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v.285

U.S. DEPT. OF THE TREASURY

PRESS RELEASES

TREASURY NEWS
deportment of the Treasury e Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON
April 1, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for approximately $8,750
million of 364-day Treasury bills
to be dated April 14, 1988,
and to mature April 13, 1989
(CUSIP No. 912794 RS 5 ) . This issue will result in a paydown for
the Treasury of about $1,050 million, as the maturing 52-week bill
is outstanding in the amount of $9,790
million. Tenders will be
received at Federal Reserve Banks' and Branches and at the Bureau
of the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m.,
Eastern Daylight Saving time, Thursday, April 7, 1988.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. This series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for
Treasury bills maturing April 14, 1988.
In addition to the
maturing 52-week bills, there are $13,959 million of maturing bills
which were originally issued as 13-week and 26-week bills. The disposition of this latter amount will be announced next week. Federal
Reserve Banks currently hold $2,350 million as agents for foreign
and international monetary authorities, and $6,097 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. Tenders from Federal Reserve Banks for their own account and as agents for foreign
and international monetary authorities will be accepted at the
weighted average bank discount rate of accepted competitive tenders.
Additional amounts of the bills may be issued to Federal Reserve
Banks, as agents for foreign and international monetary authorities,
to the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. For
purposes of determining such additional amounts, foreign and international monetary authorities are considered to hold $66
million
of the original 52-week issue. Tenders for bills to be maintained
on
the book-entry records of the Department of the Treasury should
B-1356
be submitted on Form PD 5176-3.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
10/87
the Public Debt.

TREASURY NEWS
apartment of the Treasury • Washington, D.c. e Telephone 566-204
FOR RELEASE ON DELIVERY
EXPECTED AT 9:30 A.M.
March 31, 1988
STATEMENT OF THE HONORABLE CHARLES 0. SETHNESS
ASSISTANT SECRETARY OF THE TREASURY (DOMESTIC FINANCE)
BEFORE THE SENATE COMMITTEE ON SMALL BUSINESS

Mr. Chairman and members of the Committee, I am pleased to
be here today to discuss S. 1929, the "Corporation for Small
Business Investment Charter Act."
S. 1929 would create a Government-sponsored private
Corporation for Small Business Investment, COSBI, that would
serve as a secondary market and warehousing facility for loans
to and investments in Small Business Investment Companies. The
bill would also establish a special small business investment
companies (MESBIC) trust. The MESBIC trust and COSBI would
operate a special SBIC subsidy program similar to the current
Minority Enterprise Small Business Investment Company program.
We strongly oppose S. 1929. As Secretary Baker indicated
in his October 1, 1986 letter to your Committee concerning a
similar COSBI proposal, we generally are opposed to the creation
of a new Government-sponsored enterprise. While S. 1929 has been
described as a privatization measure, COSBI would not be a truly
private enterprise, and its receipts and outlays would be
included in the budget totals for the indefinite future.
The proposed "private" COSBI would assume the current role
of the Small Business Administration in financing SBICs, and
would do so with strong Federal financial backing as well as
other benefits-typically afforded to Federal agencies. At the
same time, however, COSBI would not be subject to the same level
of oversight and control of its spending, borrowing, lending and
other activities as are SBA and other Federal agencies. Thus,
COSBI may consider itself free to dissipate its resources in the
belief that Congress, as in the recent Farm Credit System
example, may take supportive action.

.1357

- 2 To finance its activities, COSBI would be authorized to
issue voting common stock that SBICs would be required to
purchase; non-voting common stock; preferred stock; warrants
to Treasury that would be convertible into common stock; senior
debt obligations to the public and the Treasury; subordinated
obligations to the public; and participations or pooled interests
in its assets, including assets guaranteed by SBA. Although the
authority to borrow from the Treasury has been described as
a backstop for COSBI's financial obligations, the bill contains
no restriction on the use of the borrowing authority. Thus,
COSBI could borrow from Treasury for any of its authorized
purposes, including salaries and administrative expenses.
We are particularly concerned that only the issuance of debt
obligations would be subject to the approval of the Secretary of
the Treasury. All other forms of COSBI's direct and contingent
liabilities, however, would not be subject to Treasury approval.
Thus, by simply changing the designation of a financial
instrument from "debt" to "participation," the Corporation could
escape the Treasury approval requirement, with potentially
disruptive consequences for the market for Federal and federallyrelated securities, and the debt-to-equity limit. We also note
that the aggregate amount of debt obligations issued under the
bill would be limited to 15 times COSBI's capital, unless a
higher ratio is established by the SBA. Even if applied to all
direct and contingent liabilities, this debt-equity ratio is
extremely high, particularly in light of the approximate 1-out
of-3 default experience under the existing SBIC program. This
will increase the likelihood of a future congressional rescue.
Given the high default experience under the existing SBIC
program, we would not expect COSBI to perform as well as Fannie
Mae, with its 50-year long track record in the secondary mortgage
market, and Sallie Mae, the assets of which are guaranteed by
State agencies with Federal backing.
COSBI's initial asset base would be backed by the full faith
and credit of the United States. No later than October 1, 1988,
the Secretary of the Treasury would be required to sell to COSBI
the Federal Financing Bank holdings of SBA-guaranteed SBIC
debentures, which would continue to be guaranteed by SBA after
sale. The final purchase price of the debentures could not be
less than $720 million, irrespective of the value of the FFB
holdings on the date of sale. This would result in windfall
gains or losses to the FFB and COSBI, depending on market
conditions at the time of sale. Moreover, the FFB would receive
only about half of the proceeds of the sale in cash. Immediately
upon sale, $150 million of the proceeds would be transferred to
the MESBIC trust outside of the normal budget/ appropriations
process. An additional $200 million would be in the form of
COSBI preferred stock. Dividends on preferred stock would be

- 3 used to augment the resources of SBA's existing Business Loan and
Investment Fund, also outside of the normal budget/appropriations
process.
If the proposed sale of FFB holdings of SBIC debentures were
to take place, it should be in accordance with the procedures
followed in the Administration's loan asset sales program. Under
such procedures, SBA would purchase the debentures from the FFB
at a market price in accordance with existing contractual
agreements with the FFB. The loans would then be sold by SBA to
the COSBI without recourse. Thus, the costs associated with the
transaction would be reflected on the books of SBA, the program
agency, and not on the books of the FFB, the financing
intermediary. In this way, proper program cost accountability
would be achieved. Such accountability is a primary tenet of
the Administration's credit reform proposal.
The above procedures were followed by the Farmers Home
Administration in its sale of community development and rural
housing loans in 1987. These sales were made on a nonrecourse
basis. The Administration is firmly committed to nonrecourse
sales of loan assets. Although the Government would receive
higher proceeds at the time of sale if the loans were guaranteed,
these additional proceeds would be offset in the future as
defaults on the guaranteed loans occur, resulting in Federal
payments under the guarantee contracts.
The MESBIC trust, which would be under the control of four
industry representatives and one presidential appointee, would
receive SBA's existing portfolio of MESBIC preferred stock and
debentures without compensation to SBA. While the value of this
giveaway cannot be determined in advance, the subsidy undoubtedly
will be measured in billions of dollars when a final accounting
is made following the redemption of all preferred stock and
debentures.
The trust would be used to cover losses on MESBIC debentures
purchased or guaranteed by COSBI, to buy down interest rates on
MESBIC debentures, and to purchase MESBIC preferred securities.
Since COSBI's losses on its purchases or guarantees would be
covered by the trust, there would be little incentive for
COSBI to scrutinize the credit worthiness of MESBIC issuers.
Moreover, although the trust corpus would revert to the Treasury
at the end of the trust's 50-year life, there is little reason
to believe any amounts would be returned to the Treasury because
the trust would be controlled by industry representatives.

- 4 Under existing budget scoring rules applicable to
government-sponsored enterprises, COSBI's receipts and outlays
would be included in the Federal budget. Thus, the absence of
Administration and Congressional controls over the spending
activities of COSBI will only exacerbate the problems of budget
control and deficit reduction.
In view of the foregoing, the Department is strongly opposed
to S. 1929, and would recommend that the President veto S. 1929
or any similar legislative proposals.
This concludes my prepared statement. I will be glad to
answer any questions you may have.

o 0 o

TREASURY NEWS
apartment of the Treasury e Washington, D.C. e Telephone 566-2041
FOR I M M E D I A T E
March 4, 1988

CONTACT:

RELEASE

O f f i c e of F i n a n c i n g
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,414 Billion of 13-week bills and for $6,409 million
of 26-week bills, both to be Issued on April 7, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average
a/ Excepting
b/ Excepting
Tenders
Tenders

13-week bills
maturing July 7, 1988
Discount Investment
Rate
Price
Rate 1/

26-week bills
iturlng October 6, L988
Discount Investment
Rate
Rate 1/
Price

5.96%a/
6.14%
98.493 :
6.20%b/
6.49%
96.866
5.99%
6.17%
98.486 :
6.21%
6.50%
96.861
5.98%
6.16%
98.488 :
6.21%
6.50%
96.861
1 tender of $1,840,000.
1 tender of $1,450,000.
at the high discount rate for the 13-week bills were allotted 41%.
at the high discount rate for the 26-week bills were allotted 76%.

Location

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury

$ 30,180
$ 30,180
25,108,290
5,677,985
16,235
16,235
35,465
35,465
35,065
35,065
35,510
35,510
1,209,175
47,355
17,565
17,565
7,575
12,575
35,385
35,385
35,955
25,955
73,230
942,780
376,275
376,275

$ 27,980
29,223,250
12,520
28,035
24,240
20,690
986,300
11,590
12,790
40,510
41,105
893,275
538,320

$ 27,980
5,570,420
LI,520
23,035
24,240
20,690
53,750
11,5 90
7,790
40,5L0
31,105

TOTALS

$27,890,455

$6,414,330

S31,360,605

$6 .409 225

TZpe
Competitive
Noncompetitive
Subtotal, Public

$24,589,940 $3,113,315
1,004,285
1,004,235
$25,594,225
$4,118,100

327,433,600
995,100
$28,478,700

$2 ,032 ,220
995 LOO
$3 ,027 ,320

2,240,735 2,240,735

2,050,000

•s

1,331,905

1,331 ,905

Federal Reserve
Foreign Official
Institutions
TOTALS

55,495

327,890,455

$6,414,330

331,360,605

4 j

_/ 0

538 320

,050 ,000

36,409,225

An additional $32,705 thousand of 13-veek bills and an additional $bo3,395
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield

B-135S

TREASURY NEWS
epartment of the Treasury e Washington, D.c. e Telephone 566-2041
TEXT AS PREPARED
FOR RELEASE UPON DELIVERY
EXPECTED AT 7:00 P.M., E.D.T.
Remarks by
The Secretary of the Treasury
James A. Baker, III
at the 1988 Annual Meeting of the
Business and Industry Association
of New Hampshire
Center of New Hampshire/Holiday Inn
Manchester, New Hampshire
It is a great pleasure
forApril
me to 4,
be 1988
here this evening.
Monday,
New Hampshire has a long tradition of citizen involvement
with politics. I am sharing a table tonight with a Governor who
has been an educator, an engineer, and a small businessman; a
House Speaker who owns both a dairy farm and an Agway; a Senate
President who has owned both a real estate company and an
insurance agency; and a Congressman who is a lawyer. Any
government that is representative of so many dimensions of
American life is one that surely must serve its citizens well.
I am no newcomer to New Hampshire. In 1980, I spent more
time here than in my home state of Texas. And I have been back a
number of times since then.
Of course, New Hampshire has not only been on the leading
edge of America's presidential campaigns, but also on the leading
edge of the longest peacetime economic boom in America since
records have been kept. And I suspect that many of the people
who provided the inspiration for the great .economic revival in
America are sitting in this room tonight.
So I am grateful to Bill and my good friend Bonnie Newman for
giving me a chance to talk with you about one of my favorite
subjects — the Administration's record of providing an
environment for domestic economic growth and a forum for
international economic cooperation; or to put it more simply, the
facts about where we were in 1980, where we are today, and where
we are going in the months and years ahead.

B-1359

-2It wasn't so long ago that Americans were told that they were
suffering from a great malaise, and that they had every reason to
be despondent about the future.
When the Reagan Administration took office in January 1981 we
inherited a pretty sorry state of affairs. The prime interest
rate stood at 20 percent; we were mired in crippling,
double-digit inflation; productivity was in a slump; and — worst
of all — the American people were discouraged and disheartened.
I think the story of our economic recovery — and I might
add, the recovery of our national spirit — is an inspiring one.
Our progress, like any steady progress, has come in small
steps. It is real progress, it is measurable, and while our
critics don't like to hear it, it is making the United States
more competitive.
As I'm sure all of you know, competitiveness has become a
popular buzzword back in Washington. But in fact, since 1981 the
overall U.S. economy has become quite competitive — if by a
competitive economy we mean a growing economy that creates jobs
without inflation.
Now, we're painfully aware of economic problems in some
industries and in some parts of the country, and we're working
hard to overcome them. But I think you will agree with me — and
certainly the evidence in New Hampshire shows — that things are
getting better.
Record Growth and Low Inflation: Highlights
Let me give you a few highlights:
America's economic recovery began in 1982 — 65 months ago.
Since then, the U.S. has had one of the fastest growing economies
in the industrial world. Growth has averaged 4 percent a year.
That's slightly faster than Japan's growth and much faster than
Europe's. As I mentioned earlier, this expansion is the longest
peacetime period of growth since we began keeping records. And
that was before the Civil War!
I'd like to think that the landmark tax cuts for the American
people have had something to do with all this. New Hampshire has
been a good role model for tax reformers. It is no accident that
this state, which has one of the nation's lightest tax burdens,
is also one of the fastest competitors in the race for economic
growth. Yet, in 1980, who would have thought that low tax
regimes were the wave of the future? In 1980, when the top
federal rate was 70 percent, who would have thought that it would
be reduced to 28 percent before Ronald Reagan left office
particularly when you consider that one house of our federal
legislature was dominated by members of an opposite political
persuasion.

-3A low tax rate was not the only impossible dream in 1980. So
was a low inflation rate. When was the last time we've had an
economic expansion with a low rate of inflation? I know you all
remember inflation — it was economic enemy Number One I Nobody
felt that it could be controlled. The key wasn't to control
inflation; it was simply to survive it.
But during this latest expansion, the U.S. inflation rate has
averaged less than 4 percent. That has been a truly remarkable
achievement.
And this expansion has been accomplished in the face of
almost monthly predictions of gloom. The "wheels were coming
off," the critics said; the economy was going into the tank.
But the economy didn't go into the tank — in part because
interest rates came down and stayed down. The prime rate has
declined nearly a dozen points from the rate we inherited that
cold January 20, 1981, when we walked into the West Wing of the
White House. And that's been a big help to young couples
struggling to buy that first home, or families hoping to
refinance a mortgage.
Ladies and gentlemen, the American economy has also become
the job-creating envy of the world. Since 1982, America's
unemployment rate has fallen by more than five points — to
5.6 percent. We have created more than 15 million jobs since
1982, more than all of Europe and Japan combined.
At the end of last year, the percentage of the working-age
population that was employed was at an all-time high — 62.3
percent. In fact, that may be your greatest concern. So many
Granite Staters are employed in productive jobs that I understand
that you are having a difficult time trying to find available
workers for all the new jobs you are creating.
I'd also like to correct a bit of economic mythology on this
subject of jobs. You may have read reports that suggest that in
creating jobs our economy is merely trading steel workers for
hamburger flippers.
Well, the facts show otherwise. U.S. manufacturing
employment has remained remarkably constant over the past
20 years. Last year, in fact, employment in manufacturing rose
by 407,000.
And these 15 million new jobs are for the most part good,
productive jobs. Yes, many of these new jobs are in the service
sector, but nearly two-thirds of the new employment growth has
been in managerial, professional, technical, sales or
precision-production occupations. (And anyway I find it more
than passing strange to argue that we were somehow better off
without those so-called "inferior" jobs in the service sector and
the paychecks they generate. I doubt if the holders of these
jobs would agree.)

