was a reason to be concerned.
However, our view was that passage of tax cut legislation that
was phased in over 3 years would not be overstimulative to the
economy and we were not suggesting that monetary policy overshoot its monetary targets, just stay in them at the time. So that
was my major concern.
Senator PROXMIRE. My time is up, Mr. Chairman. Thank you
"'
very much.
The CHAIRMAN. Senator Riegle.
Senator RIEGLE. Thank you, Mr. Chairman.
RECIPROCITY WITH THE JAPANESE
Recently a Japanese securities firm filed application with the
Federal Reserve Bank of New York to become primary dealers of
United States Government securities and I'm wondering-as you
know, we're pretty much blocked out of their market in equivalent
circumstances. They just make us very unwelcome. But would it be
your view that we ought to _go ahead and allow the Japanese to
become primary dealers of United States Government securities
unless and until such time as th~y accord us exactly equal access
and operating privilege in their country?
Dr. JOHNSON. I think in general I support the idea that the Japanese or any other foreign government should be able to deal in securities in the United States. However, I also strongly support
their acceptance of our ability to do the same and, of course, in our
initiatives at the Treasury on opening up capital markets we have
insisted that we be accorded the same access. We've gotten very encouraging responses from the Japanese that they would be willing
to accept United States dealers.
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Senator RIEGLE. They haven't done so yet, though, have they?
Dr. JOHNSON. Not to my knowledge.
Senator RIEGLE. I say that because we've had a lot of promises. I
could give you as many lists of promises as there are articles that
you've written in the last several years here that have been made
and not kept by the Japanese.
I assume you are familiar in some detail with the National Commission on Competitiveness' report named and produced for President Reagan. Would I be right in assuming that?
Dr. JOHNSON. Yes.
Senator RIEGLE. Do you agree with and support both the findings
and recommendations of that national report in general? I don't
want to get into the fine print here.
Dr. JOHNSON. I think I generally support their final recommendations, although if I remember they had proposed a Department
for Technology which I'm not sure we need. We have plenty of programs within the current agencies.
Senator RIEGLE. But generally speaking, you found yourself in
agreement with the findings, the assessment of the problem, the
dynamics at work, and generally the recommendations as to what
ought to be done?
Dr. JOHNSON. I would say generically I agreed with a number of
the conclusions, but I have to reserve a right in some specifics that
I might have had questions with.
Senator RIEGLE. Now I ask that in relationship to the fact that
you served on a White House working group on troubled industries. What did that group conclude?
Dr. JOHNSON. Well, it was mainly a monitoring group that tried
to keep up to date on the economic condition of various industries
that appeared to be troubled. But, it was mainly a monitoring
group to provide information to the Cabinet Council on Economic
Affairs.
Senator RIEGLE. It was not an action group?
Dr. JOHNSON. It was not an action group. It was a monitoring
group.
Senator RIEGLE. And therefore it did not essentially make recommendations?
Dr. JOHNSON. It did not make recommendations. It just briefed
on the condition of various industries.
Senator RIEGLE. I want to come back a minute to our discussion
on trade because it gets into the way you view problems and issues
here and I must say that I have a different feeling than you expressed about the question of who owns our assets in the future because if we find that we have this continued outflow of U.S. capital,
which I happen to think is scarce-we've got a lot of claims on capital, we've got huge deficits that a lot of people are running, we've
got I think an overexpansion of credit-a lot of different directions-and we've got this hemorrhage of U.S. capital out of the
country in exchange for foreign goods to the tune of about $150 billion last year and no end in sight and we've become a debtor
nation and it's accelerating and I happen to think it's a real problem. We may differ on that.
But if we get out 4 or 5 years on these trend lines and if the New
York Federal Reserve Bank's estimates are right and if we're a net
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debtor nation to the tune of $500 billion or more, when we talked
about that a minute ago you were much more sanguine about as
long as they're putting the money in here in either debt instruments which in turn are used to finance some kind of investment
in the United States or activity or if they invest it in physical
plant, the fact that they own the dollars, the dollars are then
turned into yen or whatever it happens to be, you seem to feel all
right about that.
Let me tell you precisely what my area of concern is because I'd
like you to address it if you will. That is, it seems to me that
there's a big difference as to whether we're calling our own signals
in this country-economic signals and important major economic
signals-or whether those signals are being called in Tokyo, or in
Bonn, or some other place. I'll just tell you frankly I don't want
them called some other place and if we went back 100 years maybe
that situation is a little different. We're not going back 100 years
and we've got an enormous defense obligation to the free world.
We've taken it on. They've been quite happy to have us take it on.
The Japanese take a free ride generally speaking, and a lot of
others do on this defense spending. You've been part of an administration that has advocated this buildup and has provided for it and
foresees it continuing indefinitely into the future into the next century, not just to 1990.
REDEPLOYMENT OF FACTORIES OFFSHORE
I have a very difficult time understanding how you are so sanguine about the question of whether these economic signals increasingly are going to be called in some other national capital or
some other foreign firm when assets can be redeployed overnight. I
could give you 100 cases of firms that have shut down literally on 1
or 2 days' notice or 1 week's notice and workers come back the
next day with the gates locked and literally these facilities have
moved halfway around the globe in a matter of literally days in
terms of new facilities coming up somewhere else.
Do we increasingly want to be in a position where those kinds of
decisions with respect to a large part of the investment productive
base of this country are being made that way? I mean, is that not a
matter of concern or should we just figure that that's the way the
world works and in the notion of sort of free world economics if the
signals are called from Tokyo we just have to adjust to that?
Dr. JOHNSON. Well, first let me say that certainly it is possible
for companies to pull up roots and move physical capital over time.
However, my view is if the right economic climate for investment
is maintained domestically in the United States, we don't have a
problem, that in fact because of the bright prospects for investment
in the United States it would be extremely costly economically for
foreign governments as well as any other domestic investor to shift
its capital within or outside the region and therefore I think as
long as we maintain a set of stable conditions that provide an attractive investment environment in the United States we don't
have to worry about that problem unless we're talking about a
period of military crisis or something of that nature.
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Senator RIEGLE. But we have had those in our lifetimes and may
well again with some of the very countries that are now in this
more commanding financial position vis-a-vis the United States.
Dr. JOHNSON. Yes; we do maintain strategic stock,;,iles to try and
deal with particular problems like that. But what Im saying is, if
we maintain a bright investment climate domestically, not only
will foreign investors be attracted but given the resources of the
United States we will be making a lot of domestic investments and
expanding the wealth of the country at the same time.
So I'm not sure if by maintaining a good investment environment domestically we're going to increase foreign claims on the
United States in a relative sense.
Senator RIEGLE. Can you give me an example of a major debtor
nation today that is seen as a place where lots of other countries
now still want to plough in big chunks of new capital and new
debt? There's been a general backing away from countries that get
themselves overextended. We're backing away from countries that
have gotten overextended borrowing from us.
Dr. JOHNSON. I think there are a few, though, that are still in
that category. I think some of the Far Eastern countries, like
Singapore, Hong Kong at an earlier stage, and Korea are still in
that category.
Senator RIEGLE. Of course they're more analog to the way we
were several decades ago. In other words, maybe they're at that
stage of their development that you cited in our history, but they
aren't comparable to us today.
Dr. JOHNSON. There are a lot of investment opportunities there
because they still have a lot of development to do, it's true, and
rates of return are higher in an environment like that than when
you're a fully developed country, there's no doubt; but that doesn't
mean that we can't produce policies domestically that improve
rates of return in our domestic economy and I think we ought to
try and concentrate on that.
Senator RIEGLE. Let me ask you this. Gramm-Rudman is now
law. We are mandated under that law to reduce the deficit for the
coming fiscal year to $144 billion. The estimates yesterday in the
Budget Committee when Mr. Miller was in were to the effect that
that basically takes 60 billion dollars' worth of fiscal stimulus,
overstimulus, out of the picture.
If we succeed in doing that, and we're mandated by law to do it,
do you think there should be a corresponding adjustment in Federal Reserve policy in such a way that we get the monetary benefit,
if you will, through lower interest rates or whatever form it would
take that in a sense would be the tradeoff that everybody talks
about with more fiscal restraint and therefore a monetary bonus
that presumably would give us lower interest rates? Wo~ld you see
that coming and would you work to accomplish that?
Dr. JOHNSON. I think that there's a possibility in a certain way,
but I think it's important to describe it.
First, I don't think that you should expect just an automatic voluntary response to budgetary restraint. There's no automatic
reason why the Fed ought to loosen monetary policy in response to
fiscal spending cuts, mainly because when the Government cuts
spending or reduces the deficit those resources are transferred back
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to the private sector and so what you're really doing is you're shifting these resources from the public sector to the private sector.
There's no reason for the overall level of demand in the economy
to actually change.
If you are cutting Government spending and taltlng that income
that you would have used for Government spending and leaving it
in private income, owners of that income are going to spend and
save with it and the saving is going to end up in investment so that
you've got consumption and investment going on in the private
sector. So there's a direct offset between consumption and saving in
the Government sector and an increase in consumption and saving
in the private sector.
Senator RIEGLE. Is that true of the part of the deficit that's fl.
nanced by foreign borrowing? Why does that money necessarily
appear in the alternative form in the U.S. private economy in a replacement way? Why isn't that perhaps just withdrawn?
DECLINE IN FOREIGN HOLDINGS OF GOVERNMENT SECURITIES
Dr. JOHNSON. To the extent that you're financing some spending
out of foreign borrowing, it wouldn't necessarily be an absolute
shift over. However, I know that we've brought in a lot of net foreign capital into the United States but there's not a lot of strong
evidence that it's been in the form of holding Treasury securities.
As a matter of fact, foreign holdings of U.S. Treasury securities
have declined as a percentage of the total for several years now,
mainly due to the fact that the OPEC countries were the major foreign holders of U.S. securities and with the decline in oil prices
we've seen their holdings drop off dramatically. So in fact there are
actually lower proportions of foreign holdings of Treasury securities today than there had been several years ago.
But to the extent they exist, it's true that cutting back on spending and reducing borrowing from foreign sources does not necessarily mean a one-for-one shift.
But there is a way in which monetary policy might be responsive
in a situation where the deficit was cut substantially by cutting
spending if in fact interest rates were to fall as a result of the
lower deficit. If people believe there would be less pressure on the
Fed to monetize the debt and there would be less pressure on private savings so that interest rates fall relative to the earnings on a
checking account or something like a super NOW, it would mean
that people would be much more casual about holding their money
in the form of Ml type money balances. This would mean there
would be further weakness in velocity of Ml money which would
have to be offset by a monetary response if you were to try and
maintain the economy on the same course as it was before.
One of the major justifications for the Fed's strong money
growth over the last year has been the weakness in velocity due to
lower interest rates that we've experienced since last summer and
if interest rates were to drop further on their own as a result of the
cut in the deficit, which is possible if spending is cut substantially,
then it might require an additional monetary response to offset the
weakness in monetary velocity.
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Senator RIEGLE. That's an interesting point. We've got a vote on,
Mr. Chairman. I would like to ask the witness-I'm going to try to
finish our conversation privately sometime in the next week or so
and indicate an invitation to meet with you.
Dr. JOHNSON. Sure.
The CHAIRMAN. Well, I might also suggest, Dr. Johnson, that
there will be questions for your response in writing and when you
receive those we would appreciate a response as quickly as you can.
Dr. JOHNSON. Absolutely, Mr. Chairman.
The CHAIRMAN. Thank you very much. We appreciate your willingness to be here today.
The committee is adjourned.
[Whereupon, at 1:40 p.m., the hearing was adjourned.]
[Biographical sketch of nominee and response to written questions of Senators Heinz, D' Amato, Mattingly, Proxmire, Dodd, and
Dixon follow:]
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STATEMENT FOR COMPLETION BY PRESIDENTIAL NOMINEES
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loeri CM
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--
civic,. charltlbtl and other or11niut6ons.
lCappl,
Place:ot blrth:..:TroyD:Q'f_.__&8")"'- -"----------
of children: Marshal JC!hn50n 1 7
Ust belOlr all m1mbtnhlps and offleel Mid in profnsklnal, fmemll, bull,.._ ldlolarly,
1985
o.. ot bkth: 'W*11i1 13.12
Marftll status: ;narr1ed
,
Holm'£- Jr
Manuel ,_,,
Iohn ■ oo Wn
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httbern rancm; c
l913o.li&l
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Western Farx:rni C IUCX:
Dotos of
1'909ivtd
Dotos
ltltnded
lnstttutlon
Educat,On:
.!!!I!!!!.
Pnilershy of U abrrt
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Florida State University
R/220 5 l2/16n7
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lilAaliil
Fanznj C hWX:
UlBolJlll
Pttllic 0Jo1CP Scriety
=-
Be;icn,] SciM>CP & u a : - - - - - - - Auoci&ticn of D1Viroment.al , Resource F.cancrrti.sts - 1979-1981 - No Offic:a Hald .
Philadelphia Society - 1980 to preaent - No Office Held.
Employment: l'IICOl'd: U.t below arr poslfrons held since coll... , ll'il:100fnC the tttlt Of dncription of job, ,.,.. of
employment. k»tation of work, and dat• of i n c l u s i v e ~.
12 l lO 191 - Present
c c , h e i stent
TT S Treesury Dsper::tmm:lt ':Jub
5ecretaxy fnr Faxx:mi c Pol 1cy
7/27/82-12/10/82 II S TreHPqr Deplrtment Nish D C
hsi-t:ant
Secreta:cy: {Desiw>ete\ foe F-cxxxm:ic PoHqr
20t82-101t82 II S Treesnry Daper:tmmt WHb DC
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lcth,g Issi stant
Secreteq, for Fa::rrcnic Policy
Honors and awards: Uat baow tll acholltlhlps. fllllow1hlp1, honorlry . . , _ , rnllltlry fflllCSlls, hOno,.ry toeiet)'
meabtr&hlps, end lny' olhtr specltl ~nltlon, tor outstandln, ..rnc. or I C h ~ .
Grem Beret
Medal
Bat:QPt Tab
Perad:mte hedget
Konw> Sendce He1el • e s
lmgle Expert
C-?"ld Ccx:cb:+
degree Kith tnx>r:s (Om ra,rle\,
4'27/81 - 2/2/82 11 S Treeem:y Depe,..,._,t
-l,/2402-J/Jl (BJ
Onic:m Delta Eotilm (F&R:x;;mic;s fkDlr Society); D:rtoul Disvrtati'Xl
Fellcwship {Nuclear Bngulatocy C:aJrnissiml ; Tabor Fa:n:micw Pci:ze
{best
research
paper
in
Jabpr ftCDXJDic,\, Hcnor:o,q Pmsident
Tn:v
StaU Univeaity · AhRllUI of tbe Year 1982 CTrli)r State llnilersicy:) ·
Hc:nx Award for OJtst.vd.i.ng Caltril>utiaia to Pwlic: Policy (Florida Stat.€
UniVttsity) J Secretary'• Hc:nor Jwud for <Xlltribution to first foreign
targeted oecuritiea iuue (U.S. Treuury Daport,,alt).
1
W,sbingtoo DC
Dlptf1•
P.ssistent Secretary foe Fo:nanic Polic,r
9/)403-)2'))
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a,
Neea, IJni1eaity
Feirf■x
Va
P]oride Stete IIAbenity TeJJehH--
Jnetnr:t:or en1 Reeeerdt IHochte
Pmfneoc
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experience:
list any experience in or dirKt association with Federal, Stitt, or local pernments. inch~in& any advisory, conwltative, honorary or othrtr' pert-time service or poMtionl.
U-S· Treuurv
Dep&rtnymt
U. S. Treasury Peparjnent,
Aui■t;ant
SfGnrt4rv tw &mcmic fQlicy
AuiltMt
Sar;ret,ary
CDeeiQMta) fer f'ocn.Poli~
u s Trauury Pept,
Actim ANiatant sei:;retary for f'«naoic Pnl icy
y. s
[Bcytv &M111:aot 5ec:mt1
Trayury Dapt,
Cqmli.uimer PIJtsideat.'1
~""::.;:=:
Ct:rmde■im oo Itdianry
MflT'ber J>relidf;nt.'a steel MviW>tY Omnittne
l'llbH-
wrttlrcs:
list the titles. publishers and dates of books, articles, ,-ports or other published matettals
youhavtwritten.
BOOKS AND HONOCII.APHS PUBt.ISH[D
The Effect of Deficit& on Price s of Financial Aaaet1:
Theorv and
Evid•nce, U. S. Tr•••ury Department 11onograph, Wa1hin1ton, D.C.:
~ e r u 1 1 e n t Printina Office, March, 1984 .
Dere1ul1tin1 Labor Relations,
Inatitute, 1981.
(co•author), Dallas, Texas:
The Fiaher
Better Covern ■ ent At Half The Price:
Private Sector Production of
Public Services, (co-author), Ottowa, Illinois:
Caroline House
Publithert, 1980.
Th• Political Econ o mv of Federal Covern ■ ent Growth, (co-author),
Coll•&• Station , Texas:
Texas A & 11 Univeraity, 1980 .
Pushbutton Unionism, (co-author), Fairfax, Virginia:
Contemporary
Economic• and Business Aaaociation, Ceora• Mason University, 1980.
D•mographic Trends in Higher Education :
Collective !araainin& and
Forced Unionism?, (co-author), International Institute for Economic
Research, University of California, Lo• Anaeles, 1979.
An Assessment of the l ■ pact of Nuclear Power Plant Construction and
Operation on Small RegiotU, U. S. Huclaar llegulatory Co ■■ iaaion
NUREC Series, Sprin&field, Vir&inia:
National Technical Informatie>n
Service, 1978.
"Union Use of Employee Pension Funds:
An Overview," (c.o-author),
Journal of Labor Research, Fall, 1981.
"J.eaional Environ ■ ental and Econo ■ ic I•pact Evaluation:
An InputOutput Approach , " (co-author), Rea tonal Science and Urban Economics,
Fall, 1981 .
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Political
afflUatlons
and Ktlvltlea:
List all memberships and offices held in and Mt'\llces render9d to all political parties or
election comrr,itttes durin& the last 10 yurs.
Rep.Elican Naticnal
Party
Pi,Jse Cq,rjty, AlMDI 8EPJ;>lican Xruth.
Troy St,at.e
Qajprym
1972
thivw:witv Cbti DMD stldant.a far Wintm
U,S §enato 1972
~
l}.Qll'lt fgr
"Tax Li ■ itation Without Sacrifice:
Private ' Sector Production of
Public Services," (co-author), Public Finance Quarterly, October,
1980 .
"Th• Future of the Modern University , "
and Political_ Studiea, Fall , 1980 .
....
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PUBLICATIONS IN PROFESSIONA1.._J_Q_Q__RNAli
(co-author), Journal -~{_iocial_
"Natural Resource Scarcity:
E ■ pirical Evidence and Public Policy,"
(co-author), Journal of Environ ■ •ntal Economic• and Manaa•••nt,
Septaabar, 1980 .
"The Efficacy of Bond-Financed Fiacal Policy," (co-author), Public
Finance Quarterly, July, 1980 .