-4Furthermore, these basic industries are not the "bedraggled
dinosaurs," as commentators have alleged in recent years. In
fact, manufacturing productivity has been growing at a rate of
almost 4 percent a year since we came to office. That's nearly
twice as fast as the average of the previous three decades.
Many of our basic industries will get an added boost from a
more recent trend. Personal consumption has eased somewhat, and
in its place, both investment and export-driven manufacturing
industries are picking up steam. Our manufacturing plants have
boosted their productivity; the U.S. dollar has declined in the
last three years, making our products and services more
competitive in foreign markets; and foreign governments have
adjusted their economic policies, allowing faster economic growth
and greater demand for products from abroad.
American businesses are achieving unquestioned
price-competitiveness in many places across the world. Recently,
for example, America's production of steel has increased by a
third from a year earlier. And we are now even exporting steel
to Japan — the modern-day equivalent of sending "coals to
Newcastle."
The outlook for U.S. trade and industry has also been
brightened by advances in international coordination. Three
recent agreements made by the major industrial countries are
paving the way for a better-balanced world economy and hence,
additional export-led growth for the United States.
The U.S. has agreed to further curtail its deficit spending;
Japan has agreed to pursue economic policies to sustain strong
domestic growth; and Germany has taken measures to improve
growth, including advancing tax cuts and providing additional
investment incentives.
The world is just starting to benefit from these efforts at
cooperation. The U.S. is just beginning to benefit from
unprecedented trade opportunities. So we could not pick a worse
time to resort to protectionism. Yet some in Washington would
propose just that.
A House-Senate conference committee is now considering a
major Trade Bill. The members of that committee are no doubt
mindful of the lessons of the 1930 Smoot-Hawley tariff. They
surely know that nothing would more likely close foreign markets
than legislation that closes our own markets. Fortunately, the
conference committee has taken steps to clear away some of the
most flagrant provisions. But there is still a great deal of
work to do.

-5And we are continuing to work with the Congress to craft a
responsible trade bill. But the President will veto any bill
which is protectionist.
The kind of trade bill we need is one that would increase
U.S. competitiveness and open up markets for our exporters. The
proposed Free Trade agreement with Canada — our largest trading
partner — offers opportunities for all regions of our nation.
With your proximity to Canada, you clearly have a stake in
the success of this treaty. It would eliminate all tariffs
within ten years. It breaks new ground for lowering barriers to
trade in the service, investment, and technology sectors. And
that last area should come as good news to New Hampshire's
growing high technology industry.
We Must Continue Progress on Budget Deficit Reduction
If I were to summarize the economic record of the Reagan
years, I could do it in a few words: more economic growth, more
jobs, and more productivity; lower inflation, lower interest
rates and lower tax rates.
I don't mean to sound like there are no problems out there —
no challenges left. You and I know that's not the whole story.
We have some serious challenges left, and two major ones that I'd
like to touch on are the U.S. budget and trade deficits.
The future of our economy depends on continued reduction of
the budget deficit. In fiscal year 1987, the deficit dropped
from $221 billion to $150 billion. That's a significant drop.
It's equal to almost 2 percent of the Gross National Product.
What's more, after adjusting for inflation, Federal spending
actually fell in FY 1987, the first such decline in 14 years.
And the Administration and Congress have agreed on an additional
$76 billion in deficit reduction for 1988 and 1989. This will
take our federal deficit down to 2.6 percent of GNP.
The process is now firmly in place to bring the deficit down
to $23 billion in FY 1993. That's just 0.4 percent of the
projected GNP, a huge drop from the 1983 budget deficit, which
was 6.3 percent of the GNP.
And these deficit reductions will be accomplished without any
major new tax proposals.
After the Tax Reform Act of 1986, we want to give individual
taxpayers some breathing room, a chance to adapt. We must not
let taxpayers be whipsawed by a tax law that is continually
changing. Businesses as well as individuals require a stable tax
environment in order to make sensible economic decisions. There
are no more important ingredients to sustained economic growth
than low tax rates coupled with the promise of certainty.

-6But taxes aren't the source of the budget deficit anyway.
The American people, simply put, are not undertaxed — the
government has overspent. I think most of us would agree —
and recent history supports us on this.
Over the last quarter century, since 1964, federal taxes have
usually taken up from 18 to 20 percent of GNP. So did federal
spending — until the mid-seventies. Then spending really began
to soar relative to taxes.
In the last seven years, for example, average spending has
exceeded the average of the previous 15 years by 3.5 percentage
points of GNP. Our current budget aims to have spending down to
below 20 percent of GNP by 1992 — the level where taxes have
been all along. The focus of deficit reduction must continue to
be getting a handle on spending — not raising taxes.
The second major problem, the trade deficit, is showing
definite signs of improvement. In the third quarter of 1986, the
merchandise trade deficit in volume terms was at its widest.
Since then, the real volume of our merchandise exports rose at an
annual rate of 19 percent while imports increased at a rate of
only 4 percent. In fact, improvement in the real merchandise
trade balance has accounted for fully one-fifth of the growth of
real GNP, since the third quarter of 1986. And in nominal terms,
over the last several months the trade deficit has also been
trending smaller.
Conclusion
Sure, our economy has some problems; but we must recognize
how far we have come from the more serious problems of the late
1970s. We must continue to build on our progress in deficit
reduction and international coordination. We must keep taxes
low, rationalize regulations, and press forward in our efforts to
return economic opportunity to the American people — whose
talents are the true wellspring of our national strength.
And speaking of our national strength, I'm reminded of a
story our President likes to tell...
It has to do with the fellow who bought some creek-bottom
land. It was all covered with rocks and brush. And he
cultivated, and he fertilized, and he planted. And he had a
garden spot. And one day at church, he asked the preacher if he
wouldn't, after church, come on out and see what he'd done.
Well, the Reverend got out there, and he looked at that corn.
And he said, "I've never seen such corn. My," he said, "how the
Lord has blessed this land. Those melons — I've never seen
anything so big." He said, "God has certainly been good to this
place here." And he went on that way, and the farmer was getting
a little fidgety. And finally, he says, "Reverend, I wish you
could have seen it when the Lord was doing it by Himself."

-7The point of this story is: God gave us this great land.
(And when you travel abroad as much as I do, you really
appreciate the blessings of being an American.) But it really is
up to us to make America produce, to make it flourish, to make it
grow in greatness. In that way, we can pass on our great legacy
of freedom and economic opportunity to our children and to their
children.
And my friends I am supremely confident that we will do just
J
that!
Thank you very, very much.

rREASURY NEWS

partment of the Treasury e Washington, D.C. e Telephone 566-2
FOR IMMEDIATE RELEASE CONTACT: LARRY BATDORF
April 5, 1988
202/566-2041
CHANGES ZN THE DISTRIBUTION OF FEDERAL INDIVIDUAL INCOME TAX PAYMENTS
SINCE 1981
Preliminary data from 1986 individual income tax returns rtvtal
that higher-income taxpayers are paying an increasingly larger share
of Federal individual income taxes.
Percentiles drawn from Internal Revenue Service Statistics of
Income data show that the top one percent of taxpayers paid
26.1 percent of all Federal individual income taxes paid in 1986, a
r substantial increase from the 21.9 percent share the top one percent
paid in 1985.
* The 1986 increase reflects in part the continuation of a long
term trend. The share of taxes paid by the top one percent had
increased by 21 percent between 1981 and 1985, from 18.1 percent
to 21.9 percent.
* The 1986 increase also reflects the extraordinary level of
capital gains realized in 1986 in anticipation of the 1987 rate
increase on capital gains. The portion of capital gains subject
to tax (40 percent from 1961 through 1986) represented nearly
25 percent of the adjusted gross income (AGI) of top income
taxpayers in 1986, but only 15 percent in 1985 and 11 percent in
1981. For other taxpayers, taxable capital gains represented
less than two percent of AGI in all three years.
The percentage increase in the share of taxes paid by the top one
percent of taxpayers closely matches the percentage increase in their
share of AGI. Both income and tax shares for the top one percent of
taxpayers increased by about 45 percent between 1981 and 1986.
The increasing share of taxes paid by high-income taxpayers is also
reflected in data by income category.
* Between 1985 and 1986, taxes paid by taxpayers with AGI of
$100,000 or more (about 1.2 percent of all taxpayers) increased
by $38.1 billion, from $77.3 billion to $115.4 billion. This
one-year increase was larger than the total increase between
1981 and 1985 for this group of $34.1 billion (from
$43.2 bilUon to $77.3 billion).
* Lower- and middle-income taxpayers, those with AGI under
$50,000, received a net tax cut between 1981 and 1986 of
over $17 billion.
* Data by income category in part reflect the effects of inflation
and real productivity pushing taxpayers into higher income
categories. The percentile data correct for inflation and
productivity, and therefore are more meaningful.
More comprehensive data by income category will appear in the next
Statistics of Income Bulletin. The attached table provides additional
data by percentiles and income category on the share of Federal
R.I 3*0individual income taxes paid in 1981, 1985, and 1986.

CHANGES IN THE DISTRIBUTION OF
FEDERAL INDIVIDUAL INCOME TAX PAYMENTS, 1981-1986

I. Shares of Tax Payments by Percentiles

Percentile

1981

Lowest 50%

7.5%

1985
7.2%

Percentage
Change in Shares
1981-86*
1981-85

1986*
6.4%

-4%

-15%

51-95%

57.6

52.9

49.3

-8

-14

95-99%

16.8

18.0

18.2

Top 1%

18.1

21.9

26.1

+21

+44

II. Shares of Tax Payments by Income Category
1981
Taxes
Paid*

1985

: Taxes
Share : Paidr

66.8%

52.4%

1986*
Taxes
Share
Paidr

Adjusted Gross Income
Under $50,000

$189.9

$170.6

$172.4

45.7%

$50,000-$100,000

51.1

18.0

77.9

23.9

89.1

23.7

Over $100,000

43.2

15.2

77.3

23.7

115.4

30.6

Department of the Treasury
Office of Tax Analysis
* Preliminary.
1

Dollar amounts in billions.

Source: Internal Revenue Service, Statistics of Income Division.

rREASURY NEWS

partment of the Treasury • Washington, D.C. • Telephone 566-2
FOR RELEASE AT 4:00 P.M. CONTACT: Office of Financing
April 5, 1988
202/376-4350
TREASURY'S WEEKLY BILL OFFERING
Thrn Department of the Treasury, by this public notice), invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued April 14, 1988.
This offering
will result in s psydown for the Treasury of about $1,150 million, as
ths maturing bills are outstanding in the amount of $13,959 million.
Tenders will be received st Fedsrsl Reserve Banks end Branches and
st ths Bureau of ths Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Daylight Saving time, Monday, April 11, 1988.
Ths two ssriss offered are as follows:
91-day bills (to maturity dsts) for approximately $6,400
million, representing en additional amount of bills dstsd
January 14, 1988,
and to mature July 14, 1988
(CUSIP NO.
912794 QE 7), currently outstanding in ths amount of $7,102 million,
ths additional and original bills to be frssly interchangeable.
182-day bills for approximately $6,400 million, to be dstsd
April 14, 1988,
and to mature October 13, 1988
(CUSIP No.
912794 QQ 0).
Ths bills will be Issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without Interest. Both ssriss of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and In
any higher $5,000 multiple, on ths records either of ths Federal
Reserve Banks and Branches, or of ths Department of ths Treasury.
Ths bills will be Issued for cssh end in exchange for Treasury
bills maturing April 14, 1988.
In addition to ths maturing
13-week and 26-week bills, there are $9,790
million of maturing
52-week bills. Ths disposition of this lsttsr amount was announced
last week. Tenders from Fsdsrsl Reserve Banks for their own account
and as agents for foreign and international monetary authorities will
bs accsptsd st ths weightsd average bank discount rates of accepted
competitive tenders. Additional amounts of ths bills may be Issued
to Federal Reserve Banks, as agsnts for foreign and international
monetary authorities, to ths sxtsnt that the aggregate amount of
tenders for such accounts exceeds the eggregate amount of maturing
bills held by them. For purposes of determining such additional
amounts, foreign end international monetary authorities are considered to hold $2,125 million of the original 13-week and 26-week
issues. Federsl Reserve Banks currently hold $2,191 million as
agents for foreign and international monetary authorities, and $6,2 47
million for their own account. These amounts represent the combined
holdings of such accounts for the three issues of maturing bills.
Tenders for bills to be maintained on the book-entry records of the
B-1^61
Department of the Treasury should be submitted on Form PD 5176-1
(for 13-week series) or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

rREASURY NEWS
ipartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
CONTACT: Office of Financing
April 5, 1988
202/376-4350
TREASURY TO AUCTION $6,250 MILLION OF 7-YEAR NOTES
The Department of the Treasury will auction $6,250 million
of 7-year notes to refund $2,809 million of 7-year notes maturing
April 15, 1988, and to raise about $3,450 million new cash. The
public holds $2,809 million of the maturing 7-year notes, including
$153 million currently held by Federal Reserve Banks as agents for
foreign and international monetary authorities.
The $6,250 million is being offered to the public, and any
amounts tendered by Federal Reserve Banks as agents for foreign
and international monetary authorities will be added to that
amount. Tenders for such accounts will be accepted at the
average price of accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $163 million of
the maturing securities that may be refunded by issuing additional
amounts of the new notes at the average price of accepted competitive tenders.
Details about the new security are given in the attached
highlights of the offering and in the official offering circular.
oOo
Attachment

B-1362

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 7-YEAR NOTES
TO BE ISSUED APRIL 15, 1988
April 5, 1988
Amount Offered;
To the public

$6,250 million

Description of Security:
Term and type of security
7-year notes
Series and CUSIP designation .... F-1995
(CUSIP No. 912827 WB 4)
Maturity date
April 15, 1995
Interest rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
October 15 and April 15
Minimum denomination available .. $1,000
Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as an
annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest
payable by investor
None
Payment Terms:
Payment by noninstitutional investors
Full payment to be
submitted with tender
Payment through Treasury Tax
and Loan (TT&L) Note Accounts ... Acceptable for TT&L Note
Option Depositaries
Deposit guarantee by
designated institutions
Acceptable
Key Dates:
Receipt of tenders
Tuesday, April 12, 1988,
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
available to the Treasury .. Friday, April 15, 1988
b) readily-collectible check .. Wednesday, April'13, 1988

FREASURY NEWS
apartment
of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 4:00 P.M., EDT
Remarks by Secretary of the Treasury
James A. Baker, III
before the First Boston Lecture Series
at Fordham University Graduate School of Business
New York, New York
Thursday, April 7, 1988
Introduction
It is my great pleasure and honor to be the inaugural speaker
of the First Boston Lecture Series at this outstanding institution
of learning.
A perpetual challenge to any business is keeping up with the
times. * I know the Fordham Graduate School of Business recognizes
that necessity — as you have grown and diversified rapidly since
the school was founded in 1969. The fact that you are sitting
here in a new campus at Lincoln Center rather than at Rose Hill
is eloquent testimony that those organizations that adapt are
those that survive and prosper.
Perhaps this spirit of innovation and adventure has roots
in the Jesuit missionary tradition. Jesuits have been among
the world's first "internationalists." They carried a vision of
faith and scholarship to the far corners of the earth. Saint
Francis Xavier, you may recall, visited India, the Spice Islands
and ultimately established a thriving Jesuit mission in Japan.
And, wherever he and his fellow missionaries went, trade and
cultural enlightenment were seldom far behind.
International Cooperation and Economic Progress
So I believe I am in the right place to talk about the
internationalist perspective. More specifically, I want to
discuss how international cooperation can bring economic
progress. Like the Jesuit missionaries, we have been able to
cross some new frontiers — and some bright horizons lie ahead.
Let me begin with a story of a simple, ordinary consumer
good — the shirt.
B-136?

-2The typical shirt may cover more of the globe than Saint
Francis Xavier did before it gets to you. Quite Possibly, the
shirt was designed in New York City, its materials made m Japan
using German machine tools and Saudi Arabian P^roleum products
and cotton from the state of Georgia. It may then be cut and
sewn in Taiwan, with cardboard backing coming from Canada and
with buttons coming from practically anywhere, before being
sent back to the United States for pressing and marketing.
All this requires cooperation between a huge number of
perfect strangers from different cultures. Imagine all of
the communication, planning, bargaining, agreements, and
disagreements that are involved in this process. And it is
repeated for millions of shirts a year.
That's how the free market works in today's global economy.
I think that most of you will agree with me that capitalism, tor
all its flaws, is the most effective way of getting things to the
consumer and bringing economic growth and other benefits.
All this raises a question to those of us in the political
world: why can't governments cooperate as well as businesses?
There certainly seems to be a need for such cooperation.
Governments cut a large figure in the world economy.
Governments have unique and powerful authority to tax, spend,
create money, and regulate. The federal budget alone represents
about a fourth of the American economy, and this proportion is
much higher in other countries.
But as desirable as cooperation is, we would be fooling
ourselves to pretend that governments can work together like
clockwork. Some less than charitable observers might even say
that nations often conduct economic policy like blind elephants
in an aerobics class. Each performs his own exercise without
a thought to the others.
But times are changing. This highly integrated world economy
is forcing even longtime international rivals to recognize the
necessity of economic cooperation. Who in 1980 would have
imagined that the communist nation of China would welcome a
delegation from Wall Street to discuss the formation of capital
markets?
So let me examine two broad areas where economic cooperation
has been successful recently — first, in trade between the
industrial nations, and second, Third World debt.
Cooperation On Behalf Of Improved Trade
One key problem in the world economy is fairly obvious —
huge trade imbalances. By imbalances, of course, I mean
surpluses and deficits.
For some years now, these imbalances have created political
distress — particularly in Europe and the United States.

-3Here at home, hundreds of measures to cut off imports have
been introduced in the Congress — covering just about every
product you can imagine. You may recall one of the more infamous
proposals — the domestic content proposal earlier in the 1980's.
It required that up to 90 percent of an automobile sold in
America be made in America — tires, spark-plugs, engines,
interiors, you name it. And it actually passed the House of
Representatives — twice. As business managers, you know very
well the bureaucratic nightmares and business disasters that
domestic content legislation would create.
We fight these kinds of proposals every year in Washington.
They have a certain patriotic ring — however false — that a lot
of people find appealing. They seem to offer simple, concrete
solutions to complex problems. And these proposals are gaining
in popularity among some people.
Free traders must respond with more than abstract rhetoric.
People are looking for concrete actions. And that is just what
we have given them — a coordination process that will enhance
the ability of all countries to profit from world trade.
The seven largest industrial nations in the free world now
have a coordination process firmly in place. Interestingly
enough, it began with a meeting a few blocks east of here at
the Plaza Hotel in September 1985, and it has been developed
through several major conferences since then.
These seven nations have identified trade imbalances as a
serious threat to the world economy. They have agreed to improve
coordination of economic policies. They have agreed to encourage
more balanced growth.
Why is balanced growth significant? Well, a root cause of
the trade imbalances lies in the fact that since 1982 the U.S.
economy grew strongly, while most foreign economies were
relatively weaker. Weak economies don't buy many American goods.
And while our own growth was certainly a good thing, this growth
jacked up our demand for imports. In addition, opportunities for
investment in the growing U.S. economy encouraged foreign
investors to buy dollar assets — thereby driving up the price of
both our currency and our exports. All this meant a high U.S.
trade deficit — and high political tension on Capitol Hill.
So, as part of the coordination process, Japan and Germany
agreed to improve growth in their economies. For its part, the
United States promised to reduce its budget deficit — a
longstanding concern in foreign nations as well as here in
America.
To make this process more workable, a system of economic
indicators was developed — including such statistics as growth
rates, trade balances and inflation. These indicators now serve
as guidelines as the countries coordinate policies.

-4The process, let me add, is voluntary. No nation cedes its
authority to anyone else. But the process does make it easier
for nations to take steps in the right direction, to close wide
variations in growth rates. The process has become an effective
political discipline where the leading industrial nations can sit
around the table and hash out problems in a far more regular
manner than before.
And we have made significant progress.
World growth is becoming more balanced — improving overseas
and remaining strong in the U.S. As promised, Japan and Germany
are taking steps to raise their rates of growth and stimulate
domestic demand. The United States is meeting its commitment to
deficit reduction — with a $71 billion reduction in the last
fiscal year alone.
Another goal of the process was reached as exchange rates
were corrected to better reflect the underlying economic
fundamentals. Our exports are now cheaper overseas, and in fact,
the United States is shifting from a consumer-driven economy to
an export-driven economy — with a minimal degree of dislocation.
The very idea was unthinkable three years ago, but it's happening
now. The United States is even exporting steel to Japan, which
not long ago would have made as much sense as shipping sand to
the Sahara.
The net result is that at long last, both trade surpluses and
trade deficits are coming down in volume terms. Protectionism —
although by no means dormant — has subsided from its fever pitch
in the fall of 1985. In fact, in the presidential primaries this
spring, candidates espousing protectionism lost, and lost bigi
And we are encouraged that a major trade bill now in Congress —
which I will mention again in a minute — has been toned down.
Cooperation and Improving the Trade System
So far I've mainly talked of economic fundamentals such as
growth rates. We've made progress there and the world trade
system is better off for it. But we must also strengthen the
trade system itself — the rules we try to live by. That means
modernizing one existing process while also creating a new one.
For the last forty years, an international code of rules
has kept the trading lanes remarkably open. Now this code,
the General Agreement on Tariffs and Trade — called GATT for
short — must be expanded to cover the flourishing new trade
in services, intellectual property, trade-related investment,
and agriculture.

-5It will take time for the nearly hundred nations in the GATT
to act. The final fruits of the current GATT negotiations are
perhaps years away. In the meantime, two key nations have a
chance to create a procedure that will support the free trade
system. The proposed free trade agreement between the
United States and Canada — our largest trading partner — offers
tremendous opportunities for both countries. This agreement
would eliminate all tariffs within ten years and liberalize
trade in services, investment and technology. The agreement
is "pro-trade" and "pro-growth."
Every trade bill should be that — including the omnibus
trade bill now in Congress. Some of the most flagrantly
protectionist provisions in this bill have already been cleared
away. But there is a great deal more to do and we are working
with the Congress to try to craft a responsible trade bill. The
bottom line is still the same: the President will veto the final
product if it is protectionist.
Cooperation and Growth in the Third World
International cooperation also offers fresh hope for the
developing world.
The need for this cooperative action is evident. The
United States' growth, trade, investment, and currency have
enormous effect on the developing world — as their activity has
on us. Many developing nations are also nurturing democracy and
encouraging more tolerant political systems — and their people
need hope.
A major problem is the foreign debt burdens of 15 developing
countries — including Brazil, Mexico and Argentina. These debts
are owed to U.S. and foreign commercial banks, other governments,
and to organizations such as the International Monetary Fund and
the World Bank.
The current strategy that we are pursuing identifies
sustained economic growth in the private sector as the only
permanent solution to debt problems. It wasn't all that long
ago, you'll recall, that government — not the private sector —
was seen as the creator of economic health in many developing
countries. Socialism was widely considered to be the wave of
the future.
But as anyone who has read the newspapers in recent years
can see, many countries that have experimented with socialism —
whether in the developing or developed world — have come to
realize that market-oriented economies provide the only sure way
to economic growth.

-6And that's what our current strategy focuses on —
market-oriented growth. In a nutshell, it proceeds this way:
the debtors make economic reforms to encourage growth. In turn,
these reforms are supported by new debt and equity financing —
from the IMF, World Bank, commercial banks, and the return of
flight capital. Free-market reforms in return for financing —
that is the key to this cooperation.
Considerable progress has been made under this strategy
during the last two years. The debtor nations are increasingly
emphasizing market-led growth. They are adopting reforms to
improve productivity, use resources more efficiently, and unleash
the creative potential of the private sector.
Moreover, the average economic growth rate of the 15 major
debtors was 2.5 to 3 percent in 1986 and 1987. That's a big
turnaround from a short time ago, when those countries
experienced a negative growth of 3 percent in 1983, not long
after the debt crisis began. And "capital flight" is being
reversed in a number of developing countries. Citizens who once
sent their money abroad to places like New York and Zurich are
now bringing it back, because they have new confidence in the
policies and reforms of their governments.
We believe this cooperative approach is the only viable path
to lasting growth and debt reduction in the Third World. There
are no magic bullet cures for the debt problem. The problem took
a long time to get here and will take a long time to solve.
Conclusion
The cooperative efforts I have described today have brought a
good deal of progress — from reducing trade imbalances to
achieving growth in Third World nations. Nations have identified
common problems, agreed on solutions, and agreed upon procedures.
And they should not relax their efforts.
But governments should not try to do too much. In fact, the
free market must do the lion's share of the work. Governments
can't produce shirts nearly as well as private managers and
workers in the United States, Japan, Taiwan, Saudi Arabia,
Canada and elsewhere. Each cooperative effort I've described is
designed to strengthen the private sector — not least by giving
it the breathing room it needs to operate. That's why we seek
more balanced growth among nations — to ease protectionist
pressures that threaten the private sector.
In the years ahead, I'm sure you will find a greater and
greater globalization of the economy. Every day, advances in
technology are making it easier and cheaper to move information,
goods, money, people, and even factories across national borders.
Instant communication and instant capital flows are having a
major impact on the way we work and live.

-7Today a button-maker in Hong Kong can make a deal in a
few seconds with a shirt-maker in New York. The shirt-maker in
New York can raise money about as easily in London as in
New York. The shirt-maker can also get marketing information
instantly from a data base on the West Coast — or from many
other places in the world. And if information seems readily
available now, consider that telecommunications costs in 20 years
are expected to be only 1 percent of what they are today.
As such changes take place, you'll be working more and
more with other managers in plants and offices all over the
world. And I know you will require government policies that
create a proper environment for this world-wide economic system.
International cooperation on trade and market-oriented growth
policies will be vital to your ability to conduct business
efficiently and profitably.
Clearly, a future full of challenge and opportunity lies
ahead. I wish you the best of luck in the fascinating world of
business,
and very
I should
add, good luck on your exams next weekl
Thank you
much.

rREASURY NEWS
partment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
CONTACT: Office of Financing
*prn 7, 1988
202/376-4350
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION
Tenders for $8,751 million of 52-week bills to be issued
April 14, 1988,
and to mature
April 13, 1989,
were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount Investment Rate
Rate
(Equivalent Coupon-Issue Yield) Price
w
L° - 6.53% 6.97% 93.397
High
6.59%
7.03%
93.337
Average 6.57%
7.01%
93.357
Tenders at the high discount rate were allotted 4%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS

Received

Accepted

$
15,425
20,674,785
14,935
24,325
25,850
24,280
1,401,105
12,930
19,060
35,355
23,995
959,600
207,605
$23,439,250

15,425
7 ,348,785
14,*935
24,325
25,850
24,280
693,305
12,930
19,060
35,355
19,195
309,600
207,605
$8 ,750,650

$20,398,500
575,150
$20,973,650
2,400,000

$5,,709,900
575,150
$6,,285,050

65,600
$23,439,250

65,600

Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

2,,400,000

$8,,750,650

An additional$294,400 thousand of the bills will be issued
to foreign official institutions for new cash.
B-1364

rREASURY NEWS
partment of the Treasury • Washington, D.C. • Telephone 566-2041

For Immediate Release
April 8, 1988

Contact:

Charley Powers
566-8773

TREASURY DEPARTMENT ASSESSES PENALTY AGAINST
RAINIER NATIONAL BANK
The Department of the Treasury announced today that Rainier
National Bank of Seattle, Washington, has agreed to a settlement
that requires it to pay a civil penalty of $95,000. The
settlement is based on its failure to report 430 currency
transactions as required by the Bank Secrecy Act.
Francis A. Keating, II, Assistant Secretary (Enforcement), who
announced the penalty, said the penalty represented a complete
settlement of the civil liability of the bank for these
violations. Keating said that the bank came forward voluntarily,
cooperated with Treasury in developing the scope of its
liability, and has instituted remedial compliance measures.
The Department of the Treasury has no evidence that Rainier
National Bank engaged in any criminal activities in connection
with these reporting violations.
The Bank Secrecy Act requires banks and other designated
financial institutions to keep certain records, to file Currency
Transaction Reports with Treasury on all cash transactions by or
through the financial institution in excess of $10,000, and,
under some circumstances, to file reports on the international
transportation of currency or other monetary instruments in
bearer form or the equivalent. The purpose of the reports and
records required under the Bank Secrecy Act is to assist the
Government's efforts in criminal, tax and regulatory
investigations and proceedings.

B-1365

rREASURY NEWS
ipartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 11, 1988

CONTACT: EOB LEVINE
(202) 566-2041

DAVID R. MALPASS
APPOINTED DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
Secretary of the Treasury James A. Baker, III today
announced the appointment of David R. Malpass as Deputy Assistant
Secretary of the Treasury for Developing Nations. Mr. Malpass
will tie responsible for economic and financial relations with
developing nations, U.S. policies within the international
financial institutions, and economic development policies.
Prior to this appointment, Mr. Malpass served, since 1986,
as Legislative Manager for International Affairs in Treasury's
Office of Legislative Affairs. From 1984-1986, he was the
International Economist for the Senate Budget Committee. In both
of these positions, he developed and helped implement legislative
policy on trade, development assistance, and export financing.
From 1977-1983, Mr. Malpass worked as a financial and
systems analyst in Portland, Oregon: for Arthur Anderson & Co.;
as Financial Director at Consolidated Supply; and as a private
consultant. He was responsible for a broad range of corporate
financial and systems activities, including business planning,
accounting and systems management, creditor and auditor
relations, and acquisitions.
Mr. Malpass holds a bachelor's degree in physics from
Colorado College and a masters degree in business administration
from the University of Denver. In 1983, he was a Fellow in
Georgetown University's School of Foreign Service. He speaks
Spanish, French, and Russian, and has studied abroad extensively.
£orn and raised in Petoskey, Michigan, Mr. Malpass currently
lives in the District of Columbia.

B-1366

TREASURY NEWS
2041
epartment of the Treasury • Washington,
D.c.
• Telephone
CONTACT:
Office of Financing
FOR IMMEDIATE RELEASE
April 11, 1988

202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,425 Billion of 13-week bills end for $6,408 Billion
of 26-week bills, both to be Issued on April 14, 1988,
were accepted today.
RANGE OF ACCEPTED 13-week bills
COMPETITIVE BIDS: maturing July 14, 1988
Discount Investment
Rate
Rate 1/ Price
Low
High
Average

5.95%
5.98%
5.98%

6.12%
6.16%
6.16%

26-week bills
iturlng October 13, 1988
Discount Investment
Price
tote
tote 1/

98.496
98.488
98.488

6.17%
6.19%
6.19%

6.46%
6.48%
6.48%

96.881
96.871
96.871

Tenders at the high discount rate for the 13-week bills were allotted 65%.
Tenders et the high discount rate for the 26-week bills were allotted 81%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Received

Accepted

$
45,375
22,898,470
22,570
48,470
64,755
42,280
1,548,860
35,285
12,965
50,280
45,895
1,436,770
384,825

$
45,155
5,392,010
22,570
45,700
52,755
40,280
88,860
15,285
11,215
50,280
39,145
237,270
384,825

36,465
:$
- 21,064,845
21,200
:
40,165
!
40,870
!
28,285
1,171,075
;
41,025
!
14,000
!
39,815
:
32,465
. 1,147,990
:
456,050

$
36,465
5,135,145
21,200
39,215
40,870
28,285
237,885
21,025
13,050
39,815
26,515
312,840
456,050

$26,636,800

$6,425,350

: $24,134,250

$6,408,360

$23,296,335
1,161,075
$24,457,410

$3,084,885
1,161,075
$4,245,960

: $19,312,085
• 1,031,525
: $20,343,610

$1,586,195
1,031,525
$2,617,720

2,052,330

1,800,000

127,060

1,990,640

$26,636,800

$6,425,350

: $24,134,250

$6,408,360

An additional $440
thousand of 13-week bills and an additional $155,660
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
y