--
-
2 -
-
"tncre ■ sin& le ■ ource
" The tneray Crt ■ i• .tn the U. S . : An Icono ■ ic P ■ r ■ pective,
Joyrnal of Social and Political Studtu. Fall. 1978.
"Th• l ■ pact of litht to Work Lava on the lcono ■ tc leha•ior of
Local Uaton1 :
A Propert y ltahu Per ■ pectiv,." Journal of
Labor leaearch . (co-author)• Sprina. 1980 . Thia paper recaiwed
th• Labor Icono ■ i ca P r t u avardad by the Center for Study of
Public Choice for the beat l'e ■ earch oaper on labor taauea .
" The Defiaition of lur,aucrata b y Jureaucratic Definitions, "
(co-a1,1thor). Th• lureaucrat. Sprina , 1978 .
Scarcity :
Further !videnc,." (co-author) .
Quarterly 11.tviev of !conoaic• and lu ■ in•••• Sprina. 1980 .
"An Abatract Aporoa c h to tha lalativa lank.in& of
(co-author), Mabra aka Journal of lcono ■ ic ■ and
tcono ■ tc
lu ■ in•••,
Jourtaala ,"
Spr "i na, 1980.
"Mathe ■ atica
and Quant1f1cation in Econo ■ ic Literatur• : Patadia•
or Paradox?" (co-author). Journal of Econo ■ ic Education , Fall, 1979.
" Quantification and Risor in the Periodical Literature:
Trend• and
I ■ plication,. " (co-author). Akron luain••• and Econoaica leviev ,
Fall, 1979 .
" Free lidera in U.S . Labor Uniona t Artifice or Affliction? "
(co-author) , lrit i ah Journal of Induat r ial lelationa, July , 1 979.
"Pape r work and Bureaucratic le h a v iot, " (co-author), !conoaic Inquiry,
July , 1979.
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(co-auth o r ),
"lur•aucratic laperialia ■ :
Soae Sober in& Statiatica," (co-author),
The Intercolle&iate le v iev, Winter, 1977 - lll.
OTHEl PUBLICATIONS
"The Treaaury Flat-Tax Plan :
Analy1i1 and Coapariaion," Cato Journal.
a sya11oaiu ■ entitled "Th• flat late Tax :
An Idea Whose Ti ■ e Kaa
Coae? " , 1pon1ored by th• Policy Science• Proaraa at Florida Stat•
Uni v ersity, forthcoain1 .
" Effects of the Monetary and Fiscal Policiea of tnduatrialiced
Countrie1 on Capital Flovs and International Interest late,."
Financial Develop ■ ent of Latin Aaerica and the Caribbean, Caracas,
Venecuela : lnternaional Institute of Capital Harltet,, 198S ,
" The Stability of Monetary Velocit y:
Fact or Fiction? " (co - author ),
l e 1earch Paper Series , U. S . Tr eaaur y Depart a ent, Au1u1t, 1984 .
" Lava of Coaalttee Orsanicat1on i n lureaucracy, " (co-auth o r) ,
The lureaucra" , Suaaer. 1979 .
" Th• lteceaaion of 1981-82 :
A Supply- S ide Perspective," Exolanation•
o f t he lusin••• Cycle, Noraan 1 . Ture, ed . , Washi n ato n , D. C.:
Institute for lleaearch on the Econoaics of Taxation, 1983,
" Staff Spendiaa by U. S. Senators :
Liberal• Veraua Conservati v ea, "
(co-author), Policy leviev. Suaaer, 1979 . Thi• pai,e r vaa featured
in th• April 11, 1979 ia1u• of the Vall Street Jo_urn_~J .
" The Flat Tax and Covernaent Crovth, " Th e Faaily and the Flat late
Tax, 1111 Cribbin . ed. , lleston. Virainia :
Aaarican Fa ■ ily Institute .
1983.
"Corporate Contribution, :
So•• Additional Con1ideration1, " (co-author)
Public Choice , Sprha, 1979 .
"The Ad ■ iniatration'• Econoaic Policy:
lt1 Effect on Construction ,"
The Military Ensineer, May-June, 1983 .
"U.S . En•tlY Policy and the Eneray Crisis :
Polley hvhv, Sprtna, 1979.
" Econoaic Forecaatin& and the Federal lud1et," A Reconstructi·on of the
Federal ludaet, Princeton Univerait y : Th• Coaaittee for a Reap o nsib l
ludaet. 1982 .
Cause or Cure?" (co-author )
"An 1•0 Hodel of lleatonal la•i r on ■ ental •nd Econo ■ ic l ■ pacta o f
Nuclear Power Planta , " (co-author) , Land Econoaics, Hay, 1979,
"Public Versua Private Pro•i•ion of Collect!•• Goods and Services , "
(co-author) , Public Choice, Winter, 1979.
" The Political lcono ■:, of F•d•ral Coverna•nt Paperwork," (co-a1athor),
Policy l.evhv. Vinter. 1979 . Thia paper •a• featured in th• lead
••1torhl of the F•b r uary 12, 1979 hsue of the Va_ll Streat Journtl,
"lll•a•l Ali•••=
lcoao ■ lc an• Social la1u••• " (co-author) . Akron
lu1tness and Econo ■ ica levt••• Fall, 1971 .
--
"Public Policy for a Growth !coaoay : Graduation Addreaa to the Troy
Stat• University School of Jusinesa , " Cr•at lasu••• Troy, Alabaaa:
Troy State Univer•tty Pr•••• 1912 .
"The lea1an !conoatc lecovery Proaraa." rsJL.1.usj,_11._~n_d
!!.!.!!.!!., July. 1912 .
_!~on_o ■ ic
"Are Noaetarh ■ and Suppl:,-S14• lcono ■ ica Coapatlbh? " Supply-Side
lconoatca:
A Critical Appraiaal. lichard ■. Flnlt, ed., Fudericlt ,
Nar7had :
Univeralt:, Publication• of A ■ erlca, 1912.
....
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Political
contributions:
Itemize all political contributions ot $500 or ,no,- to any individual, campaian orpniu•
tion, political party, political action committee or similar entity durina: the IHt ~a:ht
years and identify the spt,clfic amounts. dates, and names of the recipients.
None
''Private Sector Unions in the Political Arena:
Public Policy Vs.
E ■ ployee Preference," (co-author). Public Policy Analy ■ i• and
M~_n•&•••nt, Richard Zeckhauser, ed., Duke University
1982.
Pr••••
"Review of Basic Econo111ic1 by Edwin C . Dolan," Aaerican Econo ■ ica
Texta:
A Free Market Critique, Jaaes Taylor, ed., 'Young A111erlca 1 1
Foundation, 1982.
"Mi s es on Bureaucracy," History of Econo11ica Society Bulletin,
Spring, 1979.
"Paperwork and Public Polic y ,"
1979.
( c o-author), Policy Report, September ,
Qualifications:
"Illegal Aliens:
Problem s and Policies," L1tgislative Analvses,
American Enterprise Institute fo r Public Polic y Research, Septa•ber,
1978.
"The Reneg o ti•ti o n Reform Act of 1977,"
September, 19 77.
Legt ■ lattve
Analyses,
E1th1ated Historical Impact of Deteriorated Water Quality on Unlted
State s Coastal Fishery Re1ourcea, (co-author), Florida State
University, December, 1974.
Adaptation to a Non-Growth Status, Tallaha11ee, Florida:
University System of Florida, Deceaber, 1973.
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The State
State fully your qualifications to MIW in the position to which you have bMrl named,
(attKhll\Nt)
Future .mployment
relationships:
1. Indicate whether you will sewr all connections with your present •mpl~. businns
firm. association or or1anization II you are confirmed by the s.n■ ta.
I will l"Nign fran my currw\t poa.ition in the U. S. Treasury a.pt .
I may retain my extended leave of abaalce, without _pay, fraa
George Muai Oniwr■ ity .
2. As tar as can be foreseen, state whether you have any plans affw compietin1 aow-m·
ment s.rvice to resume employment, affiliation or practice with your prwious employer, business firm, auoclatlon or orpnization.
If I retain my erterxlad leave of abNrloa with G«lrga Mucn university,
may retw:n
a■
pr:ofeee,c of f¥'.1'.TlCl'Oi cs after
l;J'MIODeDt
wend ce
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3. Has anybody tNde you a commitment to a job after you laave eowmment7
C--e,,ve Mle::m J!nheai ty bes offered to ext:sd ry Jere of eh
without pay.
4. Do you expect to ...-ve the full term for which you have been appolni.t7
lo-"
~
Potential conflidl
of lnt.,.st:
4 . list any lobbyin1 activity durin1 th• pest 10 y,Mrs in which you hlvie enppd for tht
purpose of directly Of Indirectly influtncinc tht l)ISSllt, defNl or modibtlon of
any lt1isl1tion It the national 1.....1of Sovernment or affectina: tM'tdmlnistr1tion Ind
encution of national IIW Of public policy.
l. Describe 1ny fin1nc i1I 1rr1n1ements or deferred compensation .. reements or othw
continuin1 dt1 lin11 with business 111oci1tes. clients or customers who will be af•
tectld by policies which you will infh,.,c. in the position to which you hwa been
nominated.
2. list any invtstments, obli11tions, liabil ities, or other relationships which mi1ht Involve
potential conflicts of inttrtst with the position to which you have been nomlMttd.
,..,.
5. Explain how you will resolve any potential conflict of internt thlt may bt disclosed b)'
your responses to the aboYe items.
3. Descri be any business relationship, dulin1 or financial tr1nSKtion (other than taxpayinl) which you have had durina the last 10 years with the Federal Government,
whether for yourself, on behalf of I cltent, or actin& as an a11nt. that milht in 1ny
way constitute or rHult in I possible conflict of interest with the position to which you
have been nomin,tld.
Civil, criminal and
lnvtsti11tory
actions:
1. Give the full details of any civil or criminal pnxtedina: in which you were I defendant
or a ny inquiry or i""'"tlptlon by a F-1tr1I, Stitt, or local .,.ncy In which you ..,.
the subject of the inquiry or lnwsti1ation.
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2. Give the full dtt1ils ol any procNdin1, inquiry or invtstiption by any profenio.\11
1uoci1tion includina any bar association in which you were tht subject of tht proctedin&, inquiry or lnviestlption.
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ANSWERS TO QUESTIONS SUBMITTED BY SENATOR HEINZ
Qualification•
Board of Governor• of the Federal
Re ■ erve
From Manuel H. Johnson
Syatem
Ouestiun l from Se nato r Heinz:
For th• paat five year•. I have been directly involved with
As
monetary and tiacal policy in the Federal government.
A ■■ i ■ tant Secretary of the Treaaury for Economic Policy during
thi• period, I often worked closely with the governor• of the
Federal Re ■ erve Board and their eta.ff. A primary fun c tion of
thi• office waa to adviee the Secretary of the Trea1ury on all
monetary affairs. Therefore, I met weekly with Federal Reserve
Board officiall to diacu•• th• moat pressing hauea of financial
policy. My d uties alao required that I serve on the economic
foreca ■ ting troika (Treaaury, Office of Management «nd Budget,
and Council of Economic A.dvieera) which prepare• projections of
the economy'• performance for estimation of th• Pre1ident '•
annual budget propo■ al•. over th ■ cour ■ e of my tenure at
Trea ■ ury I have had firat-hand experience with the operation of
Federal government debt financing and it ■ relationabip with
In addition, I have participated in development
monetary policy .
of A.dminiatration polici•• on financial sector regulation and
aupervi ■ ion, international lending, and exchange rat ■■·
Prior to rny public ■ •rvic• with the Treaaury, I was a
profeaaor of economic ■ at Georg• Mason Univer ■ ity in Fairfax,
Virginia. During my tenure •• a univer ■ ity prof•••or I taught
numerou ■ cour ■ e• in economic ■ and exteneively reaearched a host
of topic ■ ■ uch a ■ macroeconomic ■ in general and monetary and
fi ■ cal policy in particular ( ■ ee attached li ■ t of publication ■).
If confirmed, I ■ hall do my very beat to ■ erve the Na tion
well a ■ a 111elllber of the Board of Governors of the Federal Re ■ erve
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Sy ■ tem .
Despite many siq n s of co ntinuing health in th e U.S. economv,
a number of disturbing imbalance,; cloud the horizo., .
The trade deficit is at rA co rd levels and stlll
risino,
The value of. the dollar, atthouqh bel o w the r>eak
level of early 1985 in part due to a more active
intervention policy, is stlll a:t a level commens urate with con tlnui!lQ laroe current accnunt deficits .
And the federal budget defic it, although now subjec
tn 1 imi ts i l'lposed bV Gramm-Rudman, remains ennrmou!'li.
The U.S. is a net debtor nation a nd U.S. exporters fa ce
How ur11ent for the contlnuert
tremendous competitive odds.
health of the ove rall economy a:nd the u.s. trade posltion
are these steps to correct financi<'ll imhalances? A.re t.he
steps beinq taken sutficient?
An s wer:
In line. with the thrust of you r quest inn, l'li'lny ~ave
attributed economic d iffi culties larqely to the strength o f the
dollar in f oreign e)(chanqe markets, wh ir. h i e fre q uently tied to
high interest rates, which in turn are tied to the high Fe der~l
Th o ugh I have difficulty in agreeing with that
budqet deficit,i,
chain of logic, I accept the si.,cerity with whir.h those concerns
At the same time, I shoulrl point out that our
are expressed,
economy generally has hnen prC"~ucing jnhs at a re"larkabl e pace -That
some 9 plus million since the trOulJh o f the last recession.
is a pattern which o ne expects fron a r,rowinq, vibrant e co no my.
That is in mar ked contrast w-ith an0mi c employment grow-th in other·
11ajor industrial trading nations, which in a numher of i nstances
have registered little if any emplt>yment qrowth over the past
decade. · Those were countries which qener"llly experienced
depreciating curre l"'lcies from 1980 thro uqh early last year.
The U.S. ca nnot carry alone the responsibilities required
for the growth of the international economy, and that is why the
G-5 nations have agreed to r>olicy steps to foster ml'.>re b11lanced,
stronger grow-th abroad, and also to take steps which lead to
depreciation of the dollar. Our maier tradinq partners can adopt
policies that will both ameliorate their employment difficulties
and spur economic growth. These steps would alleviate some of
the current strains in the internati ona l economic environment.
At the same time, the u.s. must cu t the F'edera l budqet deficit by
cutting the rate of growth in federal expenc1itures Where the
problem clearly lies. This step will return resources to the
more productive private sector and help blunt the criticism of
l'.> ur friends abroad .
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Question 2 fr-om Senator Heinu
It is frequently asked how long the U.S. and the world
econoray can live with the present imbalances, as partly reflecteC
by our large curr-ent account deficit, and whether- the steps taken
or in process are sufficient to counteract those strains.
No one
can pinpoint exactlv as to when foreigners will becorae overloaded
with dollar- holdings.
There are certainly few signs of that at
the present time.
It seems to me that we would be ill-advised to
bargain away, for purposes of bringing the dollar down, the steps
we have taken domestically to set our economy on a more solid
footing.
The dollar has been attractive to foreigners because of
the higher returns available in this country because of the
invo:tstment policies adopted by the Reagan Administration.
we
hope that other nations will embark on similar Qaths for the good
o f their peoples and the world econoray generally. There is solid
evidence that some such steps are in the process of being
i11plemented .
Combined with our own domestic initiatives on the
Federal spending front, I am confident and optimistic that we are
on the verge of a stronger, better balanced expansion of the
lnternatlonal economy.
However, the sooner we are able to
stabilize the debt situation in the developing world through such
111P.asur-es as the Baker debt initiative, the sooner capital flight
frnm these countries will stop and allow the d o llar- to settle at
,t ,nore sustainable level.
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Concerns have been expressed that the massive deficit
position of the u.s. vis a vis the rest of the wor-ld could lead
to a lose of confidence in the u . s. economy, r-esulting in a rapid
drop in the value of the dollar- and capital inflows, and to a
dse in inflation.
Actual experience over the last year has been
of a gradually falling exchange rate and modest inflation.
What
do you believe are the prospects for a continued steady decline
in the dollar- without a notable incr-ease in inflation or the
dr-ying up of foreign capital inflows -- a so-called •aoftlanding•? How should 11onetary policy be used to addr-ess
rapid decline in the dollar or increase in inflation?
Answer 21
As I indicated in my answer to the prior question, the
str-ength of the dollar has reflected the attr-activeness of u.s.
dollar-designated investments, which have yielded a higher- return
because the pr-ospective r-eturns available on u.s. irwestment are
higher under the policies adopted since the Reagan Administratio,
.::ame into office.
Because of that, I tend to think that the
:lollar has been desired more because of better investment
opportunities; and capital came into this country despite the
1-'ederal budget deficit and not because of it.
Obviously, if the
Federal deficit were to be allo1oted to run unchecked for an
indefinite pedod, foreign investors might begin to question the
ability of this country to provide an environment conducive to
pdvate sector growth and investment.
That is one of the reason,;
why we need to cut Federal expenditures, because if we do not,
sooner or later there ftight be some loss of confidence in U.S.
policy, with possibly deleterious consequences both domestically
l!lnd internationally.
If we can check the growth in Federal
expenditures, maintain and design new incentives for investment,
while at the same time gr-owth is promoted in foreign countries b:·
private sector incentive-or-iented policies, the d o llar- may well
mov e lower as funds would then have alternative outlets abroad.
It is my view that after all is said and done, foreign
Axchange values sooner or later- reflect the relative economic
f..indamentals at play in the various countries.
For the longer
term health of the economy, I would seek a stable monetary
p,)l icy, sufficient to fund sustainable real growth at relatively
stable prices.
It would be extremely important to avoid a
monetary policy that might ignite inflationary pyschology and
1 1 i e a sharp fall
in the dollar-.
....
s
Question 3:
A more active intervention policy has been instituted by the G-5 countries to ensure that the values
of the major currencies accurately reflect the relative strengths of their economies. How important do
you believe exchange market intervention is to the
value of the dollar, and how do you see this more
active approach affecting U.S. monetary policy?
Question 4:
The Omnibus Trade Bill introduced in the Senate
contains a number of provisions i ntended to further
reduce the value of the dollar . These include :
A possible monetary conference to consider
improvements to the world monetary system ;
Enhanced coordination of G-5 monetary and fiscal
policies to promote convergence of key economic
factors such as inflation, interest rates and
money growth; and
Answer:
The Plaza Announcement of September 22 focused attention on
the fundamental role of favorable convergence of economic performance and mutually consistent and reinforcing policies among
countries, in determining exchange rate relationships. Exchange
market intervention is widely recognized as a policy tool with
only limited use over the long run as a substitute for basic
economic policies, in influe ncing exchange market trend s . Thus
there is no real inconsistency between use of the intervention
tool in the context of convergence of fundamentals of economic
pe rformance, and a monetary policy stance which supports
sustained noninflationary growth at home .
Establishment of a Strategic Exchange Reserve in
which foreign currencies would be accumulated to
increase the value of non-dollar currencies and
make u . s. participation in foreign exchange
markets more effective and credible.