Equivalent coupon-Issue yield.
B-1367

TREASURY NEWS
leportment of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 10:00 D.S.T.
April 12, 1988
STATEMENT BY
DAVID MALPASS
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
COMMITTEE ON APPROPRIATIONS
UNITED STATES SENATE
APRIL 12, 1988
Mr. Chairman and Members of the Committee, I welcome
the opportunity to appear before you today to discuss our
MDB appropriations request and, in particular, the regional
multilateral development banks (MDBs). To provide some perspective for that discussion it would be useful to review
briefly U.S. participation in and policy toward the MDBs
generally.
U.S. Participation in the MDBs
The United States played an important role in establishing
each of the MDBs, with the exception of the African Development
Bank which was entirely regional in its origin. The United
States proposed at Bretton Woods the creation of the International Bank for Reconstruction and Development (IBRD) to
facilitate the provision of private capital for the immediate
post war reconstruction of Europe and to encourage rational
economic development in the rest of the world.
The creation of the Inter-American Development Bank (IDB)
and the Asian Development Bank (ADB) similarly depended in each
case on a U.S. decision to participate in these institutions.
Other countries were unwilling to act alone; significant U.S.
participation was viewed as essential. Even in the case of the
African Development Bank (AFDB), the subsequent expansion of
its membership to include the United States and other nonregional countries was viewed as critical for its continued
viabili ty.
In 1982 this Administration conducted an assessment of
United States participation in the MDBs. That assessment
concluded that while continued U.S. participation in the MDBs
was in our national interest, the operations of the MDBs needed
B-1368

- 2 to be more effective and efficient. Specifically, the MDBs in
our opinion had to commit themselves to promoting policy reform
and to substantially improving the quality of their lending in
order to better foster sustainable economic growth. More
hard-headed economic and financial scrutiny of MDB loans was
required.
A key element of this framework is the generation of country
strategies that lay out in detail what a country's development
goals should be and how they can be achieved. These strategies
are then to be used to guide the bank in selecting projects it
will support. In this context, it is expected that greater effort
will be given to ensuring that projects are more market-oriented,
with greater attention to allowing the private sector to prosper
and generate growth.
The United States and other members have a variety of opportunities to affect MDB operations and policies. The most visible
vehicle and certainly the one which provides for the broadest
scope is the negotiation of an MDB replenishment or capital
increase.
However, Board votes and comments on individual
loans are equally important because they demonstrate the
commitment of the United States to the policies we fight for
in these negotiations.
Loan Review Process
The United States carefully reviews each MDB loan proposal,
roughly 500 per year, for its economic, financial and environmental viability. The general purpose of our review is to
develop a U.S. position on individual loans for use by the U.S.
Executive Director which will encourage the MDBs to develop
good, profitable, environmentally sound loans. The review is
also used to meet certain legislative requirements and to create
a feedback mechanism to our policy directions within each Bank.
U.S. votes and commentary on loans have been an effective
vehicle for influencing the directions of MDB lending programs
as well as their specific lending policies. In the early 1980's,
we were successful in limiting the World Bank's efforts to fund
oil and gas projects for which alternative sources of financing
are often available. We also dissuaded the Bank from setting
up a separate organizational unit devoted to such lending.
Another extremely important loan policy direction, developed
in coordination with the Congress, has been the recognition that
there is a strong connection between the environmental soundness
of a project and its economic viability. I would note that,
as in the energy sector example, this policy direction will
take time and tenacity to implement. The result we are striving

- 3 toward is multilateral institutions working as a positive
force in the environment by focusing in-country political and
economic leaders on the importance of environmental aspects of
their projects.
The United States has been successful in strengthening
some regional MDB policies. The IDB, for example, is moving
to establish standards regarding tariff rates for electricity,
water supply, and telecommunications. In the ADB, policies
concerning domestic resource mobilization — for example, cost
recovery in irrigation projects — have received much more
attention. We have stressed to all of the MDBs the need to
focus on these areas.
The United States has also been successful in altering
individual projects. Currently, for example, the African
Development Bank is redesigning a rural development project
for Benin that we objected to last month because of local
institutional constraints. We have also been able to alter
projects in the Fund for Special Operations, the concessional
fund of the IDB, where the United States as the Fund's major
contributor has a veto. There the United States can require
that loans be withdrawn and the project improved. This
control has been exercised 19 times in the past three years
as we have insisted that the terms of the loans adhere to the
Bank's own lending policies on such things as cost recovery,
the environment, and interest rates for on-lending.
We will continue through the loan review process and Board
comments to promote improved loan quality in the MDBs. I would
now like to briefly review some of the main issues in each of
the regional MDBs, beginning with the Asian Development Bank
and Fund.
The Asian Development Bank (ADB) and Fund (ADF)
In April 1986, as we have reported to you previously,
agreement was reached on a $3.6 billion replenishment of ADF
resources. The United States share of the replenishment is
$584 million (16.2 percent), to be paid in four equal annual
installments of $146 million each.
The policy changes the Administration achieved in the
course of negotiating this replenishment are consistent with
the basic negotiating framework described in the first section
of my testimony. They include:
-- increased emphasis on the private sector in promoting
long-term sustainable growth and development;
-- greater effort to seek policy reform by borrowers
in the context of lending and technical assistance
act ivities;

- 4 —

development of country strategies to guide the
lending program for each country; and

— hardening of terms for concessional lending.
The ADB has made progress in implementing these reforms,
although the implementation has not gone as fast as we would
have liked. ADF lending terms have been hardened for borrowers
which rely on a mix of concessional and non-concessional funds.
Country strategies have been and are being prepared. New
programs for making funds available to the private sector have
been developed.
It is important to understand, however, that while securing
such reforms in the course of this or any replenishment agreement
is a significant accomplishment, that is never the end of the
story. In fact, securing agreement on such issues is really just
the first step — there must be constant follow through with
other members and bank management to bring actual operations
into line with agreed guidelines. It should be noted that the
MDBs are not that different in this regard from other large
oureaucracies.
Hence, it is not unexpected at this juncture to find that,
in our view, the ADB still has a considerable distance to go in
living up to agreed commitments on reform. We are disappointed,
for instance, that the Bank has not moved more quickly to
develop country strategies, particularly for major borrowers.
We, of course, will continue to press these issues with
Bank management and other members -- both at ADB headquarters
in Manila and in other fora as opportunities present themselves.
We hope that the reforms will ultimately be implemented more
effectively than heretofore, and will keep the Committee
informed on this matter.
The Inter-American Development Bank (IDB)
The dominant issue with the Inter-American Development
Bank is the seventh replenishment of Bank resources. The U.S.
position in the negotiations has been generally guided by recommendations of the 1982 MDB Assessment but has also included the
possibility for the IDB to play a supportive role in policy-based
lending aimed at promoting economic reforms in the developing
countries of Latin America and the Caribbean.
After preliminary discussions in 1985 and 1986 with IDB
management and other major shareholders, we were encouraged to
pursue our proposal for an IDB that would join the World Bank
in improving the prospects for sustainable economic growth in
in the region. Based on these discussions, we put forward a

- 5 four point package of changes consistent with our general
framework that we considered essential to any replenishment
agreement. These included:
-- the creation of individual country strategies/
programs to guide IDB lending;
-- the adoption of appropriate policy conditionality
in Bank lending and development of a program of
well-defined well-targeted fast disbursing loans
(sector lending) not exceeding 25 percent of
total lending;
-- restructuring operating departments to do country
programming and sector lending; and
-- changing the majority needed for decisions to give
greater weight to the views of countries which
supply the usable resources.
We were and still are prepared, if agreement can be
reached on this package of changes, to seek a significant
incerease in Bank resources. At the time it was negotiated,
the replenishment would have supported a lending program of
from $20 - $25 billion during the period 1987-90. This would
have represented a doubling of lending from the Bank's hard
loan window and a tripling of lending from the soft loan window
when compared to the sixth replenishment. While we envisioned
a program of some policy-based sector lending, the majority
(at least 75 percent) of Seventh Replenishment lending would
still be for projects.
As you are all aware, despite almost 2 years of negotiations agreement has not been reached on a replenishment of
the IDB. With no progress in sight on the voting issue,
negotiations were halted in October of 1987.
Once the voting issue is resolved, we believe final
agreement could be reached quickly on:
-- the operational definitions and procedures to guide
the formulation of country programming strategies;
-- the operational definitions and procedures to guide
sector lending; and
-- a reorganization of the Bank's internal structure
to facilitate preparation of country programs and
sector lending activities.

- 6 Understanding the voting issue, however, is critical to
comprehending the future role of the IDB and U.S. policy towards
it. As part of a reformed IDB, we were seeking a greater say
for the non-borrowing member countries in the Bank's decisionmaking .process. We were not making the request purely to
assert the interests of the United States. Rather, we believe
the non-regional donor countries, including the United States,
which contribute the vast majority of resources to the IDB
should have more discretion and greater policy influence. We
believe that this change is central to reforming the IDB.
Seventy-two percent of the usable resources of the proposed
capital increase were to be provided by the United States.
Yet, the U.S. share of IDB votes is less than half that percentage -- 34.5 percent. Overall, the countries that would provide
95 percent of the Bank's usable resources would have only 46
percent of the vote.
In view of this imbalance, the change we were seeking is
not unreasonable. We want to be sure that the loans and policies
produced under an expanded lending program contribute more
effectively to creating the conditions necessary for economic
growth. Past experience indicates that with the simply majority
voting system now in operation loan quality has been deficient
in the IDB.
As of April first the IDB has a new President, Enrique
Iglesias of Uruguay. His election presents the IDB with an
important opportunity. Mr. Iglesias has expressed his intention
to seek a redefinition of the role of the IDB which he hopes
all shareholders can support. For our part, we remain committed
to the IDB and are looking forward to working with the new
President in this effort. However, we also believe that the
fundamental changes which we were seeking in the seventh
replenishment are still essential.
The African Development Bank (AFDB) and Fund (AFDF)
In November, 1987 negotiations for the fifth replenishment
of AFDF were concluded. Donor governments and Fund management
agreed on a three-year replenishment of $2.7 billion. The
United States agreed to seek a $315 million contribution over
the FY 1988-90 period — implying an annual budget authority
request of $105 million.
The Administration succeeded in convincing Fund management
and other donors to adopt our positions on lending policy
issues. Under the replenishment, Fund operations will focus on:
— promoting economic policies which assure the
most efficient distribution of resources,
including market-based incentive systems and
appropriate pricing policies;

-7—

meeting the primary needs of the poorest sections
of the population in low income countries, including
employment creation and increased incomes;

-- improving linkages between the allocation of
AFDF-V resources and the policy performance of
individual countries;
-- eliciting or promoting the direct involvement of
the ultimate beneficiaries, including women, in
the design and implementation of projects and
programs; and
-- contributing to the improvement of the environment.
In working toward these objectives, the Fund will accord
particular attention to the formulation of comprehensive country
programs. These programs would include an overall review of
country constraints and possibilities, including the adequacy
of country performance; formulation of project pipelines in
light of the country needs and Fund capabilities; and coordination of Fund activities with major donors.
The agricultural sector will be given the highest priority.
In addition, the Fund will continue to concentrate its lending
on health, education, transport and telecommunications, public
utilities and energy. Increased emphasis will be placed on
incorporating environmental considerations in all of the Fund's
projects and programs.
While the bulk of the Fund's lending will continue to be
in project loans, the Fund will begin to respond to the requirements of member countries for policy-based lending by expanding
the use of sector adjustment and structural adjustment loans.
Up to 20 percent of available resources under AFDF-V will be
allocated for such lending, which will be done in close collaboration with the World Bank and other multilateral development
institutions. This change in the Fund's lending program is
consistent with a general tenet I mentioned at the beginning
of my testimony, the need for the MDBs to commit themselves to
promoting policy reform.
In these replenishment negotiations we also stressed the
need to continue to improve the quality of Bank and Fund lending.
Management recognizes that loan quality must be improved; but
we are concerned that in the first quarter of this year too
many loans of poor quality were brought forward for Board
consideration. The Benin rural development loan which I referred
to earlier is an example. We have raised our concern through
our Executive Director and bilaterally, and will continue to
press for an improvement in loan quality.

- 8 Before concluding, I would note that one of this year's
major MDB issues is the General Capital Increase for the World
Bank. The Administration's budget requests $70.1 million for
FY 1989, the first of six annual subscriptions. The authorization legislation was sent to Congress in March. Since Secretary
Baker addressed the GCI in detail in his March 30 testimony
before this Committee, I have not included it in my statement.
However, I would be happy to answer questions on it in a moment.
Conclusion
Mr. Chairman, in my testimony today I have covered three
areas: first, the framework for negotiating MDB replenishments
that has evolved since the 1982 Assessment of U.S. participation
in the MDBs; second, the process of reviewing MDB loans within
the U.S. Government; and, third, some of the main issues in the
regional institutions. In discussing the latter I have given
you a frank appraisal of some of the problems we face, as well
as some of our accomplishments.
It bears emphasizing that our conclusion is not that the
United States should "pare down" its participation in some or
all of these institutions. We would not have some of these
problems if we had not succeeded in getting the institutions
to accept, in principal, the policy changes we sought. Even
in the case of the IDB, there is agreement that country
strategies will benefit the Bank, the donors, and, most
importantly, the borrowers.
What is needed now is follow-through on our part so that
these policy changes become a natural, accepted part of MDB
operations. But this requires a judicious use of our influence
in these institutions, and that cannot be done by lowering our
financial participation. As Secretary Baker indicated to you
in his testimony on March 30, 1988, the United States cannot
use its influence to bring about better MDB policies by backing
away from the institutions.
I believe that we have a clear policy direction within
the MDBs, one on which Congress has had substantial influence
and one which will be very effective for the United States and
the developing countries. We seek your continued support as
we follow through on these policies.

rREASURY NEWS

ipartment of the Treasury • Washington, D.C. • Telephone
FOR RELEASE AT 4:00 P.M. CONTACT: Office of Financing
April 12, 1988
202/376-4350
TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued April 21, 1988. This offering will
result in a paydown for the Treasury of about $14,175 million, as
the maturing bills total $26,972 million (including the 22-day cash
management bills issued March 30, 1988, in the amount of $4,055
million and the 17-day cash management bills issued April 4, 1988, in
the amount of $9,022 million). Tenders will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public Debt,
Washington, D. C. 20239-1500, prior to 1:00 p.m., Eastern Daylight
Saving time, Monday, April 18, 1988. The two series offered are as
follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
January 21, 1988, and to mature July 21, 1988 (CUSIP No.
912794 QF 4), currently outstanding in the amount of.$8,050 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be dated
April 21, 1988, and to mature October 20, 1988 (CUSIP No.
912794 QR 8 ) .
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing April 21, 1988. Tenders from Federal Reserve Banks
for their own account and as agents for foreign and international
monetary authorities will be accepted at the weighted average bank
discount rates of accepted competitive tenders. Additional amounts
of the bills may be issued to Federal Reserve Banks, as agents for
foreign and international monetary authorities, to the extent that
the aggregate amount of tenders for such accounts exceeds the
aggregate amount of maturing bills held by them. Federal Reserve
Banks currently hold $5,219 million as agents for foreign and international monetary authorities, and $3,537 million for their own
account. These amounts represent the combined holdings of such
accounts for the four issues of maturing bills. Tenders for bills to
be maintained on the book-entry records of the Department of the
Treasury should be submitted on Form PD 5176-1 (for 13-week series)
B-1369
or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt, Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of
the circulars, guidelines, and tender forms may be obtained
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

rREASURY NEWS
iportment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 12, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF AUCTION OF 7-YEAR NOTES
The Department of the Treasury has accepted $6,257 million
of $16,454 million of tenders received from the public for the
7-year notes, Series F-1995, auctioned today. The notes will be
issued April 15, 1988, and mature April 15, 1995.
The interest rate on the notes will be 8-3/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-3/8% interest rate are as follows:
Yield
Price
Low
8.43%
99,.714
High
8.45%
99,.610
Average
8.44%
99,.662
Tenders at the high yield were allotted 83% •
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
7,560
7,560
$
New York
14,703,729
5 ,676,089
Philadelphia
4,701
4,701
Cleveland
7,977
7,977
Richmond
23,972
23,122
Atlanta
9,036
9,036
Chicago
897,750
279,210
St. Louis
14,172
11,002
Minneapolis
5,073
5,073
Kansas City
13,544
13,544
Dallas
7,256
5,256
San Francisco
758,705
213,355
Treasury
966
966
Totals
$6,,256,891
$16,454,441
The $6,257
million of accepted tenders includes $316
million of noncompetitive tenders and $5,941
million of competitive tenders from the public.
In addition to the $6,257 million of tenders accepted in
the auction process, $500 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $254 million of
tenders was also accepted at the average price from Government
accounts and Federal Reserve Banks for their own account in
exchange for maturing securities.
B-1370

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone

FOR RELEASE UPON DELIVERY
txpected at 1U:UU A.M. DST
April 13, 1988

STATEMENT BY
DAVID R. MALPASS
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON INTERNATIONAL
ECONOMIC POLICY, TRADE, OCEANS AND
THE ENVIRONMENT
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
APRIL 13, 1988
Mr. Chairman:
I am pleased to participate in these hearings on
foreign assistance and the need for environmentally
sustainable development programs. I would like to
focus today on What we have done to implement the
Congressional mandate to promote environmentally
sustainable economic growth and improved management
of natural resources. This mandate has been clear
and strong and it has been a major theme in our management of U.S. participation in all of the multilateral
development banks.

B-1371

2041

-2Unfortunately, the adverse effects of unwise and
unsustainable development programs and projects are
only too evident in all parts of the developing
world. Examples include desertification in Africa
and South Asia and destruction of tropical forests in
Latin America, in Central Africa and in Asia. There
have also been serious problems with loss of wetlands
as well as atmospheric pollution and pollution of
waterways. In some cases, development is threatening
the survival of indigenous peoples and their culture
and causing extensive damage to wildlife, particularly to endangered species that can never be replaced.
There is be very little disagreement on the urgent
need to address these issues. We share, the goals
that have been outlined by Congress and members of
the environmental community. Our policy in the multilateral development banks has been to seek to
mitigate or eliminate such adverse effects in development projects and programs and to support national and
regional programs to improve environmental management.
This has meant the structuring of programs that encourage
growth and reduce poverty while still protecting and
preserving the natural resource base.
The first Congressional mandate for environmental
action in the multilateral development banks was
included in the Continuing Resolution Act for 1987,
Public Law 99-591. This legislation provided that the
Secretary of the Treasury should instruct the U.S.
Executive Directors in the Banks to promote a number
of very specific and detailed reforms. These reforms
included:
addition of professionally-trained staff in the
Banks.
development of plans for systematic and thorough
environmental review of projects.
creation of line units to carry out such reviews.
establishment of multidisciplinary planning
processes.
development of plans for rehabilitation and
management of ecological resources.
involvement of health and environmental ministers
and non-governmental organizations in the project
preparation cycle.
increase in the proportion of environmentallybeneficial lending.

-3A report detailing progress in these areas was submitted
to the Congress in January, 1988. I will return in a
few minutes to the subject matter of that reoort and
provide some of the details of the progress that is
being made.
The second Congressional mandate on environmentalreforms was included in the Continuing Resolution for
FY 1988, Public Law 100-202. This legislation restated
many^of the reform objectives outlined in the previous
year's Continuing Resolution and made them a part of the
permanent authorization legislation. It also provided
for a number of other initiatives including:
an analysis of debt/conservation swaps.
discussions with other donors regarding
personnel and financial support for
environmental programs in the regional
development banks.
enhancement of the early-warning system
for identifying problematic loans.
report on a comprehensive strategy to address
natural resource problems.
discussions with other executive directors in
the banks regarding integrated pest management.
promotion of requirement for IMF to conduct an
analaysis of the impact of adjustment policies
and conditionality on environment, public health,
natural resources and indigenous peoples.
This legislation took effect in December, 1987. We
have already begun to implement some of these initiatives
but action still remains to be taken in other cases.
It is clear from this brief summary that a great
deal of legislation is in place. I want to assure you
that we are making a conscientious effort to implement
it. In fact, I believe we should make implementation
our primary objective and not seek the passage of new
law on this subject.

-4Within Treasury, we are working to improve our
oversight of environmental issues in the multilateral
development banks. During 1987, we abstained on six
loans, citing concerns about adverse environmental
effects. These loans included agricultural rehabilitation in the Sudan, electric power in Peru, a paper
mill in Nepal, an abattoir in Botswana, livestock
development in Benin, and agroforestry and livestock
development in Mali. In February of this year, we
abstained on a loan to Burkino Faso for a road and
water project because of serious environmental issues.
We are continuing close coordination with State
and AID and with environmental groups in an effort
to improve the early warning system for problematic
projects. We plan to take a more active role in
international meetings on environmental issues,
particularly those that involve projects and programs funded by the multilateral development banks.
We have had particularly strong support from a
number of non-governmental organizations — the Sierra
Club, Natural Resources Defense Council, Environmental
Defense Fund and others — in gathering information and
developing approaches to increase the effectiveness of
our efforts. These organizations have assisted in the
preparation of our position on loans for cattle production in open-range savannas of sub-Saharan Africa and
on standards for evalating projects that may adversely
affect moist tropical forests. They have participated
in the early warning system established by AID to identify projects that may adversely affect the environment.
They have worked closely with us in analyzing problems
associated with specific loan proposals or with projects
that are being implemented.
Let me turn now to the question of where we stand
with regard to provisions of Public law 99-591.
Staffing and Training
During 1987, the World Bank carried out a major
reorganization of its management and staff. One of
its primary aims was to strengthen the Bank's capacity
for addressing environmental issues. A central environmental department was established in the Policy,
Planning and Research complex. Twenty-three positions
have been authorized for the three divisions in the
department. In addition, environmental units have been
created in the technical departments of the Bank's four
regional offices. Twenty-two positions have been

-5authorized for these four units. The Bank has
appointed a new director for the Environmental
Department and a new advisor for scientific and
environmental affairs. Both of these individuals
appear to be well-qualified and capable, with extensive backgrounds in environmental matters. In
addition to the 45 permanent staff positions, the
Bank has indicated that it expects to use the equiva-'
lent of 18 man-years in consultant services for environmental issues during its current fiscal year.
The regional development banks need to hire more
environmental specialists and to assign more staff to
environmental issues. We have been encouraging them
to do that. The Inter-American Development Bank has
recently hired two senior environmentalists for positions at the Bank's headquarters and a third expert
has been assigned to the Bank's field office in Brazil.
The Asian Development Bank has had five staff members
working on environmental issues; however, the chief
of their environmental section has recently been
recruited for the World Bank's Asian Environmental
Unit and a well-qualified replacement is needed to
fill that position. The African Development Bank
has said that it will increase its environmental
staff from two to four and that a well-qualified
African candidate will be sought as Chief of the
Unit. The unit is currently headed by a Norweigan
official seconded to the Bank.
Significant progress has been made on training.
In the World Bank, an environmental training program has
been introduced for Bank staff. The program is designed
to raise awareness of environmental issues in development,
to convey new techniques, and to introduce the latest
developments in the field. The integration of environmental and economic work and the importance of policy
intervention is to be included in the curriculum of the
Economic Development Institute.
The Inter-American Development Bank has initiated a
series of seminars on environmental issues. The first of
these seminars took place over a three-day period in
December, 1987, with forty members of the Bank's technical
staff participating. Similar seminars for other members
of the staff are to be held later this year. A one-day
seminar is also planned for the heads of the Bank's field
offices
in
borrowing
The
African
Bank
has
mental
environmental
sponsored
focusing
planning
on
aits
grazing
one-day
impacts
in project
issues,
seminar
andcountries.
adevelopment.
which
two-day
on thehave
economic
seminar
been
A third
problematic
on
valuation
environseminar
of

-6Management Line Units
Three of the Banks have established line units to
provide for a systematic and thorough review of projects
affecting the environment and natural resources. As I
indicated earlier, the World Bank has set up four regional
units. The Asian Development Bank and the African
Development Bank have established smaller units that
need to be strenghened. The Inter-American Development
Bank decided to create an inter-departmental Committee
instead of a line unit. It reviews projects in both the
preparation and implementation phases and is advised by
a senior environmental specialist.
Involvement of Health and Environmental Ministers
and Participation of non-Governmental Organizations
The management of the banks report that they have
taken steps to emphasize the involvement of health and
environmental ministries. The Asian Development Bank
provides special briefing materials to its country programming teams on environmental and natural resource
development projects. The environmental unit at the
bank is also in contact with environmental agencies in
borrowing countries regarding specific projects in the
pipeline that may need assessment. The African Development Bank has issued instructions to staff for expanding
consultations with health and environmental ministers.
Participation of non-governmental organizations is also
being encouraged in all of the banks. In the World Bank,
the focal point for relations with non-governmental organizations has been shifted from Public Affairs to Policy,
Planning and Research. This shift has facilitated the
exchange of views and discussions on substantive issues.
In May, 1987, the Inter-American Development Bank
sponsored a conference on environmental issues in Latin
America and the Caribbean. There was extensive participation by regional and non-regional NGO's. There was
also very broad representation from public agencies
throughout the region, responsible for environmental
protection and natural resource conservation. The
African Development Bank is making plans to hold a
similar conference during the second half of this year.
The Asian Development Bank has completed a working
paper on cooperation with non-governmental organizations.
The paper was based on consultation with a number of those
organizations. A final report is expected shortly. All
of the banks are seeking to involve NGO's in borrowing
countries more actively in the project cycle and to see
that
local
community
groups
and
organizations
are
and
the
tacts
fully
women's
cycle.
with
informed
farmers
groups.
In of
agriculture,
project
organizations,
planning
thisother
has
water
atinvolved
anuser
early
associations
wider
stageconof

-7Multidisciplinary Planning in Land Uses and
Rehabilitation and Management of Ecological Resources
All of these banks have sought to incorporate
new technologies, including remote sensing techniques,
into efforts to encourage more effective land use
planning. The World Bank has begun preparation of
comprehensive environmental action plans in a number
of selected countries. It is also preparing terras of
reference for consultants to identify areas where
multidisciplinary support can help improve project
preparation.
The multilateral development banks are providing
funds for national and international agricultural
research programs and for science and technology programs that support research into eco-system management.
The World Bank is working with Harvard University
and the Institute for International Environment and
Development to assess alternative approaches to
natural resource management. Task forces have also
been organized within the World Bank to address
desertification, deforestation, industrial accident
risk avoidance, protection of critic1 eco-systems
and mitigation of natural disasters in urban areas.
Other Aspects of Legislation
There are two specific legislative requirements
from 1986 on which I would like to report on briefly.
The creation of four environmental line units in the
World Bank should lead to better review of on-going
projects. The Inter-American Development Bank has
issued new instructions to its field offices in
borrowing countries emphasizing environmental and
sociocultural issues during project supervision and
monitoring visits. The Asian Development Bank and
the African Development Bank both report that
increased emphasis has been placed on environmental
issues in monitoring and evaluating projects. None
of the banks has created the position of an advisor
to the President for environmental matters. The
World Bank has, however, appointed a senior official as an advisor to the Vice-President for Policy
Planning and Research.
As I indicated earlier, we have begun a number
of initiatives as a result of the Continuing
Resolution that was passed in December, 1987, Public
Law 100-202.

-8We recently submitted to the Congress a report that
had been requested on debt for nature swaps. In brief,
this report recommends that the World Bank place additional emphasis on working with countries to establish
priorities for conservation projects and on improving
informational systems on species groups, critical ecosystems and major tropical wilderness areas. It also
looks to the Bank to take a more active intermediary §
role in helping to arrange debt for nature swaps and
to consider starting a pilot program in a country that
has indicated that it is willing to establish one.
An Internal Revenue Service ruling that encourages
participation in such swaps was released last December.
I can also report that we have been in contact
with other developed countries regarding the possibility of providing environmental experts to work in the
regional development banks. Environmental experts from
the United States, Norway, the Netherlands and Italy
have already been seconded to the African Development
Bank. Last month, we began consultations with fifteen
other developed countries about improving that particular program and the possibility of seconding additional experts to the other regional development banks.
Our executive directors in the Banks have been asked to
talk with management about how this program might be
expanded.
We have been holding regular meetings with representatives of other donor countries regarding improvements in
the environmental performance of the multilateral development banks. These meetings have ranged from discussions
in the Development Committee of the World Bank to more
informal consultations and conversations about changes in
policies and our positions on individual projects that
may affect the environment. This week in Development
Committee meetings, we are reviewing a number environmental issues in the World Bank. Next month we will participate in an OECD meeting in Paris seeking to promote
the development of guidelines for decision-makers in
evaluating environmental issues in the multilateral
development banks.
We placed a particular emphasis oh environmental
issues at the annual meeting of the Inter-American
Development Bank in Venezuela in March. We plan to
continue to stress these issues at the annual meetings
of
the
Asian
Development
Bank
and
the
African
Development
banks.
own
All
Bank
governments
of
efforts
that
these
will
of
to
initiatives
take
other
improve
place
countries
environmental
have
later
been
more
this
meant
effectively
performance
month
toand
involve
in
in
in
June.
our
the

-9During the past year, we have worked closely with
our colleagues at AID in implementing the early
warning system for identifying problematic projects.
We believe we can continue to enhance this system and
become more influential in shaping the environmental
aspects of individual loan proposals in the banks.
Later in the year, we will collaborate with State and
AID in analyzing more comprehensive strategies that
can address natural resource problems through the multilateral development banks and in our bilateral aid
program.
To sum up, Mr. Chairman, we have had a very extensive
legislative mandate from Congress on environmental issues
in the multilateral development banks. We have been fully
engaged in implementing the provisions of that mandate.
On some of the issues, particularly staffing, training
and the involvement of non-governmental organizations,
I believe we have been making substantial headway. In
other areas, we will continue to press for further
reforms.
I do not believe that we need additional legislation
to assist us in seeking these reforms. I am optimistic
that attitudes are changing — both in the banks and in
borrowing countries — and that we will have continuing
progress to report to the Congress as the year progresses.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UNTIL DELIVERY
Remarks by
The Secretary of the Treasury
James A. Baker, III
at the Morning Session of
The Interim Committee
of the International Monetary Fund
Washington, D.C.
Thursday,
14,
1988
The World Economic Outlook, IMF April
Quotas,
and
an SDR Allocation
Thank you, Mr. Chairman.
Since our meeting last September we have been given solid
grounds for optimism about the underlying strength of our economies
and the beneficial role of the policy coordination process in which
the major industrial economies are participating.
o The sharp October stock market declines were a source of
concern to us all. But in fact real GNP growth in
industrial countries grew faster in the second half of 1987
than in the first half. Clearly the underlying strength of
our expansion was underestimated. Now we are seeing a new
optimism about 1988 growth prospects.
o This performance by the industrial countries created the
environment in which world trade volumes grew by nearly
5 percent, the highest rate since 1984. In particular,
exports of non-oil producing developing countries rose
10 percent in volume terms last year. That rise contributed
to a 4-1/2 percent growth of their real GNP.
o In addition, reductions of external imbalances have begun in
the largest industrial countries. In the United States?
real exports rose 18 percent over the four quarters of 1987,
while imports were up only 7 percent. Furthermore, we
expect that U.S. nominal dollar trade and current account
deficits will decline this year. The trade figures released
this morning should be seen in context. As we have said
before, too much emphasis should not be placed on any one
month's figures. Monthly trade figures are by their nature
erratic. What is important is that we are continuing along
the general path of reduced imbalances. Exports continue
their very strong performance; they are 22 percent higher
than a year ago, and growing at double the rate of imports.
o Progress continues to be made in other countries as well.
Japan's trade surplus, as a share of GNP, peaked in 1986 and
has been coming down steadily since; Germany's stabilized
B-1372 last year and is expected to decline in 1988.

- 2 -

There are several reasons for this positive economic growth
with low inflation, and for the emerging success in adjusting
external imbalances. One is the inherent strength of our
economies. A second results from actions undertaken in the
context of strengthened economic policy coordination among the
major industrial countries. The agreements of the G-7 have
provided the framework for important efforts and positive
results:
o The United States reduced its federal budget deficit
by $71 billion in the last fiscal year. That drop is
equivalent to almost 2 percent of GNP. The general
government deficit — including state and local
governments — fell to only 2-1/4 percent of GNP in
fiscal year 1987.
o The budget agreement reached by the President and the
joint leadership of Congress late last year is a
significant step toward assuring continued fiscal
restraint.
o Furthermore, as the budget submitted by the President
in February makes clear, we expect further deficit
reductions in future years, with the federal deficit
down to less than 2 percent of GNP by FY 1990. We have
also successfully avoided protectionism, despite strong
political pressures.
o Japan has been pursuing economic policies to sustain
strong domestic growth and to open its markets more fully
to imported goods.
o The United Kingdom is putting into place a major tax
reform which includes a major reduction in marginal
income tax rates.
o Germany has adopted special supports for investment and
has completed the formulation of its major medium-term
tax reform program.
I believe that the early effects of these and other
coordinated policy efforts should provide the basis for the
continued reduction of external imbalances to sustainable levels
with low-inflation growth. Domestic demand in the United States
grew more slowly than GNP last year, with exports expanding
sharply. In Japan, by contrast, domestic demand continues to
grow more rapidly than GNP. The same is true in Germany. These
developments are making an important contribution to reducing
external imbalances.