With regard to these provisions, do you believe any
significant changes are needed in the monetary
system and that a monetary conference should be
considered? How important to future economic health
is convergence of G-5 policies, and how would you
see such cooperation affecting the conduct of U.S.
fiscal and monetary policy? Do you believe that
accumulation of a foreign exchange reser ve would be
an effecti~e tool for f o reign exchange intervention?
Answer:
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I share the concern of many Members of Congress that the
international monetary system needs to be improved.
Discussions
are now underway within the International Monetary Fund on
possible improvements within the international monetary system.
The Interim Committee will be meeting in April to discuss repo rts
by both the Group of Ten industrial countries and the Group of 24
developing nations on these issues. Secretary Baker has already
indicated our willingness to consider the possible value of
hosting a high-level meeting of the major industrial countries to
follow up on the Group of Ten's proposals on improv ing the international monetary system; he remains prepared to do so if at some
future date such a meeting appears to be useful. I believe that
at this stage it would be premature to determine the need for an
international monetary conference to address these issues.
I believe it is very important that progress be maintained
in the convergence of performance and policies among the G-5
countries, which was the focus of the September 22 iaeeting. At
the recent {January 18-19) meeting in London, to take stock of
developments since September 22, G-5 Finance Ministers and
Central Bank Governors expressed satisfaction with progress made
so far, and agreed that thi ■ cooperation ■ hould continue .
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(Question 15 frOCl Senator Heinz)
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Questions
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Finally, 1 believe that the creation of a Strategic Currency
Reserve to intervene in ezchange aarket ■ i ■ unnecessary. One of
the purpo ■ ea for which the Trea ■ ury' ■ Es.change Stabilisation Fund
(BSF) was e ■ tabU ■ hed wa ■ to enable the Secretary to intervene
in exchange markets and ex~sting legi ■ lation eatabliahe ■ broad
regarding the por~o ■ e ■ for ■ uch intervention. we have
been intervening under exi ■ ting ESP' authority and guideline ■ as
part of the Group of Five agreement on September 22, 1985, to
encourage exchange rate ■ which better reflect recent and pro ■pective improve ■ent ■ in underlying economic condition ■• The
proposed Strategic Currency Re ■ ene unnecessarily re ■ trict ■ the
Trea ■ ury 'a fledblli ty by tyin9 intervention to a narrowly
defined exchan9e rate objective.
guideline ■
Despite the decline in the value of the dollar during 1985,
the u.s. merchandise trade deficit re111aine at record levels.
Export-led and import-seneitive industries have borne the brunt
of the hioh dollar. Do you believe there has been any perunent
weakening of the U.S. manufacturing sector due to the hioh
dollar, and how soon do you foresee improvement in the trade
deficit aa a result of decline• in the dollar during the last
year?
Answer:
It la true that the high dollar of the last several years
has acted as a drag on the 11anufacturing sector. And the dollar
has not been the only problem, Many of our trading partners have
experienced only sluggish economic pet"formance while out" own
economy was growing rapidly. Thia imbalance in growth has also
·
contributed to the trade deficit.
I believe that the impact of these factors is only temporary
and certainly see no evidence of any permanent weakening in
manufacturing. Growth of output in the goods-pt"oducing sector of
the economy -- which is mostly manufacturing -- has been stronger
in this expansion than in any of the previous four poet-Korean
War expansions, Kany obset"vera express concern over the fact
that growth of employment in service industries is outpacing that
in manufacturing . They fail to notice that this has been pretty
much the pattern of the post-World War II era. One reason for
the slower growth of employment in manufacturing is the faster
Productivity in the manufacturing sector
productivity growth.
has advanced at a 2.5 percent annual rate since 1950, compared to
growth at only a 1.8 percent pace for the entire nonfarm business
sector.
There is also no evidence of any serious loss of competitive
In spite of two back-toadvantage in the manufacturing sector.
hack recessions, by 1985 U.S. industrial production had advanced
12-1/2 percent above the 1979 level. This was a much healthier
performance than occurred in Canada, France, Germany, Italy, or
the United Kingdom, several of which registered declines over
that five-year period.
During 1985 industrial production slowed and employment in
I expect
"lanufacturing edged lower through much of the year.
the decline in the dollar should result in son:ie improvement
1 ' , tt
; , the trade deficit cet"tainly by the end of 1986, although laos
:ween currency realignment and any effect on the trade def ic ; t
~ it. difficult to pinpoint the timing exactly.
It is worth noting, however, that there already appears tc
-o me pickup underway in U.S. manufacturing activity. E11plo1.t in this sector has now increased for thcee months in a row,
Induatrial production has
r1fter sagging eat"lier in the year.
I have considerable conr t -;en stcongly two months in a row.
t : dence in the ability of the U.S. industrial sector to produce
•·ii•: h-quality, technically advanced products with worldwide
111-!rkets and expect that manufacturing industries will continue to
r"e•J ister progress in the year to co,ae.
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,:,,,swERS TO QUESTIONS SUBMITT ED B'/ SENATOt
Ju t-s t l0n:
Given the size of the U.S. trade deficit, there is strong
s1.1pport across the United State~ for measures to improve the
compet1t1ve pos1t1on ot U.S. exportec-s. One such step was
passac;ie of the Export Trading Company Act in 1982. What are your
views o f the export trading company concept?
Answer:
The Export Trading Company Act of 1982 (1) delineated
circumstances under which bankl'> could engage in non-banking,
export oriented business; and (2) clarified existing a ntitrust
laws by clearly identifying, in the form of a certificate, which
export activities were permitted by law. The Administration
strongly supported the bill because it removed unnecessary
ba rriers to exports .
It has not contributed to dynanlic export
growth, but that seems to be more the result of the strong dollar
and weak demand overseas, than to any innate shortco111ing of the
legis lation itself.
From Manuel fl. Johnson
Queation:
On January 8, 1986, the Federal Reaerve .Board (P!Dl adopted
:~e i~!:;f~e;:~tr~.~!n::g~}ai!~:1~~o~h~• t~n~~tprl~t~. -~~lie&
corporate takeover& through the use of junk bo_J i-~ · The
intrepretation represents a departure hoa-t.hft F!p's earlier
poai tion on thh subject .
a) Do you agree with the PED'& January 8, ·199·5
interpretation?
Anawer:
No, if the purpole was to regulate corporate . ta-k~overs .
However, ■y understanding is that the red wa1_ask.ed ~for a
clarification of the rule• governing aargin uquiuaenta and that
there was no intant to regulate takeovera.
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Question:
bl It you take issue with the January 8, 1986
interpretation, could you please atate your position.
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·Juestion:
Answec-:
Since the original legislation passed, it has become clear
that a number of impediments have 1 imited the effectiveness of
the law and the impac t of trading companies. I have introduced
legislation (S.1934) t o prov i de further guidance to the Federa l
Reserve on the appropriate relationship between banks and
affiliated export tradin9 companies. These amendments would
clarify the definition of ETCs and relax certain restrictions on
me mber bank invest111ent in anrt transactions with ETCs being
applied by the Federal Resec-ve, while fully maintaining Federal
Reserve authority to protect the soundness of member banks .
Could you comment on these provisions?
Further regulation of financing of corporate takeove rs 11
unneceaaary and a detri ■ent to the aarket achieving the aoat
efficient uae of private capital . In particular , I belie ve that
use of aargin requi cementa to regulate corporate takeovers is
! ■proper .
The red haa already indicated that ■argin requireaent&
have probably outlived their uaefulneu .
I think too auch
attention baa been given to the red's recent interpretation of
regulation G. The red's interpretation indicate• a very narrow
application of the regulation.
Answer :
These provisions seem to have considerable merit but I would
need t o study t heir potential impact more carefully than has been
possible to this time. Since the Administration suppoc-ted the
,:, riglnal legislation and these amendments appear to be designed
simply to improve its operation, I am naturally inclined to
support the amendments.
I understand that comments have been
r equested from the Board of Governors on this proposal and that
Senate Hearings are expected to be scheduled for March o r
April.
I would want to follow these subseque n t development s very
,: arefully before attempting to reach a final judgment.
Question:
c) The interpretation was suppose dly liaited to certain
tranaactiona. What do you perceive to be the li ■ ita of the
interpretation?
Anawer:
The red modified the proposal on January 8 .t:"o Hait it to
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corporation•• debt i1 guaranteed by an operating co ■ pany, (ii)
there la a ■ erger agree ■ ent between the ahell and the target; or
(iii) the obligation to lend to the ahell h contingent on the
ahell acquiring aufficient stock to accoapliah a •abort-for ■
aerger• without further atocltholder or director approval.
While
I welco ■e theae li ■ itationa, I continue to be concerned not only
about the baaic question vhether the interpretation should have
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been ia1ued at all, but al10 with the allbiguity of the
definition, of both shell corporation and operating coapany.
lecau ■ e of that a■biguity, the interpretation aay be uHd by
target coapany ■ana9eaent or diaappointed potential acqui reu to
delay acqui1ition1.
Question:
d) Do you think a diltinction should have been ■ ade between
the application of the January 8, 1986 interpretation to hostile
takeovers and friendly acquilition1 or leveraged buyout, that are
financed thorugh the uae of junk bonds?
Anawer :
I want to e ■ phaahe that the interpretation 11 not
liai ted to uae of junk bond ■; !,.!ll debt i1 1ued to finance a ■ tock
ecquiaition la potentially 1ubJect to the interpretation. Beyond
that, aince ay preference ia that the interpretation not have
been h1ued, I believe hostile and fr i endly takeover ■ 1hould have
been treated 1i ■ ilarly--not at all. However, given that the red
did decide to iuue the interpretation, I welco ■e any limitation .
rir ■ t,
oueation:
e) At present, foreign inveatora who finance acqui1ition1
through foreign borrowing are not subject to the requi re ■ent1 of
Regulation G. Should legislation be enacted that would require
the application of the ■argin rulea to the•• foreign inve1tor1?
Answer i
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Al though I intend to keep an open ■ind on the subject aa I
1tudy it further, ay current inclination ia to support a repeal
of the aargin require■enta as archaic and ineffective to
eccoapliah the congreuional goal• of aini ■ hing both inatability
in the markets and the draining of capital to apeculative
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they au not repealed, I think we should take a aerious look at
any inequitie1 reaulting fro ■ the non-applicability of the rules
to foreign inveatora, taking into account queationa 1uch as
whether and how application of the rule• to such inve1tor1 could
be enforced and what such a rule would ■ean in teraa of liaitin9
United States acce11 to foreign capital.
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f) Last year • FID Study reco-ended the reped or
aodification of the SOI ■argin requireaent. Do you support the
reco-endations of thil report?
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An1wer 1
See prior answer.
q uestion:
The Banking Committee has been examining the issue of
deposit insurance reform for several month s. Part of this
inquiry has focused upon the adequacy of the minimum capital
reserves maintained by banks. Last week the COfflptroller of
the Currency propoaed a plan that would eliminate the current
..andatory requirement that banks maintain a minimum 6 percent
capital-to-assets ratio . The Cc::.nptroller recanmended
promulgating new rules that would set banks' minim1.1n capital
reserves solely by the riskine ss o f their investments .
By
c ontraat, Fed Chairftan Vo lcker proposed calculating capital
reserves according to risk but retaining the 6 percent
requirement as a base.
a) Do you believe that the minimum c apital adequacy
reserves of banks should be increased ?
b) Do you believe the plan proposed by Chairman Volcker
o r that of the COill)troll e r provides a more appropriate
so l ution?
Answer :
I h a ve been very supportive of the regulators' efforts
to raise minim1.1n capital requirements. Adequa t e capital
level s are essential to reduce the exposure of the deposit
insurance funds and to maintain banking system stability. T
concurred with the recommendation of the deposit insurance
study conducted by the Working Group of the Cabinet Council
on Economic Affairs that calls for an increase in capital
requirements.
I h av e supported the concept of risk-based c a pital
1·~:qu irements consistent with the findings o f the Federal
i- ..-s-··v e Board. I have not yet had a n oppo rtunit y t o study
rt-.,.
•rnptroller study.
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Q. Congress has been conte111plating several legislative
proposals that would i ■pose lllini11al regulation on the
previously unregulated aarket in government securities . Do
you believe that the authority to act a& the principal regulator should be invested in the F!D, the Treasury Depart ■ ent
or a self-regulatory organization?
A. First, let 11e state that in order to imple ■ ent
effectively ■ onetary policy and to minimize the cost of
financing the federal debt, it is essential to aaintain both
the efficiency and the integrity of the governaent securities lllarket . Given the dealer failures of the last several
years, I believe that continued confidence in the aarket
requires some additional regulation. Regulation is needed,
on the scale proposed in your {Senator D'Aaato•s) bill and
the Treasury bill subaitted to Congress on December 6.
However, I aa seriously concerned that there is a danger of
over-regulation of what is essentially a lllarket of institutional investors that will impede the aarket' s essential
efficiency. I have not had a chance to study alternati ve
regulatory proposals carefully. However, any proposal
should probably require some cooperative supervision between
the P'ed and Treasury.
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Oueation:
At present Bankers Trust Company, Morgan Guaranty Bank, and
Citicorp have applications pending before the FED that would
permit these institutions to undertake no-banking activities by ,
in essence , asking the rED to redefine the tera •engaged
principally" as found in section 21, paragraph 7 of the
Glau-Steagall Act. Do you believe that the re:o would be acting
within its statutory authority by granting these applications
and, by doing 10, euentially redefining the tera" engaged
principally"? Shouldn't the definition or re-definition of this
term be left to Congress?
An&wer:
In commenting on the applications of Citicorp and J . P ,
Morgan to underwrite and deal in certain securities to a limited
extent, the Justice Department concluded that those propoaals are
consistent with the Glass-Steagall Act. Their co-ent stated
that
... the "engaged principally " language of Section
20 reflects a congreuional judgaent to allow a
bank ' s affiliate, as distinguished from the bank
itself, to underwrite and deal in bank-ineligible
securities as long as such activitie• do not constitute the affiliate • , major or moat important
activity. Therefore, •ince both the Citicorp and
Morgan applications provide that only a am.all proportion of each affiliate•• total activities will
consist of underwriting and dealing in ineligible
securities, both proposals are con•iatent with
section 20 of the Glass-Steagall Act.
Consistent with the recent Supre ■e Court decision in the
Dimension case, the Justice Department adopts the view that nei~ c o u r t s nor the Federal Reserve Board are free to ignore
the plain meaning of Glau-Steagall' s language and replace it
with some other approach that they believe to be more reasonable
baaed upon policy grounds. Since the •engaged principally" lan1
~~:?e t~! ~t::~;=t~:i:;~.!~t~:t r:r:~~!!c:! rh:e!t~T~a!; ;::n:~;t~f
those words and the legislative history h eminently reasonable .
The exunt to which co-ercial banks should participate in
securities activities ii an extremely timely and significant
question which should be considered by Congress in the context of
its comprehensive review and proposals for refora of the financial services industry . That reform should focu• on promoting
the safety and soundness of the financial ayste• vhile recognizing the additional concerns of conauaer convenience and
competitive equity .
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Question 16 from Senator O' Amato
Quest ion:
Last year the Supreme Court held that commercial paper
was included within the aeope of the definition of a security
under the federal securities laws. However, cet"tain banking
institution& continue to un6erwrite and distribute commercial
paper, Do you intend to prohibit commercial bank activity in
thi• area upon your approval to the Board?
Question1
Many commentators contend that America has become overleveraged and that corporations and individuals face a debt
crisis of huge proportions. Do you believe that such a crisis
situation exists? If so, what action should the FED take to
discourage the growth of corporate and personal debt?
Answer:
Answer:
As you have stated, the Supreme Court has determined that
•commercial paper• constitutes a "security• for purposes of
the Glass-Steagall Act vhich generally prohibits banks from
underwriting, distributing, or dealing in securities.
However, as the Supreme Court recognized in that same case,
federal banking laws also expressly authorize banks to engage
in selling securities for the account of customers.
Therefore, if a bank carries out a transaction involving a
security, that particular transaction must be examined to
determine if it constitutes that type of transaction that is
expressly authorized or i f it constitutes an activity that is
prohibited under Glass-Steagall.
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The Supreme Court case to which you refer involved the
commercial paper activities of Bankers Trust Company of New
York. After deciding that commercial paper constitutes a
security for purposes of federal banking law, the Supreme
Court remanded the case to the lower court for specific
consideration of whether Bankers Trust's commercial paper
activities fell within the prohibited types of transactions.
After obtaining a detailed description of the activities from
Bankers Trust and carefully analyzing the legal issues, the
Federal Reserve Board concluded that the commercial paper
activities currently engaged in by Bankers Trust constituted
the sale of securities for a customer that is expressly
authorized and that the activities did not constitute
prohibited underwriting or distributing of securities to the
public.
What is clear as a result of this case is that bank
involvement in commercial paper transactions must be examined
on a case-by-case basis to determine i f the activity
constitutes an authorized security transaction or a
prohibited form of underwriting or dietribution. The analysis
cf the Federal Reserve Board in the Bankers Trust case
frovides guidance for drawing this distinction with respect to
commercial paper activities, keeping in mind the hazards that
Congress intended to prevent through the Glass-Steagall Act,
auch as investment of bank asset& in speculation or liquid
assets.
As a member of the Board, I would expect to support
ecamination of such activitiea using the general guidelines
S·!t forth in the Bankers Trust case.
I do not believe that the growth of debt over the past few
years can be viewed as representing a crisis situation, nor do I
think that we are heading in that direction. The debt situation
is something that should be watched carefully, and certainly some
segments of the economy face sedous problems, but overall the
economy appears to be functioning smoothly at the present time.
Much has been made of the debt situation in the household
sector, where the ratio of consumer installment debt to aftertaJC personal income reached a record 18.9 percent in November.
That ratio is somewhat exaggerated, however, by the increasing
use of credit cards instead of money to effect transactions.
Further, the numbers are probably boosted by the fact that the
baby-boom generation is now in the family formation and rearing
years when acquisition of consumer durables is typically large.
These are generally bought on credit .
High levels of household indebtedness must be weighed against
high levels of asset holding .
During the expansion, financial
asset holdings of households have grown even faster than debt.
Overall, while household indebtedness may be a mildly constraining force on growth of consumer spending in the future, it should
not be a factor which would curb the current expansion.
Nor do
households appear so leveraQed as to exacerbate any downturn,
should one occur. Of course, no one fully understands this area,
and it is one that I will be monitoring carefully in the future.
On the corporate side, the recent growth of d~bt partly
reflects the restructuring underway in a number of industries.
Firms in those industries may have considerable cash flow, but
i rwestment within those industries may no longer be attractive
because of shifts in relative prices . The natural outlet for
that cash flow is investment in other areas, often in the form of
acquisition of other firms.
An offshoot of this may be the
sub~titution of debt for equity. All this is part of the process
of ,Hrectlng resources to those industries and areas where they
can most profitably be put to use -- a process which can only
enhance prospec ts for future growth.
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CA)
ANSWERS TO QUESTIONS SUBMITTF:D BY SENATOR MATT INGL Y
Markets apparently do not believe that corpoC"ations have
become overburdened with debt, as bond yields, both for top
quality and for lesser quality issues, have come down about 100
basis points since last summer and about 200 basis points from a
year ago, despite large bond offerings.
Many investors were
badly burned during the period of rising inflation and economi c
uncertainty of the 1970°s, and would be expected to be very
careful in Committing new funds.
They do not appear to be
skittish about the future .
Certain se(Jments of the economy do face serious problems.
Farmers took on large debt burdens during the period of rising
inflation and rising land values.
The process of winding down
inflation has hurt them badly, and it will take some years to
repair the damage.
Overall howe v er, the eco nomy generally does
not appear to be too highly lever a ged.
I would note that we have
a tax syst~m that encourages leverage.
Proposals made by the
Administration would reduce the incentives for that leverage by
lowering marginal tax rates.
As for the role of the Federal Reserve System, aside from its
C"esponsibilities for bank regulation, its primary focus should be
directed at setting the appropriate framework of reserves and
monetary aggregates so that the economy may grow along a sustainable, noninflationary path.
The Board and the District Banks
have highly competent staffs, but they surely are no t capable of
acting as policemen to oversee the financial behavior of U.S.
corporations and households.
From Ma nue l John s on
•. ,-t ion:
What ia your attitude generally towar1 the Glas,.-Steagal 1
Act: and what, in your opinion, should the Ferleral Reserve Board
rl o in this area to prohibit bankB from engaging in nonbank
ar:t ivities?
Answer 1
The original intent of the Glass-Steagall Act nf 1933 was t
try and avoid future risk exposure to hank depositors from
speculative investment practices by commercial hanks anrl their
securities affiliates,
This purpose is still an admirable
nhjective today.
Howev er, the finan c ial services industry has
evolved dramatically since 1933 .
Many of the regulations
designed to protect depositors and restrict banking practices
have becor.ie outmoded due to financial innovation and
technology.
Commercial banks are losing funds because they are
becoming uncompetitive with other financial service firms for
customers.
In order for commercial banking to remain competitive, it
seems to me that the Glass-Steagall Act shoulrl he modernizeO .
This reform might involve allowing commercial banks to engage in
more securities type activities through hank holding companies,
but at the same time providing a deposit insurance system that
requires banks to reserve capital or pay insurance premiums base i
on the riskiness of their investments .
Such a change woul<i
internalize the risk of investment to commercial banks or their
holding companies while at the same time protecting rlepositors
and al lowing banks to be more competitive.
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Question:
N
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Citicorp, Banker ■ Trust and Morgan Guarantee Bank: have
applications now pending before the Federal Reserve Board that
wou ld redefine the term "engaged principally " ao as to al low
these commercial banks to engage in securities and other
nonbanking activities.
In light of yesterday's decision on the
Dimension Case before the Supreme Court, which struck down the
Fed' a redefinition of a hank:, what action ( if any) do you believ(•
should be taken by the Fed to redefine the term "engaged
principally?"
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Answer
1
In commenting on the applications of Citicorp and J.P .
Morgan to underwrite and deal in certain securities to a limited
extent, the Justice Department concluded that those proposals
consistent with the Glass-Steagall Act .
Their comment stated
that
•.. the "engaged principally" language of Section 20 reflects
a congre ■■ ional judgment to allow a bank's affiliate, as
~
di ■ tinguiahed
froa th• bank it ■ elf, to under.-rite and deal
in bank-ineligible ■ ecuritie ■ a ■ long as ■ uch activiti ■■ do
not con ■ titut.e the affiliate' ■ 111a.jor or mo ■ t import.ant.
activity. Therefore, ■ ince both the Citicorp and Morgan
application ■ provide that. only a ■mall proportion of each
affiliate' ■ tot.al act.ivitie• will con ■ i ■ t. of underwriting
and dealing in ineligible ■ •curit.ie ■, both propo ■ al ■ are
coneiet.ent with eect.ion 20 of the Gla ■■ -St.eagall .\ct .
Consi ■ t.ent. with the recent Supreme Court. decieion in the
Oiraeneion ca ■ e, the Ju ■ tice Department. adopt. ■ the view that.
"ii'iitnirthe court. ■ nor the Federal Re ■ erve Board are free to
ignore the plain meaning of Gla ■■ -Steagall 'e language and replace
it with ■ 0111e other approach that. they believe to be more
reaaonable baaed upon policy grounds. Since the "engaged
principally " language of Glae ■ -steagall is not. specifically
defined in th ■ ■ tatute, the Ju ■ t.ice Department•• reliance on the
ordinary meaning of t.ho ■ e word ■ and the legi ■ lative hi ■ tory i ■
eminently rea ■ onable.
The extent to which commercial bank ■ should participate in
■ ecurit.ie ■ activiti ■■ i ■ an extremely timely and ■ igniticant
q ueation which ■hould be con ■ idered. by Congreee in the con text of
its c01nprehenaive review and proposal ■ for reform of the
financial ■ ervic ■■ indu ■ try. 'Mi.at. reforn ehould focu ■ on
promoting the ■ atety and eound ne ■■ of the financial ■ yet.em wh ile
rMognizing tl'le additional concerns of con ■ umer convenience and
coa.petitive equity.
Queationr
What
i■
your attitude generally toward the merger and
and what ■ hould the
acqui ■ ition act.iviti ■ e in the economy,
Federal Re ■ erve Board do in thie area?
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Further regulation of financing of corporate takeover• ie
unneceeeary and a detriment. to the market achieving the moat
efficient uee of private capital,
In particular, I bel ieve that
u ■e of margin requirement ■ to regulate corporate takeover■ 1 ■
improper. The Ped ha ■ already indicated that margin requirements
have probably outlived their u ■ efulne• ■•
I think too much
attention ha ■ been given to the Fed•• recent interpretation of
regulation G. The Ped'• interpretation indicate ■ a very narrc,,,,
application of the regulation.
The Ped modified the propo ■ al on January 8 to limit it to
debt i ■■ ued by ehall corporation ■ for the purpoee of acquiring
margin ■ tock, and excluded eituation ■ in which (i) the ehell
corporation'• debt i ■ guaranteed by an operating company :
(ii) there there ie a merger agreement between the ■hell and the
target : or (iii) the obligation to lend to the ehell i ■
contingent on the ahel l acquiring ■ ufficient ■ tock to accomplish
a " ■ho rt-form merger" without further ■ tockholder or direct.or
approval. While I welcome the ■• limitation ■, I continue to be
concerned not only about. the baaic question whether the
interpretation ■ hould have been i ■■ ued at all. but al ■o with the
ambiguity of the definition of both ■hell corporation and
operating company ,
Becauee of that ambiguity, the interpretat ion
may be ueed fo r target company management or diaa.ppointeci
potential acquirer ■ to delay acqui ■ itione,
Question:
Will it be your intent to eeek reopening of the recent Junk
Bond limitation• impo ■ ed by the Fed on hoetile mergers: if eo,
why?
A.ne..,er1
As stated in "'Y reepon ■• to the question above the Fed has
expres ■ ed it ■ opinion that ma rc:ri n requirement regulation• are
probably no longe r nece ■ eary,
If action i ■ taken to address the
marqin requirement rule ■, I eee no reaaon to rev isit the Junk
Bond interpretation.
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A~SWERS TO QUESTIONS SU BMITTED B'i SENATOR PROXMIRE
From Manue 1 H. Johnson
· .- sti ••·: ;
On July 17th 1985 the New 'iork Times carried an article
1:H1titled •The Mark et for Latin Uebt• in which is is stated that
m.1,1y banks with Latin American debts are finding relief by
,;el ling them in a seco ndary market .
The article noted that
.._ o.?-.,,eral of the big money ce nter banks have refused to discuss
t.his devel opme nt.
It then said, •one reason for the reti ce nce of
th~ bankers and br o kers is that the transacti o ns provide tangible
~vi dence that many Third Wo rld loans are not worth their fac e
J.i l ue and the big banks fear that the regulat o rs would cit e that
a«. a reason t o r equ ire l o an l oss reserves.•
In May of 1985 the banki ng commi ttee of the Ameri c an
i n"ititute of Ce rtified Public Accou ntants ruled that banks that
S ',..lP l o ans must d i~ count the l oa ns o n their books if they
re c eived le ss than face value,
Do you agree wi th that rul i ng by the accountant s ? Do yo u
think if the market is saying that various o f the third wor ld
loans are not worth their face value this is a good re ason for
the regulators to require additional reserves against such
)o<'.lns? Do you think th"t the regulators should make the banks
set aside reserves against any loans that are swapped for less
than their face value?
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1\nswer:
Certainly, many banks have swapped debt; others have sold it
at <1 discount to change the composition of their portfolio and
asset holding s.
I don't see anything untoward in this ,
I see no reason to object to the AICPA ruling that you
cit e.
This refle c ts a case situation where the loan has actually
been sold i n the market and a l oss recorded,
I think the
sit1Jation of paper still in a portfolio can differ .
If particular paper were being sharply discounted in the
market, I would expect that prudent bank mangers wo uld o n their
own increase reserv es and possibly write-down some loans.
But
circumsta nces can diffe r.
If the debt on the books were being
se r viced in a timel y manner, if the country were making
adjustment e ff o rts, were i n comp liance with or nego tiating an IMF
program, such measures might not be needed.
The actual response
would need to be considered and determined by C"egu latora on a
cas':! hy case, horrower by bor rower basis.
On June 24, 1985, thft Joint Economic Committee, o n which 1
,. , ,e served for over 20 ye ars, held a hearing on the
,•. e rnational debt problem,
One witnl!SS, a senior vice president
,· Shearson-Lehman Br ot he rs, said •The banks should consider
.... ~ting off part of the debt for unless the burden of adjustment
.- more evenly shared between debtors and creditors the price,
,~h political and economic, co uld be very high , • The witnes s
~: 1ted further, •Prest o n Martin i s right in pointing to the need
f ,,. more imaginative schemes,
The cost of an interest cap, World
ll,1 ·\k guarantees , th e s tt" etching of maturities, the cancellation
, r some debt, is a small price to pay compared to the
"lseg uences of economi c and political chaos in the developing
,1,,,· td and the repercussi ons in th e u.s .•
1
Since then the Baker Plan was a nnounced at the IM!-'/World
:-1 -3.n k meeting in Korea.
Do you think that Plan is adequate t o
1~-1 1 with this problem or will some of the other measures
·n,~ :1t ioned above also ha ve to be taken?
•\:1 swer:
"
I expect that the Baker Pla n (or Program for Sustained
>r0wth) will be ad e'q uat e to deal with many aspects of the pro blem
1,,1r. there is no guarantee of success in every case.
The P rogram
1,; comple x.
It involves each of the major participants, the
l~t,tor countries, the MOBS and the commercial banks making a
sl~ nificant eff ort .
Recall the main points:
First and foremost, it is essential that the debtor nations
,J,1 Jpt comprehensive macroeconomic and structural policies to
p r lmo te growth and balance of payments adjustment, and to redu ce
i nt'lation.
Such programs should include:
increased reliance on the private sector;
more supply - aide actions to mobiliz e domestic savings
and foster efficient investment; and
greater emphasis o n market-opening measures t o
encourage f o re i on direct and portfolio investment,
capital inflows, and trade .
Seco nd, the proposal recognizes that the International
Mo netary Fund has played a central role i n the implementation of
the international debt s trategy and emphasizes that this sh o uld
co ntinue .
At the same time, it is also important for the World
Bank and other multilateral development banks (MDBs) t o play a
stronge r role to supplement that of the IMF.
........en
In particular, the U.S. has called for increased and more
effective st['uctural and sector adjustment lending by the MDBs.
We envisage a 50 percent increase over current World Bank and
Inter-American Development Bank ( IDB) disbursements to the
principal debtor nations, to $9 billion annually for 1986 through
1988, or a total of $27 billion for the full period. This would
be equivalent to an increase of 20 percent a year in overall
exposure, after scheduled repayments, or $20 billion in net new
lending over the threa years.
Thit:'d, we estimate a need for $20 billion in net new lending
by the"""'coiiimercial banks in support of growth-oriented policies by
Of course, in the extreme case, it is possible that so:ae of
the debtor countries will not make the appropriate adjustment
efforts, may not service their debt, and may further damage their
creditworthiness.
If such cases develop, it would be appropriate
for banks to increase provisions for bad debt and possibly writeoff a portion of the debt.
Indeed, there have been cases where
the regulatory agencies appr-opriately have raandated such action,
through establishment of acceler-ated tr-ansfer- risk reserves
(ATRR).
The Baker Initiative offers a better alternative,
provided the countries concerned are willing to make the
necessary effort.
the debtor nations over the next three years.
This is equivalent
to a 2.5 to 3 percent annual increase in current bank exposure.
If each of the participants does its part, and the demand
for quality lending by the World Bank increases, we indicated
that we would also be prepared to look seriously at the ti.ming
and scope of a general capital increase for the World Bank .
Implementation of the debt strategy will be a long and
c,)mplex process.
It will not involve a single event marking the
b ~ginning of operations.
Indeed, the process is already well
1.1nderway. Nor does the U.S. debt initiative provide a rigid
•plan• or •blueprint" for action which can be applied in full to
each of the principal debtor nations.
Implementation will be on
:1 case-by-case basis with the initiative providing a framework
f ,,r cooperative action to support the debtor nations' own efforts
t o improve their growth prospects. This will depend on the
individual situation in each debtor country, and each country's
rledsion to implement the additional growth-oriented measures
.,,i, ich are needed to supplement adjustment efforts already
un,Je=way.
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These views are not original; they echo the Administration's
dei.cription of the Program, but I believe the Program can work.
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Regarding the commercial banks more specifically, U.S. banks
<tc..:ounting for 95 percent of the U.S. commercial bank exposure in
t.lid principal debtor countries have pledged their support, as
1
\.J ·1e national banking groups and key individual banks in all
"ajar countries.
I believe it is up to the commercial banking community to
l~·,ise its own mechanisms for implementing its commitment to
in;rease net lending in support of growth-oriented economic
.,>r-1grams in the debtor nations.
A nurnber of ideas are now under
1i.'>cussion.
I do not believe in using government guarantees for
th~s purpose .
The Program is not a bank bail-out.
The approach
.,e~ng followed provides a means for improving the quality of
Jutstanding commercial bank loans and is strongly in the banks'
,,w, self-intet"est in those countries that are undertaking sound,
, .. •wth-oriented adjustment.
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Ouestion:
In your July 2, l'J85 speech before the Western Economic
Association you contended that the U.S. budget deficit was not
and is not responsible for the appreci.,tion of the dollar that
has occurred since 1981.
You contended in that speech that the
dollar appreciated because of our country's "sound economic
policies and higher after-tax real rates of return as investment
in the United States.•
As you know most reputable observers do not agree with your
analysis.
Despite that -- and accepting your analysis of why the
dollar has appreciated so rapidly and as a consequence made it
very difficult for our farmers and manufacturers to export -what can we do to remedy the problem.
What actions can our
govern ..ent take to bring the dollar into a more realistic ratio
to other currencies? Those who blame the bloated dollaC" on high
interest rates have a simple remedy -- cut the budget deficit.
What is your prescription for curing the problem?
As the question suggests, however, the important issue is
not whose theory is intellectually more satisfying, but what can
be done in the present situation to ease the heavy burden which
has come to rest on key sectors of the economy, both industry and
agriculture.
It is clear that the G-5 initiative undeC" SecC"etary
Baker's leadership has had a very beneficial effect and we need
to build further on that foundation.
Foreign countries must be
uC"ged to agC"ee up their domestic economies and promote more
vigorous growth,
Further initiatives must be pursued to insure
that American products are not treated unfairly in markets
abroad.
Beyond that, it will he essential to pursue sound
economic and financio!\l policies at home and to assist depressed
sectors of the economy to make as smooth a tr;ansition as possihle
to a generally less inflationary environment.
Answer:
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It is hard to understand how •most reputable observers"
could come to the conclusion that large u.s . budget deficits
would be responsible for causing the U.S. dollar to appC"eciate on
the scale observed after 1980. Surely large budget deficits as
such would be associated with a very weak and depreciating
currency. That has uniformly been the case for other
countries. Why should the U.S. be different? The other obvious
difflculty with that line of explanation is that during the
period when successive estimates of budget deficits have been
rising, interest rates have been falling.
In 1980 when the prime
rate peaked at 21-1/2 percent the budget deficit was about
$75 billion.
Now the deficit is over $200 billion and the prime
rate is 9-1/2 percent.
Clearly the simple deficit theory of the
behavior of the dollar and interest rates is seriously defective.
The lftOre sensible line of explanation, which accords with
the facts, is that the reduction of U.S. inflation, the 1981 tax
cuts and the move to market-oriented policies promoted a gigantic
net inflow of private capital for investment in this country.
As
a consequence, the price of the dollar was driven up more or less
steadily until early 1985. A. factor contributing to the net
inflow of capital was also the reduction of u.s. lending abroad,
particularly to Latin America, as prospective rates of return
declined there and rose in the U.S.
Foreigners did not invest in
the U.S. because of our budget deficits but despite them.
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Ouest ion :
Some PED watchers have sugoested that reoardless of what the
FED says it is targeting, it is really targeting real GNP
growth.
That is, when the PEL> thinks the economy is orowing too
fast in real terflls, it steps on the monetary brakes, and when it
thinks the econOffly is growing too slow, it steps on the monetary
gas peddle.
My question to you is two-fold:
(1)
Do you think this is an accurate description of how
monetary policy is actually made?
In short, while real growth must rank high among our
national economic objectives it simply is not a realistic primary
operating target for the Federal Reserve.
Do you think the real rate of GNP growth is an
appropriate target for the FEl>?
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Answer:
The description does seem to describe Fed actions fairly
well, particularly at some times in the past.
However, the Fed's
concentration on real growth may have been somewhat more apparent
than real.
For example, at times when the Fed seemed to be
interested in choking down on real growth, it may in fact have
been chiefly concerned with the associated rise in inflation
which it may have felt would eventually undercut real growth in
any event.
At times Yhen the Fed has been engaged in aggressi ve
easing, the objective could be described in terms of real groYth
or perhaps equally well in terms of preventing a cumulative
downward movement in economic activity.
Also, the Fed has
apparently at times in the past given some weight to
international considerations, domestic financial stability and
other factors.
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While the pursuit o f real growth should !:>e rey,,r .ied dS
h,ghly important by the Fed, their primary imp<\ct inevitably is
felt through financial channels and chiefly affects financial
magnitudes.
Even their ability to affect nominal GNP, for
example, may be seriously compromised when velocity behaves in an
unstable manner.
The promotion of real growth should certainly be a shortterm objective of the monetary authorities although major
reliance should probably be placed on fiscal measures to raise
the after-tax rate of return on private sector activity. The
monetary authorities probably should aim primarily at the
achievement of a stable but adequate rate of growth in money and
as low a level of interest rates as possible.
However, this
assumes that there is a considerable degree of stability in the
demand for money. When this is not the case, the Fed's task
becOMes more complex and the promotion of real growth is likely
to become more difficult.
In longer run terms, it is unlikely that the Federal Reserve
can or should aim at the stimulation of real growth.
It is
generally recognized that long run real growth le determined by
more basic non-monetary factors such as the size and skill of the
labor force, the pace of capital formation, and the incentives
for private saving.