- 3 Since the beginning of this year there has been little change
in the dollar's value against other major currencies. The
generally increased exchange rate stability reflects improved
policy coordination and the ongoing adjustment process.
Yesterday the Ministers and Governors of the Group of Seven
expressed their determination to continue to coordinate economic
policies to strengthen the underlying fundamentals and thereby
reinforce the conditions for exchange rate stability. In
addition, they agreed to continue to cooperate closely on
exchange markets.
Looking toward the medium-term, we all recognize the heed
for continued action to sustain growth, to reduce external
imbalances, and to provide an environment favorable to world
economic development and additional progress on international
debt problems. As you have observed, Mr. Chairman, this mediumterm focus requires renewed attention to structural changes in
our economies.
In the United States, we have been encouraged by the rise in
the savings rate to 4-3/4 percent in the fourth quarter of last
year. That is an increase from 3-1/2 percent earlier in 1987
and 4-1/4 percent in 1986. Business savings, which account for
80 percent of U.S. private savings, should also rise as the
competitive position of U.S. industry improves.
European countries have been making some progress in freeing
up their labor and capital markets, and reducing the burden of
regulation on business. But much more needs to be done to allow
employment to grow and to generate higher growth without
inflation.
Japan's progress in creating more competitive and efficient
capital markets has been notable. But more action is needed to
ensure greater world access to Japanese markets in order to
reduce remaining rigidities in these markets.
A number of newly industrializing economies are running
current account surpluses. They must also do more to open their
markets and to allow the underlying strength of their currencies
to be reflected more fully.
In addition to these tasks, the preservation of an open
international trading system is critical in today's
interdependent world. To achieve greater trade liberalization,
particularly in agriculture, we strongly support the work of the
Uruguay Round of multilateral negotiations. We are committed to
working toward a successful round. All countries, however, are
responsible for the ultimate success of the round, not simply the
industrial nations.

- 4 As you know, the G-7 Ministers met yesterday. We have
advanced the coordination process by developing a medium-term
framework to enhance policy consistency and to clarify
medium-term objectives. We then focused on near-term peformance
indicators to serve as tools for evaluating our progress toward
our shared goals.
As part of our coordination process, we have also agreed to
develop for inclusion in the set of existing indicators a
commodity price indicator as an additional analytical instrument.
We remain fully committed to continuing to strengthen the
international economic policy coordination process. In this
context, the Fund plays an important role in supporting
multilateral surveillance. We encourage the Fund to continue to
make greater use of economic indicators, in both individual
countries and in the World Economic Outlook. Progress on this
front can and does reinforce the progress made elsewhere.
IMF Quotas
Turning to the Ninth General Review of Quotas, the Board of
Governors is currently voting on a draft resolution to extend the
period for the review to April 30, 1989. The United States
supports this resolution. The extension is appropriate since the
IMF has ample resources to fulfill its responsibilities.
In the context of severe budget constraints, our top priority
for multilateral support at this time must be a General Capital
Increase for the World Bank.
I would also like to call your attention to the rapid growth
in arrears to the IMF. This could make creditors less willing to
provide new capital to the Fund. Steps have been taken to
safeguard the IMF's financial position, but much more remains to
be done.
We call upon those members in arrears to make every effort to
discharge their obligations promptly, and we call upon the rest
of the membership to work actively to assist in the resolution of
this problem.
In light of the seriousness of this problem, we believe it
would be appropriate for the Executive Board to provide a report
on this to the next Interim Committee, outlining steps consistent
with the Fund's monetary character to eliminate existing arrears
and avoid further arrears.
SDR Allocation
Regarding an SDR allocation, we remain unconvinced that
the criteria specified in the Articles of Agreement for an
allocation — particularly the long term global need to
supplement existing reserve assets — have been met. Therefore,
we continue to oppose an allocation.
Thank you.

'REASURY NEWS
inrtment of the Treasury • Washington, D.C. • Telephone 566-2041

TEXT AS PREPARED
EMBARGOED FOR RELEASE UNTIL DELIVERY
Remarks by
The Secretary of the Treasury
James A. Baker, III
at the Afternoon Session of
The Interim Committee
of the International Monetary Fund
Washington, D.C.
Thursday, April 14, 1988
THE INTERNATIONAL DEBT STRATEGY
I welcome this opportunity to review recent developments and
current prospects for addressing international debt problems. In
my remarks this afternoon, I will focus on two aspects of the
debt problem:
o First, the considerable progress that has been made in
overcoming debt difficulties; and
o Second, the evolution of the strategy in response to the
changing circumstances of individual countries, including
developments in the "menu" approach.
Recent Progress
The growth-oriented strategy which we have pursued since 1985
has helped move us a considerable distance toward our goals.
Substantial progress is being made by debtor nations in putting
into place policies to bring about the necessary financial
stability and the structural foundations for stronger growth and
external balance.
o According to World Bank data, 8 of the 15 major debtor
countries grew at 4 - 5 percent or better last year,
compared with only three countries in 1985.
o Debt service ratios for the group have fallen by
one-fourth and interest service ratios by one-third
since 1982.
o Aggregate current account deficits have been sharply
reduced and are in a more manageable range.
B-1373

-2o

Export earnings have rebounded to near record highs, while
imports this year should be the highest since 1982.

Despite concerns about the commercial bank component and
delays in some instances, external financial support for these
efforts by the major debtor nations has been provided in amounts
that compare well with those needed to sustain the adjustment
effort.
The support includes approximately $17 billion in new
commercial bank loan commitments, over $220 billion in commercial
bank reschedulings, $17 billion in Paris Club reschedulings,
almost $14 billion in new World Bank loans, and $5 billion in
temporary payments financing from the IMF since October 1985.
The international financial system is on a sounder footing,
as commercial banks have increased capital relative to their loan
portfolios, and enhanced reserves. Moreover, some debtor nations
that experienced arrears are working to normalize relations with
creditors. Indeed, there is now a deeper understanding of the
negative repercussions of both unilateral moratoria and arrears
that I believe is constructive.
While these are positive developments, we must all recognize
that problems remain. A full return to creditworthiness by
debtors is not a short-term process and will not be completed
overnight. Additional efforts are still needed to reduce fiscal
and external deficits, control inflation, encourage new
investment and savings, and unleash the creative potential of the
private sector within debtor nations to help catalyze new loans,
equity flows, and the return of flight capital. These are
essential to improving and sustaining growth.
Industrial nations must also assure stronger growth within
their own economies as a stimulus to developing countries'
exports. They must renew their opposition to new barriers to
trade while jointly reducing existing barriers through the
Uruguay Round negotiations.
The important point is that the process is working;
demonstrable progress is being made; and it is vital to stay the
course. There is no viable alternative.
Evolution
The debt strategy also provides a basis for meeting the
changing circumstances of individual countries while maintaining
a steady focus on the following key principles:
o First, the importance of sustained economic growth;
o Second, the need for market-oriented reforms in debtor
countries;
o Third, external financial support for these reforms; and
o Fourth, a case-by-case approach to meet the individual
needs of debtor countries.

-3I firmly believe that these basic principles should continue
to guide our approach in the period ahead.
Within this context, our strategy is an evolutionary one.
By emphasizing a diversity of options for commercial banks and
innovative financing techniques, the "menu" approach to
commercial bank financing provides a vital mechanism for
sustaining commercial bank support and assisting the return to
creditworthiness. The development of such "menus" is an ongoing
process. The options selected in individual cases are the result
of voluntary choices developed and mutually agreed upon by the
debtor governments and commercial creditors themselves.
For several countries, additional borrowing will be needed
to support reforms, meet external obligations, and provide a
stimulus to production and growth. Such flows, if used
productively, can help to strengthen the debtors' own resources,
and they can be fully consistent with the objective of restoring
creditworthiness and reducing the real debt burden over time.
Trade credits, project loans, and onlending for specific uses in
the private sector all help to target resource flows for stronger
growth. New money bonds which have some of the characteristics
of a senior claim may also be attractive to some banks as a way
of providing additional financing.
Debt conversion techniques have also been playing an
increasingly important role in the debt strategy. They can
shorten the debt workout period for some countries, or reduce
current debt service burdens, or permit some banks to exit from
the concerted lending process, thus streamlining procedures and
accelerating the conclusion of new financing packages. Such debt
conversion transactions may hold benefits for all parties and can
supplement — but not supplant — the fundamental reform and
financial support elements of the current strategy.
A number of such conversions have already been negotiated.
Some $7.5 billion in debt/equity swaps have been consummated in
5 debtor countries in the past 3 years alone. Other countries
are developing debt/equity swap mechanisms. There is a growing
interest in debt/conservation and debt/charity swaps, as well.
Through these swaps, debt instruments can be retired in exchange
for local currency for important conservation or other social
programs in the debtor country.
We are encouraging the World Bank to provide technical advice
for debt/equity and debt/conservation swap programs. The U.S.
has already taken steps in both the regulatory and tax areas to
facilitate such conversions. Debt/equity conversions in
particular have considerable untapped potential and should be
given more attention by both debtors and creditors.
The recent Mexican debt exchange offer is yet another
innovative technique, which can increase flexibility for dealing
with the current stock of debt. I expect that other creative
financial market instruments of a similar nature will be
developed in the period ahead.

-4To be successful, such efforts must be voluntary, privately
financed, and developed within the market to benefit commercial
banks and debtor nations alike. In contrast, we strongly oppose
any approaches which are generalized, global, financed by
creditor governments or mandatory in nature. This includes the
creation of an international debt facility under the auspices of
the IMF or World Bank aimed at providing a global "quick-fix" of
the debt problem via debt purchases or securitization of
commercial bank loans.
The "siren song" of debt forgiveness through such approaches
is both impractical and counterproductive. Such schemes merely
shift the risk on private commercial bank debt to the
international financial institutions themselves and their member
governments —- which we certainly are not prepared to accept.
We would strongly discourage all from entertaining such
notions. They would not support the adoption of necessary policy
changes, but in fact would only delay needed adjustment and
financing. Moreover, they would undermine the restoration of
access to markets that some debtor nations are now achieving. In
sum, such proposals could distract attention from the real work
at hand: establishing a sound foundation for sustained growth.
Conclusion
The IMF has a continuing and central role to play within
the debt strategy. It must assist debtors in devising
growth-oriented reform programs, support those programs with
temporary balance of payments financing, and help catalyze
private financial flows. This committee will be discussing in
more detail this afternoon proposals on the evolving role of the
Fund in the debt strategy. I am pleased that we have come this
far in the short period since specific proposals were made in
these areas last fall. I hope we can soon put into place
strengthened mechanisms to support the debt strategy.
We consider it important that both the Fund and the Bank
adapt to changing circumstances while remaining true to their
basic missions. While supporting the evolution of the "menu"
approach, they should avoid creating unrealistic expectations
about the general availability of debt reduction, or using a
debtor country to test the market on new financing techniques
that might actually delay needed external support. Both
institutions must steer an active but cautious course, avoiding
the extreme of forcing their own predilections upon debtors and
commercial banks, while spurring both to reach agreement on
needed reforms and financing in a timely fashion.
As we know, this can be a real challenge. At the heart of
the task, however, is continuing the cooperative approach we have
been pursuing since 1982. We call upon all parties to focus on
practical steps for continuing to achieve progress within this
Thank you.
approach.
I am convinced that together we can assure its
success.

rREASURY NEWS
>artment of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UNTIL DELIVERY
Remarks by
The Secretary of the Treasury
James A. Baker, III
at the Afternoon Session of
The Interim Committee
of the International Monetary Fund
Washington, D.C.
Thursday, April 14, 1988
ROLE OF THE FUND IN ADJUSTMENT AND FINANCING
Thank you, Mr. Chairman.
The International Monetary Fund has played a central and
effective role in the international debt strategy and should
continue to do so. The Fund has successfully adapted to the
changing needs and situations of its members. At the same time,
it has adhered to the basic principles of its monetary charter
that underline its real effectiveness.
As we consider steps to strengthen the IMF's capacity to
address current problems, we must not lose sight of certain key
points.
o Any new IMF policies or financing mechanisms must be fully
consistent with the revolving character of IMF resources
and the use of those resources to catalyze, not supplant,
other financing.

The increased focus on growth-oriented structural reforms
should enhance, not weaken, the effectiveness of IMF
conditionality, and should complement, not replace, the
Fund's traditional focus on macroeconomic policy.

B-1374

-2A Combined Compensatory and Contingency Financing Facility
The IMF Executive Board has reached agreement on a new
combined compensatory and contingency financing facility. We
welcome this agreement, which in our view represents a fair and
constructive compromise that takes into account a wide range of
interests. The prospects for success for this new facility are
enhanced because it was born out of a consensus that reflected
the spirit of cooperation and compromise that is central to the
debt strategy. All told, I believe the facility will strengthen
considerably the IMF's ability to help cushion members' reform
programs from unforeseen adverse developments in the world
economy.
By giving them greater assurance that their growth-oriented
reforms will not be thrown off-track by external shocks,
countries will have greater confidence to embark on bold,
comprehensive economic programs. As a result, the ability of
developing countries to implement corrective measures while
sustaining growth will be enhanced.
Incorporation of the old Compensatory Financing Facility into
this new combined facility, along with other changes to its
operations, will improve its effectiveness, while reducing its
size. I believe the Committee should strongly endorse the
Executive Board's agreement and call for the early resolution of
remaining technical issues in order that the new combined
compensatory and contingency facility can enter into operation
promptly.
Extended Fund Facility and Program Design
There is growing recognition that restoration of a viable
balance of payments position cannot be achieved solely through
macroeconomic and exchange rate policies. These are fundamental,
but there is a need also for broad structural reforms that
enhance growth. The specific structural measures will vary from
country to country, but in general they should increase the
market orientation of the economy to improve the efficiency of
resource allocation. Such measures might include:
o A greater focus on market determined prices, by allowing
exchange rates to reflect supply and demand, removing
subsidies, and liberalizing price regimes;
o Tax reform to increase incentives to work, save and invest
and financial market reform to provide for more efficient
allocation of savings; and
o The liberalization of trade and foreign direct investment
practices to open the economy and provide access to
foreign goods, technology and capital.
The IMF's Extended Fund Facility (EFF) is designed to promote
structural reforms. The United States supports efforts to
revitalize the EFF, but believes that this can be accomplished
within the current framework and policies of the facility.

-3Revitalization should proceed cautiously on a case-by-case
basis as we need to ensure that the EFF is more effective than it
has been in the past. Use of the EFF could be appropriate for
members that have already made some progress in correcting
domestic and external imbalances and that are able to spell out a
strong structural reform program to complement an equally bold
macroeconomic program.
In such selected cases, strong programs deserve strong
external financial support, including the Fund.
In this connection, I have noted some concern that the IMF
has experienced net reflows in the past 2 years. We should not
be concerned about this since it is appropriate and consistent
with the unique and revolving character of the IMF, and reflects,
in part, the heavy IMF lending in the early 1980s. Furthermore,
many of the countries that used Fund resources at that time are
not now seeking IMF assistance. This development does not in any
way conflict with the need for the Fund to continue to play an
active role in supporting the economic programs of individual
debtors.
The need for the IMF to promote structural reforms is so
important and pervasive that structural objectives should be an
integral part of virtually all Fund programs, not just Extended
Arrangements. As I proposed at last year's Annual Meetings,
structural performance criteria should be added to IMF programs
to facilitate a greater structural focus. At the same time,
longer term stand-by and extended programs should include
semiannual performance criteria and disbursements in order to
provide authorities more time to focus on their medium-term
programs. I call on the Executive Board to complete its work on
these issues soon in order that steps can be taken to implement
agreed proposals.
The IMF and World Bank both have roles to play in promoting
growth-oriented structural reforms. We view these roles as
complementary, and believe that they can best be achieved through
close collaboration between the two institutions. While notable
progress has been made, particularly through the development of
the Policy Framework Papers for the low-income countries, there
is a pressing need for further improvements, especially in regard
to the middle-income countries. I hope the Boards of both
institutions will give further attention to these issues after
the Interim and Development Committee meetings.
Conclusion
Mr. Chairman, nearly 6 years ago the IMF took up the
challenge arising from the debt crisis with vigor and vision.
Nearly 3 years ago, the Fund helped lead the way in the second
phase by emphasizing the need for growth in resolving debt
problems on a lasting basis. In both periods, the Fund
contributed significantly to maintaining a sound world economy
and stable financial system.