Indeed, there are risks in the short run
t:h.,t the unqualified pursuit of real growth will only lead to
il"',f\ation ,rnd the eventual disruption of economic expansion.
I introduced an amendment to the Banking b ill which the
Senate took up in 1984, to include foreign deposits in the P1.HC
premium base.
l\s you know many of the large money center banks
have half or mo re of their deposits in their foreign brancl,e:1 dO,i
pay n o premiums against these deposits even though they are 100
percent. de facto insure<l by the FtHr..
One of the arguments raised against this proposal is that it
would put our large banks at a competi tive disadvant.aye dga.inst
foreign banks.
What. do you think. o f my proposal anU the argument
raised by the money center banks against it?
~~\!~ :
Your p['oposal, 'l.S I understand it, would exten,J the deposit
insurance premium base to include f o reign Ueposits and reduc e
the premium rate from !/12th of one percent to !/15th of one
percent . The effect of these t..,.o changes ,..ould be revenul!
neutral.
Although your plan woulri slightly redu ce the insurance
premium for thousands of small banlcs, it would significant ly
increase the costs' for large internati ona l class ban~s and ,..ould
not increase the size of the ins1.1rance fun,t.
I thinl< Congress and the Administration 1!lust consider :
(1) whether the benefits of this plan outweigh the competitive
problems it ... u1 create in the international lending mark~t anJ
( 2) to .,..hat extent the plan will strengthen the safety and
soundness of the deposit insurance system.
In the past, I have suggested that there might be mar~
effective ways than foreign depoisit insurance assessments t o
increase satety and soundness and protect the insurance funo.ls .
These would include increasing capital requirements for
depository institutions and introducing risk-related priciny
for federal deposit insurance. liowever, your plan deservei.
serious consideration.
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There has heen considerable rlebate in the last few years
whether the Federal Reserve ought to be .=1llowed any dison in the conduct of monetar-y policy,
Those against
.J, ...; c c etion argue that a discr-etionary policy is inherently
,1.. , · thilizing and that monetary policy ought t o be conducted
d1 · ; .•·ding to a strict rule,
The nature of the rule varies fr-om
;.,.n. me asure of money to some measure of price such as gold,
f ,,·..- i g n exchange rates or commodity prices.
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Those against a r-ule-based monetary policy argue the economy
L ;
t.,>o complex to be run in accordance with a simple r-ule, They
,._., , that any rult! will not cover all the situations arising in a
J;q,-t rnically changi.ng economy and that the monetary authorities
"H t be allowed discretion.
Withou t getting into the question of what is an appc-opriate
r ·il~, where do you stand on the question of discretion vec-sus a
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Should the Federal Resec-ve be allowed discc-etion, or
,; t1J• 1ld we seek to constrain its policies with a rule?
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The debat e over rules versus discretion in monetary policy
s t-e "!'l s likely to continue into the future with neither of the
,.- xt.,..emes of a simple rigid rule or total di s cretion being
--:x ~c uted successfully.
There has been some movement in recent
/ 0 .H' S toward greater application of a monetary rule -- in the
,=; e r"\'3e of trying to stay within predetermined targets foe- monetary
-~r ·J..,th -- and a lively debate continues over alternati v e ways in
wl-.ich a c-ult! or rules might be implemented.
It is infrequent in
this day and age to find much support for a total gc-ant of
cihs()lute discretion to the monetary authoc-ities,
It would
LH"()bably be correct, therefoc-e, to infer that the case for a
monetary rule has been gaining ground.
Advocates of a monetary rule argue that recent experiments
here and abroad have not constituted a fair test.
It is ditficult to avoid feeling some sympathy f o r their position.
They
ne ed to face up to the fact, however, that a monetary rule
f..:,cusing upon the quantity of money can be executed successfully
•. Jnly if monetary velocity displays some measure of stability,
While velocity seemed to be stable during much of the pec-iod
following World War II, sophisticated statistical testing
suggests that even that degree of stability has frequently been
ovec-estimated.
No refined statistical tests are needed to show
that velocity has been extremely unstable during the l980's .
Therefore, some discretion in applying any monetary rule has
been essential recently.
For example, during 1985 the rate of
growth in Ml was approximately 12 percent anc1 monetary velocity
fell at roughly a 5 percent annual rate.
Real growth was
sluggish during much of the year although recession never
threatened.
We cannot know with certainty what would have been
the effect on the economy if the Federal Reserve had been forced
by rigid application of a monetary rule to hold the rate of
growth in Ml to some lower figu r e -- for example 6 percent which
would have been near the middle of the target range at the
beginning of 1985. There is a strong presumption, however, that
the economic c-esults could have been seriously advec-se, perhaps
even recession.
This does not mean that we should 1 ive from year to year by
stating monetary targets and then abandoning them.
It suggests
that some latitude for monetary discretion is an insurance policy
against velocity or other surprises.
During settled conditions
with a stable demand for money, monetary policy can perhaps
safely be placed on automatic pilot.
During periods of economic
turbulence, there will probably be a need to take a more activist
stance. The monetary authorities must always be cautious,
ho wever, lest their own zeal for activism end up by introducing
an additional degree of instability into the process.
More research and experience are needed before a monetary
rule or rules can safely be applied, but the effort to develop a
more rule-oriented approach needs to continue.
At the worst, a
grant of total discretion could allow the monetary authority to
do whatever it pleased, without being subject to much if any
discipline.
Few people would regard that as a healthy state of
affairs.
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Question:
Chairman Volcker has expressed concern about the rise in corporate debt.
For example, in 1984 and 1985 nearly $80 billion of
corporate equity "'as exchanged foe- debt.
As a result, the
corporate debt/equity ratio ~as risen sharply.
Some suggest the rising levels of corporate debt are making the
economy far more vulnerable in the next economic slow-down.
Others suggest that more corporate debt is a good thini;.J -- that
it keeps corporate managers on their toes since they must meet
the interest payments.
Where do you stand on this issue.
Is the rising level of corporate debt a threat to the economy, or is it a blessing in
diiguise?
Answer :
An increase in debt, by itself, certainly cannot be counted
a ,; a blessing, but the increase we have witnessed during the
c ur-rent expansion does not appear to be cause for alarm.
Debt ot
n 'lrtfinancial corporations increased by a quite modest 5.0 percent
during 1983, by a sizable 15.9 percent during 1984, and then by
'),l percent, annual rate, during the first three quarters of last
:;e:1,C".
(The wrap-up of fourth-quarter figures is not ye t available.) Over that entire period, growth of debt of the nonfinan.::ial corporate sector was a little less than for all other
n ·Jnfinancial sectors of the economy combined.
Typically,
c<1rporate debt expands rapidly during the second and third years
>f expansion, which aC"e the years of large capit<'.11 investment.
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The deht situation needs to be put in perspective.
The
,:·:>m1nonly cited debt/asset C"atios exaggerate the debt situation,
.-\5 the assets are based on book values.
If assets are capitaliLe.J at market values, such ratios cuC"rently are well below
p,1stwar highs.
Much of the substitution of debt for equity during the past
tw 1 years appears to relate to a restruct1Jring of the economy, or
least of a number of industries.
Due to shifts in relative
rices, new investments within certain industries have become
l~'l<J attC"active, while firms within those industries continue to
,Htp -irience a sizable cash flow.
The natur-,1 outlet for that cash
~1-,,., is investment in other industdes, and that has frequently
Ukt!n the for,n of a buyout of other firms.
All this is part of
ttie process of shifting resources into areas wht!re they can most
pr11fitably be put to work, a process which can only enhance
:HOipects for longer-run economic growth.
.1t
The maC"kets themselves aC'e perhaps the best judge of whether
corporations have become overburdened with debt.
Investors in
bonds were badly burned by the rising rates of inflation and
uncertain economic environment of the 1970's, and can be expected
to undertake careful assess111ents of the long-run prospects for
the economy and for particular firms before commiting new
funds.
The markets have taken in stride the large bond offerings
of the past year ' or so.
Despite these large offerings, corporate
bond yields are now about 100 basis points below levels of last
summer and 200 basis points below yields of a year ago.
There is
no particular evidence of any flight to quality, such as might be
expected in a pedod of financial uncertainty.
Spreads between
AAA and BAA rated corporate bonds have been little changed for
over two years and substantially narrower than in the 1980-83
period.
I note that internally generated funds of nonfinancial
corporations in the third quarter of last year (the latest for
which data are available) more than covered the total capital
expenditures of those corporations.
This is an unusual development for that stage of the cycle and is indicative of the relatively sound financial position of most corporations.
I would finally point out that one of the incentives for debt
as opposej to equity financing will be reduced if marginal tax
rates are lowered in accordance with Administration tax-reform
proposals. Overall, I don't view the rise in corporate debt as
cause for serious concern at the present time, but it is a
situation which I will continue to monitor closely .
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Question:
There are &Offle who argue that bank de regulati on ha s ru n
its full course and that ba nks should not be g ranted any new
powers. Others continue to argue that banks ne ed new powers
in the area of real es tate, ins ur ance, and se cur ities if they
are to c ompete with ot her financials servi ces co nglomerates,
What ar e your views -- do yo u favo r expanded p owe r s for ba nk s
and bank holding c ompanies o r should we hold the line?
At some future date it migh .t b e approi,riat·e t o author . ze
h.•µ -:, -;i tory i nst it ut io n holding compa nies to engage ·:1n mo r e
in su rance , etc, fiel~i However,
! wou ld prefer t o examin e the perfo rman ce of depos.1,,;
ry institution holding companies using the powe rs p r o p o sed be re
:ons;J ering authorizing them to engage in ai1 d itional 'activities.
.1.:: t av i ties in the s ecur it l ee ,
Answer:
The cha ngi ng nature of t he financial services industr y
and the growth o f diversified financial services firms h ave
give n both depositors anc'I borro wers a much b r oad e r array of
poten tial providers fo r services traditionally off ered b y
depository institutions.
Although banks and thrifts have been able to expand into
s ome new se rvices, they have not been able t o a chieve the
sa"'e degree of dive r sific at io n as have other financial services
firms.
Specifically, secur it ie s firms and r etaile r s n o w off er
all the products available at depos ito r y ins t itutions , while!
banks and thrifts 41'"8 still excl uded from the co l'" e p l'" oduct
area s of these f irma.
9
The expansion of othe r dive c-s i fied finan cia l services
firms into traditional bankir19 ac-eas has been o ne factor
contributing to a decline in commercial ba n ks' share o f
business l oan s , consuner c r edit , and the finan cia l a ssets
held by all private finan c ial institutions.
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In light of the ex pansi o n of o thec- finan cia l institutions
into the banking area and the declining mark et share o f b ank s,
I believe that an expa nsi on of bank and thrift holding
company produc t powe c-s i s a crit ical step i n enabling depository
institutions to compete o n an equitable basis for customers.
The A.dm.inistr ation (myself included) supported the Garn
Bill which pasaed the senate in 1984. It would have authorized
bank and thrift hold ing companies to underwrite and de al i n
muni c ipal revenue bo nds, mo rtgage-backed s ecurities and canmerc i al
paper.
In his te stimo ny last June Secretary Baker i ndi cated
that th e Adminietration would like to add to this llat o f
proposed additio nal powers fo r depository i nst itutio n holding
companies two furth er activiti es:
11) authority to spon so r,
distribut• and adv ise mutual fu nds , and (2 ) authority to e nga ge
in activities •of a financial nature• and determined by t he
Federal Reserve.
A.a As sista nt Treasury Secc-etary I s upported
th i s po ■ ition.
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There has been some talk about merging ·uie FDIC and the
FSLIC in order to streng then the latter in&titution. According
t o studies by the Bank Board's staff, the potential losses
from unde r water thrifts could exceed $15 bil li on wh ile the
FSLI C has less than $ 4 billion in u n- encumbered r eserves .
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~at are your v i ews o n t ~ issue? SIIC;?,i.tt11.!':'•· merge the
two ins t ituti ons , o r s hould we. ry to keep~~~: separate ?
Answer:
I agree wit h the recommendation of the Vi c'e President ' s
Task Group o n Regulation of Financial Servic es that the
FSLIC and FDI C establish a uniform r99ulatory approa c h ,
including common accounting and minimt..m c apital standards t o
be phased i n over time if ne ce s s ary,
These steps woul d ma ke
it easier t o merge the in sur ance funds and agepcte.s s h o ul d
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the finan cia l conditio n and the l'}a'tur·e- .Qf -i'p~ed risks
among the different type s of i n sur ed 't>r°~~ nizati ons. The
Task Gro up has rea c h ed the same conc lrisJon .
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Agricultural Credit
UUESTIUN:
conyress has before it a nUlllber of proposals for eaainy
One idea is to extend
the ayricultural credit crisis,
the net worth cer tif ica te prO!,lram provided to thrift
Another prOl)OSal
institutions to a!:JC"icultural banks,
is to allow ayricultural banks to detec loan losses
o ver a longer period of time rather than takin<J the
Many banks
entire hit when the loan is written down.
ha ve urged that 4\ilricultural banks be afforded the
same relief Cong r ess made available last year to the
t'arm Credit System.
How seri o us is the fal:'m credit problem, and what p roposals,
it ant, would you recommend for dealinr., with it?
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It has been estimated that about 120,000 commet"cial tanners
acco unting t or about 12 percent of farm assots are
experiencing substantial financial stress and will need
t.O aevelop some kind of workout .>lan if t.hey are t. O
Many of these, however, will not be
continue far11ing.
able to undertake additional borrowing and will have to
liquidate their holdinys and discontinue their operations,
Several studies within and outside the GoverMl8nt have
found that ade4uate credit is available at rea sonable
interest rates to c r edit wort hy borrowers in rural areas.
Even ba nk tailu re s have been less disruptive than they
miyht have been because of prudent l'' DIC policies: The
l'' DIC teetifhtd in late November that it had reopened
Declininy farm
40 ot the 50 farm banks that had failed.
income is the primary factor causin._i many farmers to
undertake major adjustments in their debt structure.
I do not believe current tarm c redit problems p o se a
iecent
aarious threat to the national lendinc., systems.
le gislative and administrative actions will aid adJustments
in the rural credit systems and new programs are not
l-'or example, the farmers Home
necessary at this time.
Administration obliyated nearly $6 billion in loans to
finance farm ownership and operation duri~ FY 1985 ana
In
expects to Obliyate over SS billion again in l-'Y 1986,
addition, the 1985 Farm liill includes a $490 million
interest rate reduction program to aid ba nks in writiny
down interest rates on farm loans. The rarm Credit
leyislation enacted late last year will help the System
to provide funds at a lower cost t o farm operators,
enable the syste11 to deal more effectively with problem
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loans and cash flow problems, and reassure tarm borrower s
l-'inally,
that their investment in the syste11 is secure.
the re'ilul atory •uencies have reomphasized long-standinu
policies to avoid super v isory actions that. may diecouragtbanks from worki ng with far1Nra to restructure their
debt obl ic;iations.
Consquently, I would not propose new loyislative actions at
In particular, I do not support the extension
this time.
of the so-called •mtt worth certificate• proyram to
ayricultural banka n or tne "lo11s amortization• proposals
Indeed, such efforts to move
that have been sugyested .
away tr om consistent and a cc urate accountiny practices
could undermine public conf idence i n the~e banks with out
imvroviny their actual financial healtn.
Proposals tor admini s trative actions that woula .,iromote
diversiticat.i o n ot l oa n portfolios in rural creait
institutions s hould ~ given serious co nsiderati o n,
however,
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Credit Ca r-d Interest Rates
Quest ion:
Question:
The House is ahout to pass legislation requiring banks to
make checks deposited by consuners available in two or three
business days. As you know, some banks restrict availahility
for ten days or even longer. Many consu,.,ers have complained
about this practice,
Consumer groups have charged that the rate of interest
charged hy banks on credit cards is way out of line with the
bank's cost of funds,
They point out that while all other
interest rates have come down, credit card interest rates have
stayed the same or gone up.
I am told that some banks charge
much as 24 percent.
what are you views on this issue? Do you support the
passage of lP.gislation such as the bill being considered by the
House?
~:
The "Expedited Funds Availability Act" passed by the House
on January 23, 1986, addresses signficant consurner concerns.
Consu1T1er groups have pointed out that so"'e banks deny consurners
access to their deposits while the banks profit fro,, "float"
on checks that usually clear within a few days.
However, the Administration believes that the House bill is
unnecessarily rigid and prescriptive.
It could result in the
inposition of substantial costs on depository institutions.
These costs would, in all likelihood, be passed on to consuners
of bank services.
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The senate's "Fair Deposit Availability Act of 19R6", which
was passed by the Senate in 1984 as part of the Garn bill,
addresses consumer concerns in a more realistic and attl'linable
way.
This bill would require depository in!';titutions to notify
depositors of their funds availability policies and would give
the Federal Reserve Board needed flexibility with regard to
iMproving the check clearing system and expediting the
availability of depositors' funds.
Senator D'Amato has introduced a bill to put a federal
ceiling on credit card interest rates.
Do you agree that credit
card interest rates are too high, and if so, do you favor federal
legislation to control them?
Answer:
There are a number of factors involved in determining the
interest rate banks charge on various types of loans other than
their cost of funds,
Among these factors are processing costs,
which for credit cards are relatively high because of the
numerous small transactions involved, and the risk of default.
1
am not a banker and cannot presume to be able to determine the
level of interest rate appropriate for various types of loans.
I do observe, however, that credit card rates have
traditionally been high but have generally remained quite
stable,
I am attaching a chart from my March 17, 1983 testimony
before the Subcommittee on Consumer Affairs of the Senate
Committee on Banking, Housing, and Urban Atfairs. The chart
shows that over the decade from 1972 to 1981, when ]-month
Treasury bill cates soared 10 percentage points, the rate charged
on credit cards edged up only about 1 percentage point.
Placing a federal ceiling on credit card interest rates
would serve no useful purpose, in my opinion, and would most
likely end up harming the consumer.
Such a ceiling amounts to a
price control which would distort the efficient allocation of
financial resources that characterizes our market economy.
According to the 1983 Survey of Consumer Finances, close to
half of credit cac-d holders use their cards as a substitute for
cash.
They nearly always pay their outstanding balance in full
and thus are not affected by the high rates. A substantial
portion of revenues from bank card plans, on the other hand, are
derived from finance charges.
If interest rates were held
artificially low, banks would probably be forced to take several
types of action that would be detrimental to consumers.
Among
other things, banks might try to reduce credit card losses by
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COMPARISON OF 3-YR TREASURY RATE
AND SELECTED BORROWING RATES
c-ationing cc-edit; they might c-aise the cost to mec-chants o f
presenting credit card receipts; or they might raise the annual
f~es, All of those actions would have a major impact on
con su11ers , including tho s e who rarely use the revolving credit
func t ion of thelr card s.
The cr edlt card industry appeac-s to be o n e o f intense
competitio n, with numerous f inane ial companies continually adding
new services and vying for new c ustomers. There has even been
evidence l ately that some banks are sta c-ting to lower financing
c harges vo luntadly . The fact that nearly two-thi r ds o f American
families ho ld at least one credit card indicates that co nisumers
are large ly satisfied wit h the offerings available to them.