-4This success is, I believe, in no small measure due to the
Fund's ability to adapt to changing circumstances while being
true to those principles that safeguard its unique monetary
character. As we look to the future, I continue to believe that
the Fund should play a central and active role in the debt
strategy. This does not imply a larger financial role, however,
nor a more interventionist approach towards the precise elements
of any particular financing package. Instead, it should continue
to be a catalyst for implementing strong economic programs and
for Thank
appropriate
you. external financing in support of those programs.

TREASURY NEWS
Department
of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 10:00 A.M. DST
April 14, 1988

TESTIMONY OF FRANCIS A. KEATING, II
ACTING CHAIRMAN OF THE ENFORCEMENT COORDINATING GROUP
OF THE NATIONAL DRUG POLICY BOARD
BEFORE THE HOUSE SELECT COMMITTEE ON NARCOTICS
APRIL 14, 1988
Mr. Chairman, I am pleased to appear before you today as the
Acting Chairman of the Enforcement Coordinating Group of the
National Drug Policy Board to testify on the enforcement, or
"supply side," Lead Agency Strategies recently presented to the
Congress by the Policy Board.
With me this morning is Don Newman, Under Secretary of the
Department of Health and Human Services. Mr. Newman is appearing
on behalf of Policy Board Vice-chairman Otis Bowen and will be
reviewing the Policy Board's "demand-side*' strategy implementation plans. Together, we will bring you up to date on our
efforts to improve the national drug policy and strategy process,
as the Attorney General promised you last December.
Specifically, I will describe the new comprehensive national
strategy recently developed for the National Drug Policy Board by
the five enforcement Lead Agency Committees, and the process by
which these strategies were created.
As you know, the National Drug Enforcement Policy Board was
created by the National Narcotics Act of 1984. An Executive
Order of March, 1987 added to the Board responsibility for
demand-side issues and to reflect this expanded focus changed-the
name to the National Drug Policy Board. The National Drug Policy
Board is organized in three tiers:
1. The cabinet-level Policy Board, chaired by the Attorney
General, meets monthly and develops overall drug
program policy, facilitates coordination, and resolves
interagency issues.
2. Two agency-level Coordinating Groups, one which deals
with demand-side issues and one which deals with
supply-side issues, translate the Board's policy
decisions into an integrated strategy. Dr. Ian
Macdonald chairs the Drug Abuse Prevention and Health
Group, and I chair the Drug Enforcement Group.
3. Nine lead agency committees, created by the Board in
May, 1987, submit strategy plans to the Policy Board
for approval, implement the strategy, and work to

ensure interagency coordination within their particular
area of responsibility.
As noted in the March 12, 1988, GAO report on the Policy
Board—and I quote—"The Policy Board brings together...officials
at several levels—cabinet members, agency heads, and program
managers—enabling them to discuss, plan, and coordinate operations and programs and provides a forum to discuss and resolve
interagency disputes. GAO believes that the Policy Board's
efforts to facilitate coordination have been worthwhile and
responsive to the requirements of the law establishing the Policy
Board."
"
As part of its coordination effort, in May, 1987, the Policy
Board issued its Lead Agency Directive designating lead agencies
for the nine functional areas of the Federal drug control program. Of the nine lead agencies, five were designated for
Enforcement. The Drug Enforcement Administration (DEA) is the
lead Federal agency responsible for drug investigations and for
intelligence. The Justice Department is the lead Federal agency
for the prosecution of drug trafficking investigations and
related crimes. The State Department is the lead Federal agency
responsible for coordinating the U.S. drug control efforts
overseas. The Customs Service is the lead Federal agency responsible for the interdiction of illicit drugs into the United
States; Coast Guard is the principal deputy.
In August, 1987, the Attorney General tasked each Lead
Agency Committee to develop a document detailing the policies,
strategies, programs, objectives, and necessary resources for its
area of responsibility. In September, 1987, the initial drafts
of these strategies were provided to the Policy Board staff.
In October, 1987, the Enforcement Coordinating Group and the
Prevention and Health Coordinating Group reviewed each draft
strategy. After revisions were made, the Policy Board reviewed
each strategy document during November and December, 198 7.
In January, 1988, the Policy Board approved in principle the
nine Lead Agency Strategies. In addition, the Board reviewed and
discussed the President's FY89 Federal Drug Budget, which provided
an overall increase of 13% over FY8 8. In February, the Lead
Agency Committees were requested to convert their strategy
planning documents into FY8 8-89 strategy implementation plans
consistent with available resources.
Members of the House and Senate and their staffs were
briefed on the strategy implementation plans on February 25 and
-2- final drafts of each Lead
26, 1988. On March 9 and 15, 1988,

Agency Strategy implementation plan were provided to over 150
members of Congress.
I will now summarize the contents of the five Enforcement
Strategies beginning with the strategy developed by the
Intelligence Committee chaired by DEA.
INTELLIGENCE STRATEGY
The principal objectives of this strategy are to:
o Expand and improve the collection, analysis, and
dissemination of intelligence information; improve
support to programs and functions of other strategies;
and improve coordination.
o Assess responsibility for drug intelligence requirements.
o Improve all-agency, all-source field collection.
o Ensure full dissemination in a timely manner and in a
useful format.
o Support tactical, strategic and operational requirements with increased analysis and estimation capabilities.
o Integrate systems for communication, storage, retrieval
and sharing of intelligence information.
INTERNATIONAL STRATEGY
The principal objectives of the strategy developed by the
International Committee are to reduce the supply of cocaine
shipped from Latin America; reduce the amount of heroin shipped
from Asia and Mexico; reduce the amount of marijuana entering the
United States from worldwide sources; increase intolerance for
drugs and stimulate focused support for effective narcotics
control worldwide; eliminate major trafficking networks and
cartels; and secure increased international cooperation in
worldwide narcotics control matters.
Highlights of this strategy include:
o Negotiation of international agreements to provide for
the reduction of the amount of coca, cannabis, and
poppy cultivation through eradication and other law
enforcement operations.
-3-

Increasing host-nation eradication and other law
enforcement activities, including destruction of
clandestine laboratories and airfields, through cooperation with country law enforcement agencies, enhanced
training, better intelligence sharing, and tight
controls on precursor chemicals.
o Strengthening the legitimate economies of Latin American
and Caribbean countries and encouraging these countries'
acceptance and adoption of the U.S. Government's
cocaine control efforts through additional economic
support and military assistance.
o Utilizing public diplomacy initiatives to raise public
awareness and increase demand-reduction efforts worldwide.
o Assisting countries in reducing the demand for heroin,
cocaine, and marijuana through dissemination of preventic
and treatment information, technical assistance, and
training with host countries and international organizations.
o Assisting nations to strengthen their legal and judicial systems to eliminate narcotics trafficking organizations.
o Securing international cooperation on financial investig<
tions and asset seizure and forfeiture to prohibit
money laundering of narcotics profits.
o Gaining consensus among developed nations that positive
performance in narcotics control is a condition for aid
to producing and trafficking countries.
INTERDICTION STRATEGY
The primary goal of the National Interdiction effort is to
reduce the quantity of illegal drugs entering the United States
by targeting the transportation link between drug supply and
demand. More specifically, interdiction focuses on the detection,
sorting, interception/tracking and apprehension of illegal drugs
as they move from their departure zone in source countries, along
smuggling routes (transit zone) to our borders (arrival zone).
The objective of the interdiction strategy is to raise the level
of risk to the point where significant numbers of organized
smuggling groups will cease operation and to deter other potential
smugglers from entering the trade.
-4-

The Interdiction Strategy is divided into three parts which
address the separate but interrelated issues of air, land, and
maritime smuggling. The following is a synopsis of the three
plans:
Air Interdiction Strategy Implementation Plan
The Air Interdiction Plan is designed to interdict general
aviation aircraft transporting illegal drugs into the United
States. Objectives of the Plan are to:
1. Strengthen a fixed detection net in the Southeast.
2. Develop a fixed detection net in the Southwest.
3. Begin to establish a mobile detection net in departure
zones near source and transit countries.
4. Improve the sorting process by establishing command,
control, communications, and intelligence (C3I) Centers
in the Eastern and Western United States.
5. Improve interception/tracking and apprehension capabilities to respond to improved detection and sorting.
6. Provide dedicated air detection support to the Maritime
Interdiction Strategy Plan.
Land Interdiction Strategy Implementation Plan
The Land Interdiction Strategy Plan is intended to interdict
illegal drugs at airports, seaports, land border ports, between
ports of entry and in international mail. Objectives of the Plan
are to:
1. Improve targeting through more sophisticated use of the
Automated Commercial System (ACS) computer data base
for every commercial importation, especially aimed at
containerized cargo.
2. Increase the number of "100 percent" inspections of
containers and commercial trucks.
3. Mobilize available resources along the Southwest Border
through increased coordination of all agencies (Operation
Alliance).

-5-

Expand cooperative programs and data exchange with
private industries involved in international trade and
travel to improve detection and sorting systems.
5. Establish an information base for interdiction targeting
in departure zones through special analytical teams.
Maritime Interdiction Strategy Implementation Plan
The Maritime Interdiction Plan is intended to interdict
illegal drugs being transported through the maritime region into
the United States. Objectives of the Plan are to:
1. Increase maritime interdiction capabilities in departure
zones off source countries to perform surge and pulse
operations.
2. Increase detection and apprehension assets in Caribbean
"Choke Points".
3. Address air drops in the Bahamas with helicopters, by
operating existing radar balloons (aerostats) and
adding aircraft detection and maritime interdiction
assets in the arrival and transit zones.
4. Improve sorting of maritime drug smugglers from legitimate vessel traffic in the arrival zone.
INVESTIGATIONS STRATEGY
The principal objectives of the Investigations strategy are
to immobilize trafficking organizations by arresting the most
significant members; reduce the availability of illegal drugs
through seizures, eradication, and precursor chemical controls;
and remove drug-related assets through seizures and forfeitures.
The objectives of this strategy are to:
o Emphasize multi-agency investigations.
o Target and prioritize the cartels and organizations of
the highest level violators.
o Monitor distribution of precursor chemicals.
o Increase initiatives against clandestine laboratories.
o Support domestic and foreign eradication.
o Apply seizure and forfeiture statutes.

-6-

Assign resources to priority targets.

PROSECUTION STRATEGY
The principal focus of the prosecutions strategy is to
better marshal our Federal efforts to reduce the supply of
illegal drugs in the United States by pro-active targeting of
major traffickers, assisting state and local narcotics prosecutions, and attacking significant local and regional narcotics
threats. The objectives of this strategy are to:
o Divide prosecution and assistance efforts into three
categories: priority targets; state and local assistance; and regional narcotics threats.
o Direct 80% of Federal narcotics prosecution resources
and virtually 100% of Organized Crime Drug Enforcement
Task Force (OCDETF) resources against priority targets
beginning in FY89.
o Create a high-level targeting group to maintain the
focus of Federal investigative and prosecution efforts
on multi-national traffickers and other priority
targets.
o Support state and local anti-drug efforts through
equitable sharing and adoptive forfeiture funds.
o Improve state and local training programs.
o Draft model legislation on money laundering, RICO,
electronic surveillance, asset forfeiture, enhanced
penalties and grand jury powers.
o Curtail the demand for drugs through the selective
prosecution of users consistent with our zero tolerance
policy.
o Utilize federal cross-designation, technical and
laboratory facilities, and non-English language capability to improve effectiveness of Federal, state and
local prosecutions.
o Prosecute selected local and state narcotics threats to
maintain public confidence and avoid perception of gaps
in narcotics enforcement.

-7-

Mr. Chairman, that concludes my formal statement.
now turn our presentation over to Under Secretary Newman
review of the "demand-side" strategy implementation plan

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UNTIL DELIVERY
Remarks by
The Secretary of the Treasury
James A. Baker, III
at the Morning Session of
The Development Committee
of The World Bank and
The International Monetary Fund
Washington, D.C.
Friday, April 15, 1988
Chairman Chidzero, President Conable, Managing Director
Camdessus:
I welcome this opportunity to discuss the challenges facing
the developing countries and what the world community, including
developed and developing countries, can do to address them.
We are particularly pleased with the establishment of the
Multilateral Investment Guarantee Agency (MIGA) this week. We
look forward to MIGA taking the lead role within the Bank Group
in providing technical assistance and policy advice to stimulate
the flow of new investment to developing countries.
The debt difficulties of the middle-income, heavily-indebted
countries continue to be a priority concern. Cooperative efforts
focused on achieving stronger, sustained growth through economic
reforms and adequate international finance remain the only viable
and realistic approach for addressing these problems.
While a lot more must be done, we can take heart at how far
we have come. Needed reforms are being adopted in most of these
countries. According to the World Bank, growth in 1987 was in
the 4 - 5 percent range or higher for 8 of the 15 major debtors.
Export earnings rose sharply last year; imports have increased;
and debt service ratios have fallen.
The development of a "menu" approach to commercial bank
financing packages provides additional flexibility for both new
financing flows and new debt conversion techniques. Trade
credits and project loans can help target financing for more
specific end uses to boost production and growth. Debt/equity
swaps and other debt conversions can help reduce debt service
burdens and support new investment, environmental objectives, or
B-1375
research and development.

-2The proposed General Capital Increase for the World Bank wi
position the Bank to maintain its strong support for debtor
reforms. We believe that the key contribution of the World Ban
should be to encourage sound economic policies in the debtor
countries that will catalyze private flows of capital. The Ban
and the Fund must continue to work with debtor nations to reduc
fiscal deficits, control inflation, boost domestic savings and
investment, and attract both foreign equity and reflows of flig!
capital.
While voluntary, market-based, debt conversion techniques c,
be a useful part of the evolving menu approach, it is the
position of the United States to oppose generalized debt relief
such as through the creation of a new international facility.
Shifting risk to international financial institutions and tneir
member governments is simply not a realistic option.
Mr. Chairman, the resolution of debt problems will take tim<
and patient and determined effort. Clearly, we all have an
important role to play in advancing progress under the debt
strategy. This evolutionary approach is the only realistic
framework for addressing debt problems.
Turning now to the low-income countries, we note that in
comparison with the early 1980s, the economic and financial
prospects of the Sub-Saharan African countries are somewhat more
favorable. During the past year, creditor countries pledged a
substantial volume of resources that will support economic
adjustment programs in the countries of the region, including
through the Bank's new cofinancing program and the Fund's
Enhanced Structural Adjustment Facility.
The Bank estimates that these resources should meet the
financing needs over the next few years of the poorest and most
heavily indebted of those countries that are committed to
economic reform. The resources will also help ensure positive
economic growth in the context of strong programs of
macro-economic and structural reform. Policy Framework Papers
(PFPs) should provide a focal point for Bank and Fund assistance
to borrowers in the formulation of such programs. Through this
and other efforts, Bank-Fund collaboration should be greatly
strengthened.
The success of the low-income Asian countries in maintaininc
good rates of economic growth is praiseworthy. My country has
provided them substantial aid in the past, and they will remain
an important priority for the future.
Environmental conservation is not only a social issue but
also an economic issue. The World Bank should reinforce the
understanding that economic growth, development, and
environmental preservation must be approached as an integrated
whole. The Bank has taken important steps to improve its
management of environmental issues. But we believe there is a
need for stronger action on the environmental front, particular!
in implementing policies already in place. And we must continui
to focus closely on the environment issue in future meetings.