Attempts t o legi s late usury c eilin gs for credit cards would only
disturb what no w appears to be an active and smoothly functi o n i ng
c ,-, nsu11er mar ket for credit.
Percent
20
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83
Qu,:>'iliO'l:
In testifying before the Joint Economic Commit.tee in October
of 1983, you said:
•1t appears that the secular trend of
Jeficits, if kept at a sustainable level may be more conducive to
economic growth than if the corresponding amount of funds was
raised by taxing the productive factors in the economy.•
I am not sure what you meant by this, but it sounds as
though you believe there is some permanent, acceptable level of
budget deficits that not only are tolerable, but are actually
desirable.
Is this what you meant, and if so, what is the
desirable level of budget deficits?
The intention of the passage was not to !;uggest that there
is some optimal level of the deficit which can be known with
precision in advance, but simply that there is in principle some
sustainable long-run level or levels of the deficit -- not
necessarily equal to zero.
The sentence to which the present
question refers, went on to point out that given some sustainable
level of the deficit, it might be hetter ( in terms of economic
performance) to persist \11/ith that situation rather than to raise
taxes since tax increases have lonq-run disincentive effects on
the private sector and thereby red~ce real growth,
Answer:
It may help to clarify the intent ot the sentence in
question to repeat the sequence of argument in that section of my
October 1983 statement before the Joint Economic Conmittee.
The
passage reads as follows:
•one can only speculate on the effect of continuing deficits
on interest rates and, more fundamentally, on economic growth.
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In brief, for some combination of elasticities of supply of
tabor and private savings, a given structure of marginal taxes, a
composition of government expendituc-es ( in terms of gc-owthenhancing and growth-retarding categories), and other parameters,
there will be some sustainable level of secular budget deficits
relative to GN~hat is essentially not resulting in an
explosive growth of the debt-to-GNP ratio.
It is not possible to
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be higher the greater are, among others, the responsiveness of
supply of labor and savings to net rate of return; marginal
output-to-labor and output-to-capital ratios: average man~inal
taxes; and the proportion of productive invest ..ents in total
government spending.
But satisfactory econo111etric estimates of
these parameters do not exist yet.
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However, simulations (performed by IMF econo111.ists among
others) based on a range of reasonable values of relevant
parameters indicate that the effects of tax rate cuts on the
supply of aggregate output, while rather weak in the short run,
may, in the long run, dominate the demand, i.e., the stimulative,
effect.
Therefore, it appears that the secular trend of
deficits, if kept at a sustainable level may be more conducive to
economic growth than if the corresponding a .. ount of funds was
raised by taxing the productive factors in the economy.•
It will readily be recognized that the deficit concept
employ@d in the discussion was long-run in nature incorporating
effects on the supply of output, rather than the simple Keynesian
concept of the deficit as a tool of demand management,
The
purpose was simply to isolate for analytical purposes the fact
that in the long-run the tax-related effects on supply are quite
likely -- indeed, in my opinion almost certain -- to outweigh any
stimulative effects emanating from the budget.
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O')
Question:
I would like to get your view on the interplay between
fiscal and monetary policy. One view suggests that monetary
policy should be influenced by fiscal policy.
That is, if the
President and the Congress are pursuing a loose fiscal policy,
the Fed needs to temper the effect with a tighter money policy.
Those who hold this view argue that if the Federal deficit can
indeed be cut through Gramm-Rudman, that the Fed can then loosen
up on the monetary reins.
The opposite view suggests that monetary policy should be
conducted with a view towards long-term price stabllity and
stable growth and should not be influenced by fiscal policy.
What is your view on this issue?
Answer:
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The question states very concisely two co1npeting views of
the fiscal-monetary relationship. The first view, emphasizing
the opportunity of varying the fiscal-monetary ,.mix•, had its
origins in the Keynesian view that fiscal and monetary policy.
should be partners in the task of demand management. Monetary
policy was usually viewed as a junior partner and given the task
of keeping interest rates as low as possible, while fiscal policy
played the majoC' role. The long-run role of the money supply in
determining inflation was largely ignored or even denied and as
inflationary pressures did develop the fiscal-monetary mix was
supplemented by some form of wage-pC'ice policy. This view of the
fiscal-monetary relationship still persists to some degree, but
the generally unsatisfactory results to which it led by the late
1970's has greatly reduced its influence.
The opposite view emphasizes the role of monetary policy in
determining the level of prices and views fiscal policy primarily
in terms of determining the division between the public and
private sectors rather than the overall level of activity. This
would come somewhat closer to my own thinking if supple..ented by
a recognition that long-run real growth is determined by real,
supply-side forces.
It should be emphasized in passing that
there always is a potential, and clearly undesirable, linkage
between fiscal and monetary policy if budget deficits are
routinely monetized.
It is assumed tor the purpose of this
Oiscussion, that respect for the traditional independence of the
FerJeral Reserve rules out such a possibility.
It is questionable in my opinion whether any clear linkage,
or ~ R.r2. ~ , can or. should be establ ishecJ. between cuts in the
structural budget deficit and monetary policy,· If those cuts are
accomplished, as they should be in my opinion, through cuts in
expenditure the empirical evidence with which I am familiar
suggests that real interest rates are likely to fall.
The idea
that a tiscal raove in one direction can or should be offset by a
monetary move in another direction is open to serious question.
I would not want to rule the possibility out in all circumstances, but I would feel the burden of proof should rest on
those who uC'ge that such a change in policy mix would be
beneficial. The past evidence for beneficial effect is not very
convincing.
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;,:,.swr:RS TO QUESTIONS SUBMITTED BY SENATOR DODD
From Manu el H. Johnson
'Ju e <; ti on :
A group ca lle d "Citizens for a Sound Economy .. produce a
·i-:.,,slette[" entitled •capita l Comment" and the January 21st
~• lit.ion is entitlec1 "Manuel Johnson--F["esh Ideas for the Fed."
~Iii le they do not quote you, they seem to believe that you
s,Jpport the notions they support,
Therefore, I •' iOUld like to get
y-,u, views on some of the ideas they support :
First, the publication says that "the variability o f the
,?t :,r1e y growth rate around its a verage has been almost twice as
h l y"I unde[" Paul Volcker as in the next highest pe["iod , during the
1941.l's.
Not surprisingly, output an,j employment have also
c,>l lowed an unpredictablA patte["n.
A steady growth rate will be
on!:! of Johnson's primary goal~ in his new post."
Do you think the vadability of the money growth rate has
bee,1 a problem in recent years and, if so, how would you propose
tho: Fed go about achieving a ste<'ldy g["owth rate?
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It is certainly a statistical fact that the variability of
money growth has increased substantially since 1979. As this
y~<:t r' s Economic Report points out, the standard deviation of
quarterly Mi growth 1ncroased froTTI 2,2 percent i n the 6-year
period prior t o October 1979 to 4,8 percent in the 6-year period
thereafter.
Some recent specific examples also serve to make the
point.
From October 1980 through July l1J82, the annual rate of
growth in Ml was 4 . B percent.
It then more than doubled to a
10,4 percent rate from July 1982 t o June 19B4 before slowing
abruptly to a 4.1 percent annual rate between June 1:184 and
December 1984 ,
Since December 1984, Ml growth has accelerated
o nce again to an 11.8 percent annual rate.
Empirical work at the Treasury and elsewhere suggests that
this high degree of variability in monetary growth has been
responsible for holding short-term real interest rates several
hu ndred basis points higher than th ey might otherwise have
l>e l?n.
In this c leady defined sense, monetary variability has
be~n a problem.
It is only fair to recognize, however , that the Federal
l{eserve has had to cope with a difficult situation.
Institutional cha nge and other factors have caused monetary
velocity to behave in an unpredictable manner,
Paradoxically,
this has meant that some variability in monetary growth has been
necessary and beneficial t o offset shifts in the demand for
money.
That seems rather clearly to have been the case in 1985
when literal adherence to l ow monetary targets might well have
turned the moderate retardati on of real growth into something
m0rl.! ser i 'J.JS .
It 1s partly an informational problem in that the Federal
ReservP. s hould probably convey its intenti o ns with respect to the
monetary ta rg ets more clearly than it has at time s in the past.
Markets are understandably disturbed when the Fed persistently
overshoots (or undershoots) its ta rgets at a time when it
professes to be attempting to operate within them.
If the Fed
were simply to state that for a certain period of t ime, because
of s hift s in the demand for money, literal adherence to the
monetary targets would not be attempted, the end result in terms
of financial market pec-formance and real activity would probably
be improved.
In situations where the demand for money is stable, there
may well be certain changes in ope r ational procedure which the
Fed mi ght implement in the pursuit of less variable monetary
growth. One should not be dogmatic on these issues but the vast
amount of day-by-day Fed intervention in the market and the
consequent c hurning almost inevitably leads to some degree of
de facto targeting of interest rates by the Fed.
This leads
aTmostTnevitably to more va riable money growth.
In shoc-t, there are pe["iods when variable monetary growth is
desirable t o offset fluctuations in velocity, but on balance the
Fed probably has caused more monetary variability in recent years
than it should hav e .
The diffi c ulty, which should not be
minimized, is in diagnosing in advance whether or not the demand
for money has shifted.
The Fed should in uncertain s ituations
examine a range of other indicators such as prices, foreign
exchange rates and financial market performance in order to
assess their proper course of action.
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quest ion :
second, Capitol comment says that •overlapping regulatory
agencies, laws forbiddil"Q interstate branch banking, and
restrictions prohibiting financial institutions from offering
a full range of services all result in higher coats and reduced
consumer choice•.
It goes on to support nationwide banking,
family banks and permitting banks to engage in insurance,
brokerage setv ices • and othec- f ielde. •
Do you think we should chaOQe the banking laws to permit
the items mentioned or, if you think the list should be diffet'ent,
what legislative changes would yoo support?
Answer:
Holding Company Activities
The Administration (myself included) supported the Garn
Bill which passed the senate in 1984, It would have authorized
bank and thrift holding companies to underwrite and deal in
municipal revenue bonds, mortgage-backed securities and commercial
paper.
In his testimony last June Secretary Baker indicated
that the Administration would like to add to this list of
proposed additional powers for depositor-y institution holding
companies t'IIO further activities:
(1) authority to sponsor,
distribute and advise mutual funds, and (2) authority to engage
in activities •of a financial nature" and determined by the
Fejeral Reserve.
,\a Assistant Treasury Secretary I supported
this position,
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At sol'le future date it might be appropriate to authorize
depository institution holding companies to engage in more
activities in the securities, insurance, etc. fields.
However,
1 would prefer to examine the performance of depository instituti•)n holding companies using the powers proposed before
considerinlJ authorizing them to engage in additional activities.
lnter_state Ban~
Now that the Supreme Court has confirmed that states can
Join together to fonn regional compacts, I believe Congress
should address the issue of a trigger mechanism tor nationwide
interstate banking. Secretary Baker indicated in his testimony
1.1,;t June that five-years would appear to be a reasonable time
period within which regional banks could make the transition
to full interstate banking,
I do not believe, however, that
the issue of an interstate bankil"Mil trigger should detract from
C~n9ressional attention to more impot"tant leoislation regarding
deposit insurance reform and expanding the permissable activities
of deposit~ry lnstttution holding companies.
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2 -
Regulatory Reform
The Administration, in consultation with the Federal
Reserve Board of Governors, has proposed that certain initial
stepa be taken to reatructure the regulation of financial
services with an elf{)hasis placed on the principle of regulation
by function.
The starting point proposed by the Administration
Ls found in the July 1984 study •Blueprint for Reform: The
Report of the Task Group on Regulation of Financial Services.•
The major proposals of the •Blueprint• are outlined in the
attached •appendix•.
I was involved in this study and generally
support the recommendations.
It is worth highlighting the fact that the study does
not propose to eliminate any of the current federal banking
agencies, although a streMll ining of their regulatory responsibilities is suggested. Thus, the Federal Banking Agency ( FBA)
would replace the Off ice of the Cccnptroller of the Currency
(OCC) as a Treasury Department agency and would assume all of
the duties of the OCC with respect to regulating national banks;
all state chartered banks as well as major bank holdil"IIJ companies
'IIOuld be regulated by the Federal Reserve Board: and the FDIC
would no longer be involved in the regulation, examination and
supervision of state non-member banks (concentrating instead on
its responsibilities as an insurer of deposits),
In addition,
most bank holding companies would be requlated by the primary
regulator of their lead bank. While by no rneans extreme, these
measures would result in a more logical real ignmont of bank
regulatory responsibilities than we have currently.
Attachment
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Appenr:Ux
The Major Proponh of th• Blueprint {ci,r Reform
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-rh• three exi ■ ting federal banlt r•9uhtor• v0uld be
reduced t.o two by eliminating the P'DJC•• role in
•••mining, aupervia!ng and r•gulating at.ate non-me:nber
ban\ ■,
A n•111 "Fcd.•r•l B ■ nltinc;i Agency" ("F8.\"') vould be
created vi thin the Treasury Depart1Mnt, incorporating
and upgrading the exilting occ. Th.ii agency would
regulate all national bank ■, While th• FRB vould be
responsible £or federal regulation of all eute•ch•rtered
banks,
---
The regulation of bank holding companiea would be
aubstantially reorgani&ed. At proaent, u,e FRD reguhtea
all bank holding companiea, even tllough a different
agency uaually regulate• th• aublidhry banlt(a) of the
holding company. Under the new system in al110at all
casH the agency that regulate ■ a 'bank would aho
aupervhe its parent holding company. Thia wotld make
it. possible for moat. banking organi&ations to have a
aingh federal regulator rat.her than two.
The FRB would transfer it ■ llutllority to eatablhh tl\e
permisdbl• activities of bank holding companies to the
nh, FBA, alt.hough it would maintain a Jimited veto right
over n•..,. activities.
4.
The FRB would contin1,,1e to supervise tl!ia holdini cOfflpanies
of the very largest domHtic banks, as well a1 those with
significant. international activities and foreign-OW"ned
in1t.itutiona.
5.
The FDIC would be refoc1,,1aed exclusively on providing
deposit insurance and adminiaterin9 the deposit ins1,,1rance
ayst.em. All its current rHponsiblliti•• for environment.al,
consumer, antitrust and other lawa. not. directly related
to the aolvency of insured bank• would be transferred to
other agencies, •• would lt ■ raaponaibiUti•• for ro1,,1tin•
••■ r'lination, aupervition an.S reg1,,1lation of et.ate non-member
banlts. At the same tbu, the FDIC wo1,,1ld asa1,,1 .. nN
authority to revie"" ia1uance of inaYrance t.o all inttit1,,1tions, •• well •• to examine all trouble!! inst.it.utlon1
and a Hl!lple of non-troubled fir•• in conjunction wit.h
tlle primary auperviaor. The FDIC would aho llave ne..,
autllority t.o t.a'ke enforceraent Action againat violation ■
of federal law concerning unn.f• banking practicea .in
any bank examined by it where the prianary re91,,1lat.or failed
to take au.ch ection upon prior requeat of the FDIC.
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6.
A ne..,. program would transfer c1,,1rrent. federal euperviaion
of many ■ tate-chartered bank ■ anel SI.La (anel their holding
compani ■■) to the better at.ate reg1,,1latory agenciea,
creating n•..,. incentives for et ■ t•• to •••Y"'- • at.ronger
&ol• in auparvhion,
,.
Th• apecial regulatory ayat.em for tl!irifts would be
111aintaine:1, but eligibility would be based on whetller an
inatitut.ion i ■ act1,,1ally competing aa a thrift, rather
than on it.a type of charter.
8.
The FDIC an:1 FSLIC woulel be req1,,1ireel to eatablhh common
minimum capital requirement• ancl accounting at.andards for
insurance purposes.
9,
Antitrust anel aecuritiea matt.era would each be han;1le,1 by
a aingle agency rat.her than five different agencies at
present.
10. Sor.ia apecific regulatory proviaiona would be simplified
to eliminate unnecuury b1,,1rdan. Th••• incl1,,1de edating
le9islative provisions that. encourage wastef1,,1l litigation,
•• well as outdat.•CI application requiroments in various
areas .
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Privati ution
guest ion 1
v.
Finally, the newsletter supports private deposit insurance,
a viewpoint that has not been widely shared by the witnesses
before this C0111t11ittee. Do you support private deposit lnsurance?
Currently there are ■ ix ■ tate chartered, or ■ tau regulated,
private deposit insurance COftlpanie ■ that pri,-.rily in ■ ure depo■ it ■
in ■ tate chartered ■ avings and loan a ■ soclatlona. Th••• private
insurance c0111panies, however, generally lnaure institutions with
under $100 million in •••eta and the largest number of institution ■
In addition to their
ln ■ ured by ■ ny one private inaurer 1 ■ 145.
capital, five of the depo ■ lt insurance companies have increased
their financial resource ■ through line ■ of credit with CDl'lmerc:ial
banks and two have reinsurance contracts with two general insurance
c0111panl ea .
~:
In 1985 a working group of the Cabinet Council on Economic
Affairs completed a study entitled •Recommendations for Change in
the Federal Deposit Insurance System•. The study addc-essed the
feasibility of both prlvate deposit insurance and private
coinsurance. It concluded that neither was very practical. I
would refer you to the discussion of these subjects on pages
54-56 of the study which I have attached. I support these
findings. During my hearing I supported the alternative concept
of risk based capital requirements ln addition to the current
deposit insurance system. The Federal Reserve Board has
endorsed such an approach.
Attachment
While private or state insure re aight ■ erve a ■ co insurers
with the federal governme-nt for certain cl••••• ot depo ■ lt ■, the
private ■ ector appear ■ unlikely to provide •11 deposit insurance.
Furthen110re, it h doubtful whether ■ upplemental private in ■ uranee
is likely to be supplied. Certainly, virtually none has been
marketed for depoaits over SlOO ,000 or for 1110ney ■ ark•t fund1.
Totally private deposit inaurance la unlikely for at least thr••
• igni f icant reason ■• First, external economic conditions Jnay
The ■ yste,dc nature
adver ■ •ly impact all bank ■ at the ean.e time.
of the risk makes the provision of insurance itself highly risky.
Second, there were over S2.1 trillion of demand, ••vinos
and time deposits held in commercial bank ■ and thrift ■ at yearend 1983. Although most of the s2.1 trillion h not at rhk
because of assets available to cover it, pi-lvate ln ■ urance firms
11ay ■ till not be able to obtain the capital nece ■ aary to support
such in ■ urance. The FDIC estimated that, in 1981, the maximum
leoal capital of all domestic property and liability insurers,
including domestic reinsurance organizations, could cover $7.5
billion of depo ■ it• at any one institution. This amount ii well
below the level of uninsured deposits at the lart;iest commercial
banks . In light of self-impo ■ ed exposure limits, • more realistic
estimate ls that S1 to S2 billion in coverage per institution
might be available.
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Third, there are external social and political benefitt in
maintaining a 1table financial ey1tem that do not accrue to
individual banks within the system. A. totally private insurance
system would, therefore, be likely to provide too little insurance
for the total ay1tem and tend to •ini11ize lo•••• by closing
troubled in ■ titutlona too early. However, possible alternatives
include private coinsurance and ■ tate coln ■ urance.
A.
Pr~'l,l'ate Coin1urance
In their 1983 reports to conoress on deposit in ■ urance
(•Aoenda for R•form• and •o.po■ lt In ■ urance in a Changing
Envlrol'lftent•), the FHLBB and the FDIC re ■ pectlvely addreued
the prospects of greater private sector involvet11ent in the
provision of deposit ln ■ urance. Private in ■ urance would likely
be u ■ ed to insure uninsured laro• deposit ■ that are de facto
insured by the govern.ant. The de facto in ■ urance would thus be
converted to explicit insurance with • correspondino reduction
in the federal financial liability due to · private ■ ector
aasumption of aome of the risk.
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Private insurers vould set their own rates and be able to
impose conditions and covenants on institutions. However,
certain conditions or safeguards would have to be established
for private insurers to protect the federal financial interest .
Private insurers would have to meet federally desionated qualification standards and would have to be independent of the
institution insured.
In the event of a failure handled by payoff , the federal
insurer would pay off all depositors, imJnediately bill the
private insurer for its shac-e of the funds payable, and over
time, remit to the private insurer its share of the collections.
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On the other hand, thou;h, to the extent that nationa l
uniformity is perceived as • 1t1ore equitable approach, significant
variations in either premium levels or structure between states
could result in a lesa •fair• system. Incentives could develop
for certain types of institutions, such as large banks, to locate
in aome stat•• c-ather than others . Alao, state insurance funds
would be more subject to the downturns of a less diversified
economy than would a nationwide system. As a c-eault, premiums
would need to be hioher .
In the event of an assisted takeover or direct assistance, the
federal insurer would bill the private insurer for its share
of the cost.
Market pricing of even limited privat• deposit insurance
and the monitoring by private in1urera of institutions' lending
pr-actices and other activities would provide incentives for 111or-e
pr-udent risk-taking by depository institutions. More prudent
rilk-taking, in turn, could lead to reduced costs to the federal
insurance funds and a reduction in regulation.
However, because of externalities, auch as cyclical changes
in capacity and the need to fulflll re;ulatorily imposed contract
conditions, competitively priced private insurance may be more
costly than is economically approprl11te. Moreover, difficulties
may arise in balancing the financial interests of private insurers
and federal regulator,. Private insurers would probably insist
on some role in determinin; solutions to individual failure
cases to protect their flnancial interest. The discretion and
flexibility c u rrently exercised by federal regulators could
consequently be diMinished.
Finally, to the extent that some
large depositors are not totally covered by private coinsurance,
a degree of instability in the syste111 would be introduced.
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B.
State Coinsurance :
The Unemployment Insurance Model
The depo sit insurance system could be restructured to rely
far more hea v ily on a state role using the genec-al Model of the
unemployment insurance system. The FDIC end the FSLIC would
determine each year the she of the in•ura.nce fund and the total
premium required from each state, baaed on the recent loss
eKperience in the state. Each state, howevec-, would determine
individual bank premiums, subject only to the requir•ment that
total premiums meet or exceed the state's obli;ation to the funds
and a prohibition on discrl111ination a;ainst national banks or
thrifts. Any state could choose • flat-rate premium structure,
risk-based premiums, or any other method it desired.
This proposal would provide a laboratory in which 50
jurisdictions have an incentive to innovate and develop efflcient
preMium structures. The state coinsurance vac-iant would give
states an even greater incentive to consider carefully the
effect of their laws and supec-visory policies on bank safety and
soundness. Dele;ating the premium structure decision to the
states would also permit prenliut1 decisions to be 1110re closely
tailored to local preferences.
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Quest i ~ n:
In yesterday's New York Til'Ma, Lester Thurow argued that our
financial markets are so fragile today that
could once again
see the financial panics of .the 1920 1 s and the oreat depreHion
of the 193U'a.
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Por example, he said that, • the loan portfolios of American
hanks include more than $500 billion in farm and third-world
debt, where default is easily imagined. As oil prices fall, what
were good oil loans are rapidly becoming bad ones. Major banks
are sinking under the weight of falling real estate values.
Mergers and leveraged buyouts lead to firms that can barely meet
interest obligations in boom periods and that could not meet them
in a recession.•
As a member of the Board of Governors, I would hope to
contribute to the development and extension of current policies
which it seems to me are headed in the rioht direction.
A
moderate and stable rate of orovth in money, healthy econ011ic
growth and a gradual transition toward price stability are
objectives which the Ped should continue to pursue.
In addition,
the Ped must never lose eight of its traditional role as a lender
of last resort and should stand ready to take decisive action to
prevent financial instability from cumulating. The Fed has had a
good record in that re9ard
with the late 1920' e and early
1930 1 s a notable exception -- and that record must and can be
extended.
How fragile do you think the financial system is?
What would you plan to do to alleviate the problems as a
meJ1ber of the Fed?
If you could control both monetary and fiscal policy, what
w-,;.1ld you do about these problems?
An=;wer:
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The overall financial system has displayed a great deal of
strength and resilience throughout the period since World
:<iar II.
It is questionable in my mind whether it should be
referred to at all in terms of •fragility• although in the last
analysis the choice of such terminology is quite subjective.
l)Qlllestically, there are problem situations but the number of
hstitutions while seemingly large in absolute terms is actually
" very small proportion of the total. Successive problem
situations at large co111mercial banks, which some commentators
f~lt imperilled the entire system, have been dealt with
<,uccessfully, Other situations such as that in some parts of the
thrift industry and in the agricultural credit ayste111 are
,tifficult but give few signs of widening into a situation which
w"l1ld threaten financial stability •
The debt situation of Latin American borrowing nations
J':o dously has links to the financial position of many of our
lMgest banks. That situation is being managed in a cooperative
<:!ffort with the banking system, the borroving countries, and the
n ,' tilateral lendin~ institutions. The Baker Plan proniiaea to
r~ i nvigorate the process and guide it in a promising direction.
I n an environment of stronger international economic 9rowth and
,:r.-,tinued cooperative action, the situation would appear to be
.nc1 ·1aqeable,
Monetary policy should continue in the pursuit of price
stability. Fiscal policy needs to concentrate on narrowing the
deficit by reducing what has become a clearly excessive rate of
growth in spending. Taxes need to be kept as low as possible -particularly marginal tax rates -- in order to promote a dynamic
and productive private sector.
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'Juei.tion :
question:
As you well know, the Congressional concern wit h huge budget
deficits resulted in the Gramm-Rudman-Hollings legislation, To
meet next year's t,u·get deficit of $144 billion, we will probably
have to cut about $60 billion.
I won't ask you whether we can do
that without incc-ea ■ lng revenues, because that is a question for
us, but what I would like your opinion on is whether it would be
better to reduce the deficit by $60 billion, if we had to raise
some revenue to do it, or reduce it by some lesser amount -- say ,
$40 billion -- with o nly expenditure cuts?
What do you think we should do to strengthen our deposit
i nsurance funds?
Answer:
In my opinion, whatevec budgetary target is agreed upon as
necessary and desirable -- whether it be $40 billion, $60 billion
or some other amount -- should be achieved by cuts in the rate of
c.irowth o f federal spending .
It is spending which is out of line,
amounting recently to about 24 percent of GNP, far o1bove the
normal range of recent experience.
Receipts, on the other hand,
at about 19 percent of GNP are running closely in line with
previous experience.
More fundamentally, it is Federal spending which ,..._ cJa.iMs
scarce resource• and thereby i .. poses real costs . Once the
spendinQ has been done and the resources have been pulled away
fro .. productive use in the private sector, it is a subsidiary
issue as to whether the 1,1overn111ent borrows or taxes.
In one case
-- borrovinQ •- the transaction is at least voluntary since no
one is compelled to buy the bonds, where in the other case -taxation -- the pay111ent is not voluntary and reduces the aftertax rate of return on private sector activity.
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It ie a delusion to believe that raising taxes somehow has
beneficial effects on the economy. Quite the contrary, economi c
growth is inevitably affected adversely.
For these and other
reasons, the President has properly insisted that expenditure
i:eduction ia the ne cessa ry way to go about dealing with the
budgetary problem..
He has consistently viewed taxation only as a
last resort after spending has been reduced as far as possible.
Tax increases are not a way of solving the budget deficit problem
but a way of avoidiOQ the expe ndit ure cuts which are clearly
required in the present situation.
Answer:
While I believe both the Federal Deposit Insurance Corporation and the Federal savim:ois and Loan Coq:oration (FSLIC) are in
reasonably sound condition at this time, 1 think consideration
should be (:oliven to ways to bolster the resoui:ces, particularly
of the FSLIC, should that be necessary over the next few years
as the thrift industi:y recovers fran the curi:ently depressed
real estate market.
Regulators should also address proposals to
reduce the n1.1T1ber of pi:oblan institutions that must be dealt
with by the deposit insurance agencies.
These proposals relate
to such things as depository institution capital adequacy and
risk-related deposit insurance premiums .
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ANSWERS TO QUESTIONS SUBMITTED BY SENATOR DIXON
Prom Manuel H. Johnson
oueation1
Do you favor restrictir'IQ the amounts of prefer-red stock
and aandatory conver-tible inatrwrenta includable in priJ11ary
bank capital, aa propo■ ed by the Board of Governors in Noveaberof 19857
SOClle em.all and independently-owned bank• have commented
that the propoeal will eliminate, for them, a pcincipal source
of permanent equity and curtail the use of advantaoeoue estate
and tax planning tools. Do you believe the proposed r-egulatory
limitations could have such an adverse effect or whether
closely held c~aniea could be exempt fran ita provisions?
Does the proposed limitation on the components of bank
capital improve the reoulation of capital adequacy which is
currently analyzed on a subjective, bank-by-b ank basis?
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The issue of capital adequacy f or bankino oroanizati o ne
ia of great iaport. I have been supportive o f curre nt efforts
b y the r99ulatora to reexamine both the adequacy of minimum
capital requir'enients aa well as the various components of
bank capital.
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The Federal Reserve Board' a proposal, which was issued
for public coounent, vould limit the amounts of preferred
stock, mandatory convertible securit ies , and perpetual debt
that could be incllrled aa pritllary capital. The proposal waa
issued, at least in part, in response to a concern that
nceaeive reliance on these capital inatrumente might impair
an organization's financial flexibility were it to encounter
aerioua or- prolonged earnings difficulties.
The concern is an important one, but I have not yet
studied the apecific proposal. I an interested in learning
what the public cOaJnents are on this proposal, particularly
with respect to possible adverse effect ■ on amal l banking
companies that are closely held.
Finally, while the propoeal would establish greater
uniformity in the regulation of capital adequacy, I nonetheless
believe that examiner judgnent in aaaeaeino the adequacy of a
given institution's capital would continue to play an important
role.
Queation s
Should thi ■ co-itt•• uvhw the entire iaau• of the
•control• of bank ■, conaidering i ■ au•• ■ uch as what ■ o••
ar9u• au in effect caHa where then ii de facto control
by non-voting aecurity holden and holding coapany
cud1tora7
Ansver1
The applicability of the Bank Holding Company Act 1•
baaed upon a finding that a coapany has •control• of a
bank. For purpo ■ ea of that Act, a coapany has control of a
bank if -(A) th• coapany directly or indirectly or
acting through one or aore other persona owns,
controls, or haa power to vote 25 per centua or
aou of any chu of voting HCuritie1 of the bank
or coapany;
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(8) th• coapany controls in any aanner the
election of a aajority of th• diucton or
truauea of th• bank or coapany; or
c.:i
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(C) the Board deUrainea, afUr notice and
opportunity for hearing, that the coapany directly
or- indirectly exerciH ■ a controllin9 influence
ov•r th• aanageaent or policies of the bank or
co ■pany.
( 3) For the purpo ■•• of any proc•eding under
paragraph (2)(CI of thia 1ubHction, there ii a
preauaption that any coapany which directly or
indirectly ovna, control ■, or has power to vote
less than 5 p•r centua of any cla ■■ of voting
■ ecuritha of a 9iven bank or co ■pany do•• not
hav• control over that bank or coapany.
Th• r•deral leHrve Icard ha ■ iuued regulation, under
this provision of law to explain when, in th• loard•• view,
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2~:~i~~!) c~~-~~:u~:ldin
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: ; ~!:tt;o~:::t:!~~~t (
•controP under the Act. TheH n9ulationa are both
coaplex and controveraial . Th• question of •de facto
control,• therefore, aay well be an area that aerita
con9reaaional consideration.
H ~r~a~•
NOTls
above.
Attached au copha of both
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regulation ■
c1Ud
f 225.139
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validates transfers to which It appUes,
and In a creat many cues the Board
hu acted favorably on appltcatlona to
have the preaumpUon diapelled. It
I ZZS.139 PrnumpUoa or contlnUN con• merely provides a procedural opportutrol uftffl' Mdlon Zl1 )( 3) of tht Bank nity for Board conaideratlon of t.he
effect of 1uch transfers In advance of
HoldJn1 Company Act.
<a> Sect.Ion 2<&>< 3> of the B&nt Hold • their belnir deemed effective. Whether
Ing Company Act nhe " Act" > est.&b- or not the statutory preaumpt.ton
ll.sh ea a statutory presumption that a.rtae., the aubltantlve teat for uaeaawhere certain specified relationahlpa ln& the effectlveneaa of a dlve1tlture la
exist between a tr&n1feror and trana- the aame-that is, the Board muat be
feree of shares, the tranaferor <If It la uaured that all control relatlonahtpe
a bank holdlnr company, or a compa- between the tranaferor and the tranany that would be such but for the ferred propert)' have been terminated
tranafer) continues to own or control and will not be reestabllahed. •
<c) In the course or admln.laterin&
lndlrecUy the traneferred aha.res. 1
This presumption llriaea by operation section 2<1><31 t.he Board hu had aev•
of law, u of the date or the t.ranafer, er&l occaa.lona to conalder the 1eope of
without the need for any order or de- that section. In addition, queatlona
termination by the Boa.rd. Operation have been niaed by and with the
of the presumption may be tennlnat.ed Bo&rd'1 at&ff u to coveraae of the seconly by the luuance of a Board deter- tion. Accord.Jn&ly, the Board believes It
mination, alter opportunity for hear- would be useful to set forth the fol•
lns. "that the tranaferor la not ln fact lowlns lnt.erpretatlona of aectlon
capable of eontrolllna the tranafer- 2(&)( 3 ):
<1 ) The terms .. transferor" and
ee." •
lb) The purpoee of section 2<1><3> Ls " transferee," u used In section 2<1'X3>,
Include parenta and 1ubeid.Jarle, of
t.o provide the Board an opportunity
to uaeaa the etfectlvenesa of dlveatl• each. Thus, for example, where a
turea In certain aituatlona 1n which transferee la Indebted to a 1ubatd.lary
there may be a rt.st that the dJveatl• of the transferor, or where a epeclfted
t.ure will not reeult 1n t.he complete lnt.erlocklna rel&tlonahlp exlat.1 be·
termination of • control relatlonahip. tween the tranaferor or tramteree and
By Pffluminl control to continue u a a 1ubs1dlary or the other <or between
matter of law, aectlon 2<1><3> operates 1ublidlar1ea or each>. the preeumptlon
to allow the effectlveneaa of the dtve• &rlaea. Similarly, if a parent of the
tlture t.o be uaeaed before the dtvest- tra.nateree la Indebted to a parent of
lnc company LI permitted to act on the the transferor. the praumpUon ar1Ha.
uaumptlon that the dtveatlture la The preaumpUon or continued control
complete. Thua, for example, if a hold• a eo &r1aee where an Interlock. or debt
Ing company d.Jveat.l It.I bank1ns int.er• n.latlonahlp la retained between the
eat under clrcumat.&ncea where the dJveat1n1 company and the company
presumption of continued control beinl' divested, 1lnce the divested comarlaes, the d.lvesttns company muat
continue to consider It.self bound by
' It ahould be noted. however. that the
the Act untll an lll)proprlate order la Board
wtll req\llre t.erminaUon of utJ lnterentered by the Board dJapellinl the lockinl mana,:ement
relaUon,,hipa between
presumption. Section 2<r><3) does not the dlveatln1 compan)' utd the tramferee or
establish • aubatantlve rule that ln- the dJYat.ed COIDP&ll1' u a precondition of
flndlna that a dtYeatlture la complete. etml·
Wly, the retention of ut economic interest
'The preaumptlon ar1Rs where the trans- In the divested oom.pan7 that
would aw.te
feree "la Indebted to the tr&Nferor. or hu an in«ntlve for the dlveatlna
company to
one or more omcen. dlrecton, truawn. or attempt to influence
the manaaement of
beneficiaries ln common with or aubJect to the divested COIIIPUl7 wUJ preclude a llndcontrol b)' the tranaferor."
lna that the dlftlUture la complete. <See
'The Board hu delept.ed to It.a General the Board'• Order
the matter of "Int.er•
Counsel the a.uthor1t)' to Laue auch determl• national Bank", 11'1'1ln Federal
Haem Bullen&llona. 12 CPR 2U.2<b)( IJ.
tin 1101, 1113.1
f 225.139
pany wlll be or may be viewed u a
"subsidiary" of the transferee or
l"roup or transferees.
<2> The terms " officers," "directors,"
and " trustees," aa used In sect.ton
2<1' >< 3>, Include persons performln1
functions normally aaaoclated with
such poaltlons (lncJudln1 1eneral partners In a partnership and limited part•
nera havlna a rl&ht to participate In
the manaaeme nt of the affairs of the
partnership> u well aa persona hold·
Ina such positions in an advteory or
honorary capacity. The presumption
ulses not only where the transferee or
transferred company has an officer,
director or trustee "In common with"
the transferor, but where the transfer•
ee hirnaelf holds such a position with
the transferor. • It should be noted
that where a transfer takes the form
of a pro.rat.a d l..strlbutlon, or "spin•
off, " of shares to a company's share·
holden, officers and directors of the
transfe ror comp,-ny are llkely to re•
celve a portion or such shares. The
presumption of continued control
would, of course. attach t.o any shares
t.n.nsrerred to officers and directors of
t.he diveatln1 company, whet.her by
" splnoff" or out.rt1ht sale. However,
t.he presumption will be of lesal sl1niflcance-and wlll thus require an •P·
plication under aectlon 2<1)(3>-only
where the total number of shares 1ubJect to the presumption exceeds one of
the appUcable thresholds In the Act.
For example, where officers and directors of a one.bank holdln& company
receive In the assre1ate 25 percent or
more or the stock of a. bank aublldlary
beln1 dlveated by the holdln& company, the holdlna company would be pre•
eu.med to continue t.o control the .. diveated" bank. In such a cue it would
be neceaaary for the dlveatin& compa'It haa been auHest.ed that the worda "ln
common with" In aectlon 2c1 MJI evidence an
lntent to mate the presumption applicable
onl)' where the trana.fe:rff la a comJ1Gnr
h&vln1 an lnterJock with the: trana.feror.
Such an lnterpre:taUon would, In the
Board'• view, create an unwarranted pp In
the coveraae of aectlon 2c1 1<31. Furthermore. became the presumption cle&rl)'
arlaea where the trana.feree la an Individual
whO la Indebted to the tranareror auch an
lnterpret&Uon would result In an llloalcal Internal ~ , In the atatut.e.
12 OR Ch. N (1-1-15 Edlt;on)
ny to demonstrate that lt no lon1er
controls either the divested bank or
the officer/director transferees. How•
ever, If officers and direct.on were to
receive In t.he a1sreaate Jess than 25
percent of the bank's stock <and no
other shues were aubJect to t.he presumption>, sect.ton 2<1X3> would not
have the JepJ effttt or preau.mtn1 continued control of the bank.• In the
cue of a dJveatlture or nonbank
shares. an applJcation unl:ler section
2(11(3> would be required whenever of.
flcen and d.Jrectora of the dlveatln1
company received In the &&ll?'esate
more than 5 percent or the shares of
the company bein1 divested.
<3> AJthou1h aectlon 2<1)( 3> refers to
transfers of "shares" It Ls not, In the
Board 's view. limited to dlspoaltlon or
corporate •tock. General or Umlted
partnership lnteresta. for exampJe, are
Included within the term "shares."
Furthermore, the transfer of all or
substantially all of the aaaet.l of a company, or the tranafer of such a aiptlftcant. volume of uaeta that the transfer
may In effect conatltut.e t.he dl..spoaltlon of a separate activity of the com•
pany, ia deemed by the Board to Involve a transfer of "aharea" of that
company.
(4) The term " lndebtedneaa" &lvlnl
rtae to the preawnptlon of continued
control under section 2<&>< 3> of the
Act LI not limited to debt lncurred In
connect.Jon with the tra.nafer; ... Includes any debt outatandln& at the
time of transfer from the tra.naferee to
the tranaferor or It.a aubeidla.rlea. However, the Board believes that not every
kind of lndebtednesa WU Within the
contemplation of the Consreaa when
aectlon 2<&X3J was adopted. Routine
buaineu credit of limited amount.a and
loans for penonal or houaehold pur•
poses are irenerally not the kinda of lndebtedneaa that, standlnr alone, ,up.
port a presumption that the creditor la
able to control the debtor. Accordln&ly. the Bo..-d does not. reprd the presumption of section 2<1'X3) u appllca•or coune. the ract that aecUon 2cax1>
would not operate to preaume continued
control would not neceaarU.1 mean that
control had In fact been terminated If control could be exerclaed throu1h other
....
~
O')
companies have 10u1ht to make aubstantlal equity lnveltmen tl In other
bank holdlna companlea acrou state
llne1, but without obt&lntns more than
& per cent of the vottns aharea or control of the acqutree. Theae lnveetmentl Involve & combinati on of the
followtnr arranaeme nta:
<1> Optlona on, warrant.I for, or
rl1ht1 to convert nonvottna 1hara
Into aubatantla l blOCU of vottns ■ecu•
loam
atudent
UI>
;
rtttea of the acquiree bank holdlnr
vtdual tranateree
made tor the educatJon of the lndlvtdCOlttPUl)'.Or ltl • u ~ dbant(1):
U&l tranateree or a apouae or child of
ut> Merser or · · t &eQWIIUon
f ..tate bank
the tranateree: <HU a home mortcaae
aareemen ta with lhe o
tranlferee
lndlvtdual
y that are to
an
to
IO&n made
or, bank holdJn&.
the
for
for the purchue of a residence
ited Jn:~e event Intercolllliriun
be
1144)
lNl.
U.8.C.
<12
lndlvk:lual '1 penonal uae and secured
state b&nklnl II permitted;
uun,
by the realdence; and <Iv> loam made (U PR 1214. Peb. 14. ll'JI: 41 PRll'JI.
<Ill> Provlalona th4t limit or reetrtct
u
12,
to companies cu defined In aecUon Apr. 11 , ll'JI; 41 PR IHJI, Apr.
:,:~rlo ~:P~:~. acv:=u:o n:!f maJor policies, operattona or declllona
PR
45
lNO:
,
'I'
Peb.
nao.
PR
41
at
the
2<b> of the Act> ln an aa.-resate amended
a bank: That la, In the worda of
of
the acqultte; and ·~
of
amount not exceedlnr ten per cent of 11121. Peb. 20, 1NOJ
statute. "for any action to be taken
<iv) Provialona UtJt.i,.t:e acqut.atuon
the total purchue price <or Jf not aold,
that cauaea a bank to become a 1ubald•
trana•
12
<
...
the
of
company
value)
holdln1
market
bank
fair
a
the
iary of
f ~ property. The amount, and
U.S.C. 1842Ca><2n. Under the Act, a slble or economica lly lropractlca ble.
I Hl.143 Pollc7 statement on 11Gn•otht1'
terma of the precedlna cateaortet of
bank II a 1ubefdlary of a bank holdlns
e41ult1 ln•eat.enta t.y buk hoWI_,.
The various .1"tr.nn.tl, optlona, and
credit ahould not differ aublt&ntla lly
company If:
CGMptinln.
·; ~1e by the In•
rlehta &{t! ~
from almllar credit extended 1n compaCl) The company directly or Indirect•
<1) In recent
· company unJe11
on.
Introductt
Ca)
ve1ttna ban£'
are
who
power
othen
to
with
rable ctrcwmta nce,
ly owns, controla, or holds
of bank holdlns
·" permitted , but
_; ~
cent or more of the l n t e n t a ·-.t e
per
not tranafereea. It ahould be under- months, at number
25
vote
to
l
subltantl&
the lnveator
made
companJe have
may be
bank;
the
of
atood that. whUe the statutory preahl.NI
votlna
after the pu.
in & bank or bank
·
Imm
either
any
In
rola
cont
company
sumption In litu&Uona lnvolvinr theee equity Investment.a(the ••acqulree" ) Jc,.
The
(11)
company
the
holdln1
apply.
not
of
may
majority
credit
a
cate,ortea of
the
manner the election of
: : ~ ~ of
cated In states other than the home
Board la not precluded In an, cue
the board of d1recton of the bank; or
company
(2> Mter ;:., ·~u1 review of &
from H.amlninl ' the fact.I of a particu- state of the lnveattna
<HU The Board detennfne a, after
the
a,
arreement
dleee
throu1h acquLltuo n of preferred stock
,
of
number
he&rtna,
for
ty
lar transfer and flndJ.ns that the dlVN•
opportuni
nottce and
shares of the ac· tnveatmen tl In
tlture of control wu lneffecUve baaed or nonvottna common
that the company hu the power, dJ· Board ~lnei that
quiree. Because of the evident lnterat rect1y or indirectly, to exerct.ae a con• nonvot1n&.1tock. t.bsent other arnnaeon the ft.eta of record.
beand
tl
Act.
inveatrnen
the
In these types of
over the ma.nap. mentl, can;be conatatent with
Cd) Sectton 2<•><3> prov:ldel that. a
1ublltanUal queaUona trollinl Influence
bank. <12 Some , of the aareement a reviewed
Board detemun& Uon that a tranaferor came they raise Holdlnr
Company Act ment or poUde1 of the
under the Bank
appear conalltent with the Act llnce
ii not In fact capable of controuin . a
U.8.C. 11411d)).
ap1a
It
believes
Board
the
"Act">,
<the
oppor•
attuattona, the they art .Jlmlted ~veatm enta of rel•
transferee •hall be · made after
lntrutate
In
<2>
rel&l'd•
sutdance
In nonvottna
atlvely fflQCI~,
tuntty for hevin•. It hu been the propriate to provide
of auch arranaeequity that 1$u: •' m'li vottns equity
Board'• routine practice atnce 19M to Ina the conalltenc y
publiah noUce In the PcaAL Raoi:• mentl with the Act.
l{.....~ t e b&nk1na la author•
inl aubeldlarle a. However, where the
the
out
set.a
aectlon
1tatement
(2) Thia
na of appllc&Uona filed under
acqutree la located out.aide the home
lnveatlnvesttna bank holdlna · <3> ~owever, , other acreemen ta re-l
2<•><3> and to offer Interested partJea Board'• concerna with thae
the Board atate of the
aublt&nUa
an opportuni ty tor & hearln&, Virtual• ·. mentl. the conaideraU onadetermlnl
company, HCt1on 3Cd> of the Act pre• viewed by the Board ralle
na
In
y with the conaccount
comment.I
no
Into
take
will
uceptlon
ly without
venta the Board from approvtna any problem. of COnatat.encAct
conat.at•
are
tl
becaUN the
!
lnveatmen
the
appllc&•
whether
n that will permit a bank trol provtakJna of the
have been aubmltted on such
applicatio
pneral
the
or when
Uona by parties other than the appU. : ent with the Act. and
holdlnl comp&ny to "acquire, dlrect.ly Invest.on. uncertain whether
,
any votlna shares of. In• Intent.ate banklna m&J' be authortaed
cant and, wtth the exception of one · acope of arnnaem enu to be avoJded
. The or Indirectly,all
or aublt&ntla lly all of have evidently eou1ht to uirure the
cue 1n which the request was later • by bank holdlna companies
tereet In, or
y
compleir.tt
the
re•
ta. prethat
been
lnv•tmen
have
·
Bo&rd recosnlza
withdrawn , no heartnp
of an, additional bank." c12 aoundneu of tbelr
auetl
the
nu
for
of Jeatttmate buatneu arranaeme
vent ta.teoven- by ~en. and allow
queatecl in auch cues. Becauae the
U.8.C. 1142<d)(l) ),
to cover
Board believes that the heutns provl• precludee rlsld rules dealpect
(C) Rev1no of ~ t , . Cl> In ap~.t ~ C X :
all altuatlona and that dec:illona relion In aectlon 2<&><3> wu intended u
parent expectaUo n of statutory . ~~tl~~t
of
ablence
or
are
who
exlltence
the
nrdlna
mate lntentate chotce: In ~e event a third party ot,..
a protection for applleanta
cue must chan,es that mtahte, bank: holdlna talrw c;pntrol of the acqulree or the In·
aeetlna to have the praumptl on over• control In any p&rt.Jcular
permiulbl
ban.tins
the
come by a Board order, a he&r1n1 take Into account the effect of
ble to the followlns catesort"ea of
credit.. provtded the extenaion1 of
credit are not aecured by the tnnaferred property aild are made ln the
ordinary coune of buslne11 of the
tranateror <or Jtl aubaldiar)'> that 1s
re,ularly enp,aed 1n the buatnea of
ext.endlna credit:
m Conaumer credit extended for
penor.al or houeehold uae to an lndJ-
would not be of uae where an applic&·
tlon 1a to be aranted. In llaht of the
upertence lndtc:atJns that the publlca•
Uon of Pl:DSUL R•nnn notice of
auch appUcaUona hu not Nrved a
uaetul PUJ"P(lae, the Board hu decided
to alter ltl procedure a ·in auch cue&. In
the future, Pl:Da.u. Raoi:na notice of
aectJon 2Ca><3> appllcatJo na wW be
pubUahed only In CUN in which the
Board'• General CoWIHI, act1na under
delented aut hority, hu determine d
not to arant 1uch an applicatio n and
hu referred lhe matter to the Baud
tor dect.alon. •
combinati on of provlalona and COY•
enanta In the aarreemen t u a whole
and the parttcular fact.a and clrcum•
1t&nces of each cue. Neverthel eu, the
Board bellevet that the facton out•
lined In thll atatement provide a
framework for 111ldln1 bank holdln1
companies in compJylna with the re•
qulremen tl of the Act.
<b> Statuto111 and Fl!O"Ulato,w- J)TOv1 •
aio,u. <1> Under aectton 3Ca> of the
Act, a bank holdlna company m&Y not
acquire direct or tndlrect ownenhlP or
control of more than 5 per cent of the
votJna shares of a bank without the
Board's prior approval. <12 U.8.C.
1842<a><3)). In addttton, thla aectlon of
the Act provides that a bank holdlns
~~~ b~~~ ~~1u::-i:n~
~~:n: upon
0
<g
N
g:
~
C")
0
~
n
=~:=~~c111:::8:;c:
~
:!r..
~~: .!
....
~
f 225.143
veator otherwile becomes diaaatla fled
with !La Investment. Since the Act pre•
eludes the ln,eaton from protecting
their lnveatmentl throush ownenhlp
or uae or votlns ahues or other exer•
clae of control, the invest.on have sub•
at.ltuted contractual ureementa for
rlshte norm&lly achieved throu1h
votln&aharea.
( 4J For example, varloUI covenant.I
In certain of the qreemenLI seek to
the contlnuln& aoundneu of
the investment by aubetanUally limit•
lnc the d.llcretlon of the acqulree'a
UIW't
manacement over major poUclea and
declllona, lncludlna restrlctlona on entertn1
Into new banldn1 KtlvlUes
without the ln•eator'a approval and requirement.I for extensive conaultatlon.s
with the investor on financial matt.en.
BJ their t.errm, the.e covenant, au11eat control by the tnveatlnl' company
over the manacement and policies of
the acqulree.
<&) Slmllarly, certain of the a,rtt•
menta deprive the acqulree bank hold·
lns company, by covenant or becauae
0
'fu
N
~
~
(')
0
~
n
of an option, of the rlaht to aell. trana•
rer, or encumber II m&Jortty or all or
the vot.lna ,hares or It.a sublldlary
bank<•> with the um or ma.lnt.alnlna
the 1ntet"rltY or the lnve,t.ment and
prevent.In& takeovers by others. These
Ions-term reatrtctlons on v0Un1 aharea
fall wU.hln the preaumptlon In the
Board'• Resulatlon Y that attributes
control or shares to any company that
enters Into any ac,eement placln1
lone-term reat.rtctlona on the rt1hta or
a holder or vot1n1 aecurltle,. (12 CFR
220.2(b>C4 )).
<I> Finally, Investors wtah to rea,erve
the rt1ht to aell their optlona. warrant.6 or rl1ht.1 to a per10n or their
choice to pre'fent belnl locked Into
what may become an unwanted lnveatment. The Board hu taken the poel t.Jon that the ability to control the ultimate diapaalUon or vot.1n1 , hares to a
per10n or the tnveator'a choice and to
aecure the economic beneflll there•
rrom Indicates control of the ,hares
under the Act.' Moreover, the ability
to transfer rl1hLs to Jarse block.I or
votln, shares, even tr nonvotlna In the
hands or the tnveat.ln1 company. maY
'Sff Board letter dated M&f'C'h II. IH2. to
c . A . Cavendes. Bocl~ Financier&.
12 CR Ch. N (1•1.-S I d - )
re,ult 1n auch a subltantlal poeltlon or
levera,e over th e manaaement or t.he
acQulree u to involve a structure that
Inevitably ruuUa In control prohibited
by the Act.
<d> Provuio,u that auo(d control. <1 J
In the context or any particular acreement. provl.tlona or the type deacrtbed
above may be accept.able tr combined
with other provlalons that aerve to
preclude control . The Board believes
that 11uch aareemenll wtu not be consiat.ent with the Act unleu provl.alons
are included that wlll preaerve man•
aeement's dlacretlon over the pollcln
and declalona or the acquiree and
avoid control or votln1 ahuea.
<2> As a flnt atep towards avoldln&
control, covenant.a In any asreement
should leave man&a"ement free to con•
duct ban.kins &nd permlaalble nonbanklnl' activities. Another step to
a\/0id control la the rlsht or the acqulree to "call" the equJty lnvettment
and opt.Ions or warrant.I to uaure that
coven&nt.a that may become Inhibit.in&
can be avoided by the acquJree. Thia
rl1ht makes such lnveatmenta or
..-reementa more like a loan 1n which
the borrower hu a rt1ht to eacape covenants and avoid the lender·, 1nnuenoe by prepaytn1 the loan.
<3> A meuure to avoid problems or
control arls1ns throu1h the lnveator'a
control over the ultimate dlapoaltlon
or rt1ht.a to sublt.ant.1111 amount.I or
votln1 shares or the acqulree would be
a pro\llslon sn.ntlna the IICQUlree 11
rtaht or rtrst refuaal. before warrant.a,
options or other rtshta may be aold
and requlrin& a public and dLlperHd
dl.at.rlbutlon or theae rtahta If the rl1ht
or (lrat reruaa.I I.a not exerclaed.
(4) In this connection, the Board believes that acreementl that Involve
rt1hta to leu than 2$ percent or the
votln1 share,. with a requirement for
a dllpersed public dl.atrlbutlon In the
event of sale, have II much 1Teater
pro,pect. or achlevtn1 con.Latency with
t.he Act than qreementa lnvolvln1 a
areater percent.ace. Thi.a 1Uldellne la
drawn by analOIY from the provlalon
In the Act that ownenhlp or 2$ percent or more or the vot.ln1 aecurttlea or
a bank con1tltutea control of t he bank.
<6> The Board expect.a that one
effect of thla 1uldellne would be to
hold down the alze or the nonvotln1
f - • - • Syale•
equity lnveatment by the lnveatln&
company relative to the acqulree'a
total equity, thus avoldlna the potent.ta.I ror contrc:;l becau.e the investor
holds a very lu1e proportion or the
acqulree's total equity. Obaervance of
the 25 percent suldellne will allO mall.e
provlllona in a,reementl provldlnl tor
a rt1ht of first refuaal or a public and
widely dlaperaed orrertna or rts'hta to
the acqulree'a aharea more practical
and reallatlc.
<I) Finally, certain arranaementa
■hould clearlY be avoided resardlea or
other pro\11.tlona 1n the aareement that
are deaisned to avoid control. The.e
or,:
(I) AsreemenLs that enable the Jnveattna: bank holdJn1 company <or It.a
dealsnee> to direct in any manner the
votln& of more than 5 per cent of the
votlna aharea of the acqulrff;
(II) AsreemenLs whereby the lnveatlns COlllP&flY bu the richt to direct
the &CQuiree'a u,e or the proceed.I of
an equity lnveetment by the lnve■ttns
company to effect. certain act.Iona.
auch u the pun:bue and redem.ption
of the &0Qu.lree'1 voUna ■hares: and
<W> The acqulltUon or more than &
per cent of the votl.na ah.ares or the acqutree that "almultaneoUlly" wtth
thelr acqullltlon by the invest.Ina company become nonvotln& aha.rel, remain
nonvottns ■hares while held by the ln•
veator, and revert to vottna: aharea
when tranaferred to II third party.
<e) Retriftl by tM Bocint. Thll statement does not consUtute the excluatve
ecope of the Board'• concern,, nor are
the coml.der&tlons wtth reapect to control outlined 1n th1a 1tat.ement an eshaUIUve e&taloc of permla■ible or lJn.
perm.llltble arransementa. The Baud
hu Instructed tLs ataff to review aareementl of the kind dlacuued 1n thl■
1tatement and to brtnl' to the Board'•
at.tent.Ion thoae that ralle problem, of
consistency with the Act. In tht■
reaant. companies are requested to
notify the Board of the Lenna or auch
propoaed mer1er or auet acqulaltlon
aveemenLs or nonvottns equity In•
veatmenll prior to their execution or
consummation.
[47 FR JotN. July It, IN2J
.....
I:.:)
00
@FedFRASER