-3Mr. Chairman, our common interests are also at stake in the
GATT Round. Clearly, developed countries have a responsibility
to lead efforts worldwide to liberalize trade. However,
developing countries, and in particular, major traders, must also
assume greater responsibilities that match their growing
importance in the world economy. In this context, we believe
that trade restrictions that try to address balance of payments
problems actually damage developing economies in the long run.
GATT rules in this area should be reviewed and revised.
Finally, protectionist agricultural policies are among the
most serious problems in the world trading system. The United
States has proposed a comprehensive solution — a complete
phase-out over 10 years of all agricultural subsidies and
barriers to trade. Mr. Chairman, the Uruguay Round is serving
our common interests. I assure you that the United States will
work hard for concrete results for the mid-term review, and for
a successful outcome of the Round.
My delegation looks forward to further consideration of the
items on our agenda as our meetings progress.

TREASURY NEWS

epartment of the Treasury e Washington, D.c. • Telephone 566FOR IMMEDIATE RELEASE Contact: Bob Levine
April 15, 1988
TREASURY RELEASES
DEBT-FOR-NATURE STUDY

(202) 566-2041

On April 13, 1988, the Secretary of the Treasury submitted a
report to Congress regarding possible initiatives by multilateral development banks (MDBs) to facilitate "debt-for-nature"
swaps with developing countries.
"Debt-for-nature" swaps involve an exchange or cancellation
of an external debt obligation in return for environmentrelated action on the part of a debtor nation. Typically,
a conservation or environmental group buys or receives as
a donation the external debt of a developing country; exchanges
the debt paper for local currency from the developing nations
central bank; and pledges to use the proceeds for conservation
programs in that country.
The Treasury Department supports the development of private
sector initiatives aimed at converting a portion of developing
nations' debt into local currency for conservation and environmental use.
The Treasury report offers a description of these debt conversions,
and progress to date. It also offers a description of current
World Bank and other MDB environmental programs, as well as
recommendations regarding World Bank initiatives and a tentative
schedule for following through on these proposals.
The Treasury Department recommends World Bank initiatives in
the following areas:
oo "piggy-backing" debt-for-nature conversions onto MDB loans
and environmental programs,
oo having the World Bank serve as an "information broker"
and help set priorities regarding conservation,
oo integrating environmental policy with the Bank's structural
adjustment and sector loans,
oo considering a pilot program in countries with swap programs,
in order to integrate all of the recommendations, and,
in this context,
oo exploring the possibility of making new loans available
for tropical forest and wetland protection, and offering
technical assistance regarding the start-up of debt-for-nature
programs.
B-1376

TREASURY NEWS

apartment of the Treasury • Washington, D.c. • Telephone 556-2041
EMBARGOED FOR RELEASE UNTIL DELIVERY .
Expected at 1:00 P.M., DST
April 18, 1988
STATEMENT OF THE HONORABLE JAMES A. BAKER, III
SECRETARY OF THE TREASURY
BEFORE THE
SENATE COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE ON TREASURY, POSTAL SERVICE
AND GENERAL GOVERNMENT
MONDAY, APRIL 18, 1988
MR. CHAIRMAN, MEMBERS OF THE COMMITTEE:
It is my honor to appear before this Subcommittee today to
discuss the operating budget request for the Department of the
Treasury for Fiscal Year 1989.
In March, I testified before the Senate Budget and
Appropriations Committees. At that time, we discussed the
Federal budget for Fiscal Year 1989 and the Nation's economy. I
noted that this President's Budget was developed to uphold the
deficit reduction efforts that characterized last fall's historic
Budget Summit. The Budget was crafted in accord with the spirit
of the Bipartisan Budget Agreement that was produced and offers
the prospect of substantive progress toward our ultimate goal of
deficit elimination.
Today, my remarks focus upon that portion of the overall
President's Budget that pertains to the operations of the
Department of the Treasury. This Departmental budget was
developed in accordance with the Bipartisan Budget Agreement. It
supports the revenue targets in that agreement. It provides for
the effective and efficient conduct of necessary Federal
responsibilities and does so within the parameters of the
governmentwide effort to contain and reduce deficit spending.
Essential governmental functions entrusted to the Department
of the Treasury include:
o Collecting the government's revenues through an
efficient administration of the Nation's tax system;

B-J377

- 2o

Combating illegal drug trafficking;

o Conducting other enforcement activities, such as
protecting the President and Vice President as well as
candidates for these offices, enforcing trade laws,
apprehending violators of federal firearms laws, and
providing law enforcement training;
o Maintaining government accounts and financing the
public debt;
o Producing the Nation's coin and currency; and
o Advising the President on the economy and fiscal
policies.
For Fiscal Year 1989, the Department is requesting a total
budget of $7.7 billion and 153,358 total staff years. This
represents an increase of $283 million and 1,557 FTE over the
Fiscal Year 1988 levels contained in the Continuing Resolution.
There are several overall objectives in this Budget that I would
like to highlight:
I. Our key objective is to maintain an effective tax
administration system and to continue the orderly transition to
tax reform begun in Fiscal Year 1988.
The request for the Internal Revenue Service will promote
tax compliance and continue to fund high yielding revenue
programs, including enhancements begun in Fiscal Year 1988.
Funding for IRS direct enforcement activities is designed to
support revenue targets set in the Bipartisan Budget Agreement.
This budget provides for increased emphasis on modernizing
tax administration and provides for continued support begun in
earlier years for the "service side" of IRS—processing of
returns and service to taxpayers—especially important during the
transition to tax reform.
Finally, the IRS budget permits an expansion of
international operations along with enhanced activity aimed at
detecting tax fraud through criminal investigations.
II. Our second objective is to meet effectively our law
enforcement and protection responsibilities and in particular to
continue strong support for the President's War on Drugs. The
request for Customs builds on the strong base developed in Fiscal
Years 1987 and 1988 by allowing for a strengthening of drug
enforcement staffing and the effective operation of air
interdiction assets previously acquired or modified.
In addition to its role in drug enforcement, the Customs

- 3 -

Service budget provides for enforcement of the Nation's import
and export laws along with rapid clearance of passengers and
cargo. Corrective legislation will be forthcoming to make the ad
valorem user fee consistent with provisions of the General
Agreement on Tariffs and Trade. The level of resources contained
in this budget will allow the Customs Service to collect an
estimated $17.8 billion in revenue.
The Bureau of Alcohol, Tobacco and Firearms will oversee the
collection of over $10 billion in excise taxes in Fiscal Year
1989. This budget supports the efficient collection of those
revenues as well as funds the development of an improved law
enforcement information system.
During the first half of Fiscal Year 1989, the Secret
Service will conclude those additional protective
responsibilities related to the 1988 Presidential campaign and
election. This request for the Service addresses these
responsibilities and includes support for better security,
modernized information and communications systems and centralized
headquarters administration.
In FY 1989, the budget of the Federal Law Enforcement
Training Center will provide for the execution of its basic law
enforcement training programs. This will include support of
anti-terrorist training and training for Operation Alliance.
III. A third major objective for the Department is to effectively
manage the Nation's finances and service the public debt.
This budget supports continued efforts to promote financial
integrity governmentwide in the areas of cash management, credit
administration and financial information. Systems modernization
efforts proposed in the fiscal services area will provide more
secure and efficient management of the government's financial
resources.
IV. Fourth, the production of sufficient coinage and currency to
meet the Nation's business transaction needs is the next
important objective in this budget. The requested budget for the
U.S. Mint supports the essential mission of the manufacture and
supply of domestic coins, as well as research and development
initiatives to improve production operations. The Bureau of
Engraving and Printing does not require annual appropriations.
V. The funding request for Treasury's Departmental Offices will
help secure the formulation of national economic, financial and
tax policies and the management oversight of bureau operations.
In sum, our $7.7 billion request for the Department of the
Treasury represents:

- 4o

A necessary investment in the IRS to preserve the
integrity of tax administration and to maintain a high
level of service to taxpayers in the post-tax reform
period;
o A continuation of effective revenue yielding activities
at the IRS;
o A continuation of the strong support of the President's
War on Drugs through effective law enforcement
activities; and
o A commitment to maintain the essential governmental
functions of the Department.
Mr. Chairman, that concludes my opening remarks. I will be
happy to answer any questions that you or the other Subcommittee
members may have.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 18, 1988

CONTACT:

Office of Financing
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,402 million of 13-week bills and for $6,409 million
of 26-week bills, both to be issued on April 21, 1988,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing
j u i v 21. 1988
Discount Investment
Rate 1/
Rate
Price

Low
High
Average
a/ Excepting 1
b/ Excepting 1
Tenders at the
Tenders at the

Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS
y

5.77%a/
5.94%
98.541 :
6.09%V
6.37%
96.921
5.79%
5.96%
98.536 :
6.17%
6.46%
96.881
5.78%
5.95%
98.539 :
6.14%
6.42%
96.896
tender of $4,850,000.
tender of $4,175,000.
high discount rate for the 13-week bills were allotted 81%
high discount rate for the 26-week bills were allotted 11%
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received
$
36,520
23,888,955
24,525
32,470
38,435
26,145
1,878,185
10,000
3,270
33,970
29,965
1,052,495
188,920

36,020
$
5 ,789,810
24,525
32,415
38,435
26,145
137,240
10,000
3,270
30,700
19,965
64,495
188,920

$27,243,855

Accepted

23,550
17,164,110
20,005
26,090
26,360
28,150
1,003,580
11,850
5,205
39,490
25,620
1,027,580
406,645

23,550
$
5 ,416,860
20,005
26,090
26,360
28,150
260,780
11,850
5,205
39,490
20,620
123,440
406,645

$6 ,401,940

: $19,808,235

$6 409,045

$23,624,885
871,170
$24,496,055

$2 ,782,970
871,170
$3 ,654,140

• $15,673,935
'
879,900
• $16,553,835

$2 ,274,745
879,900
$3 ,154,645

2,000,000

2 ,000,000

•

1,539,300

1 ,539,300

747,800

1,715,100

1 ,715,100

$27,243,855

$6 ,401,940

: $19,808,235

$6 .409.045

Equivalent coupon-issue yield.

B-1378

26-week bills
maturing October 20, 1988
Discount Investment
Price
Rate
Rate 1/

TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
EMBARGOED FOR RELEASE UNTIL DELIVERY
Expected at 11:00 A.M., DST
April 19, 1988

STATEMENT OF THE HONORABLE JAMES A. BAKER, III
SECRETARY OF THE TREASURY
BEFORE THE
HOUSE COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE ON TREASURY, POSTAL SERVICE
AND GENERAL GOVERNMENT
TUESDAY, APRIL 19, 1988
MR. CHAIRMAN, MEMBERS OF THE COMMITTEE:
It is my honor to appear before this Subcommittee today to
discuss the operating budget request for the Department of the
Treasury for Fiscal Year 1989.
In March, I testified before the Senate Budget and
Appropriations Committees. At that time, we discussed the
Federal budget for Fiscal Year 1989 and the Nation's economy. I
noted that this President's Budget was developed to uphold the
deficit reduction efforts that characterized last fall's historic
Budget Summit. The Budget was crafted in accord with the spirit
of the Bipartisan Budget Agreement that was produced and offers
the prospect of substantive progress toward our ultimate goal of
deficit elimination.
Today, my remarks focus upon that portion of the overall
President's Budget that pertains to the operations of the
Department of the Treasury. This Departmental budget was
developed in accordance with the Bipartisan Budget Agreement. It
supports the revenue targets in that agreement. It provides for
the effective and efficient conduct of necessary Federal
responsibilities and does so within the parameters of the
governmentwide effort to contain and reduce deficit spending.
Essential governmental functions entrusted to the Department
of the Treasury include:
o Collecting the government's revenues through an
efficient administration of the Nation's tax system;
B-1379

Combating illegal drug trafficking;

TREASURY NEWS

department of the Treasury • Washington, D.C. • Telephon
FOR RELEASE AT 4:00 P.M.
April 19, 1988
TREASURY'S WEEKLY BILL OFFERING

CONTACT:

Office of Financing
202/376-4350

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be Issued April 28, 1988.
This offering
will result in a paydown for the Treasury of about $200 million, as
the maturing bills are outstanding in the amount of $12,989 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Daylight Saving time, Monday, April 25, 1988.
The two series offered are as follows:
91 -day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
January 28, 1988,
and to mature July 28, 1988
(CUSIP No.
912794 QG 2 ) , currently outstanding in the amount of $6,543 million,
the additional and original bills to be freely interchangeable.
182
-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
October 29, 1987,
(CUSIP No.
a n d to mature October 27, 1988
912794 QB 3), currently outstanding in the amount of $9,284 million,
the additional and original bills to be freely interchangeable.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing April 28, 1988.
Tenders from Federal Reserve
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to Federal Reserve Banks,
as agents for foreign and international monetary authorities, to
the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. Federal
Reserve Banks currently hold $1,790 million as agents for foreign
and international monetary authorities, and $3,257 million for their
own account. Tenders for bills to be maintained on the book-entry
B-1380 of the Department of the Treasury should be submitted on Form
records
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of
the circulars, guidelines, and tender forms may be obtained
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS

lepartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
April 20, 1988

CONTACT:

Office of Fin
202/376-4350

TREASURY TO AUCTION $8,500 MILLION OF 2-YEAR NOTES
The Department of the Treasury will auction $8,500 million
of 2-year notes to refund $9,876 million of 2-year notes maturing
April 30, 1988, and to paydown about $1,375 million. The public
holds $9,876 million of the maturing 2-year notes, including $867
million currently held by Federal Reserve Banks as agents for
foreign and international monetary authorities.
The $8,500 million is being offered to the public, and any
amounts tendered by Federal Reserve Banks as agents for foreign
and international monetary authorities will be added to that
amount. Tenders for such accounts will be accepted at the
average price of accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $1,429 million
of the maturing securities that may be refunded by issuing additional amounts of the new notes at the average price of accepted
competitive tenders.
Details about the new security are given in the attached
highlights of the offering and in the official offering circular.
oOo
Attachment

B- 1381

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 2-YEAR NOTES
TO BE ISSUED MAY 2, 1988
April 20, 1988
Amount Offered:
To the public

$8,500 million

Description of Security:
Term and type of security
2-year notes
Series and CUSIP designation .... Z-1990
(CUSIP No. 912827 WC 2)
Maturity date
April 30, 1990
Call date
No provision
Interest rate
To be determined based on
the average of accepted bids
Investment yield
To be determined at auction
Premium or discount
To be determined after auction
Interest payment dates
October 31 and April 30
Minimum denomination available .. $5,000
Terms of Sale:
Method of sale
Yield auction
Competitive tenders
Must be expressed as an
annual yield, with two
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the average price up to $1,000,000
Accrued interest
payable by investor
None
Payment Terms:
Payment by noninstitutional investors
Full payment to be
submitted with tender
Payment through Treasury Tax
and Loan (TT&L) Note Accounts ... Acceptable for TT&L Note
Key Dates:
Option Depositaries
Wednesday, April 27, 1988,
Receipt guarantee
of tendersby
Deposit
prior to 1:00 p.m., EDST
designated
Acceptable
Settlement institutions
(final payment
due from institutions):
a) funds immediately
Monday, May 2, 1988
available to the Treasury
Thursday, April 28, 1988
b) readily-collectible check

TREASURY NEWS
epartment of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 12:30 P.M., EDT
Remarks by
The Secretary of the Treasury
James A. Baker, III
to the Canadian Club of Ottawa
Chateau Laurier Hotel
Ottawa
Ontario, Canada
Thursday, April 21, 1988
CANADA-U.S. FREE TRADE AGREEMENT: THE INTERNATIONAL PERSPECTIVE
This has been a noteworthy year for Canada. Two major
international events — the Winter Olympics and the World
Economic Summit — are hosted by Canada this year. They should
focus the world's attention on something that many of us already
know — that Canada is a vibrant, exciting nation that is leaving
its mark on many quarters of the world.
As I watched the Olympic games, I couldn't decide who most
deserved a gold medal — the many athletes, or their Canadian
hosts, whose vitality, efficiency, and courtesy ensured Calgary's
top-rate performance. And I fully expect that the world leaders
who gather in Toronto in June will be equally impressed with the
gold-medal quality of your dynamism and international leadership.
They will certainly be aware of the tremendous economic
growth that Canada has achieved over the past four years — and
of the initiatives Prime Minister Mulroney and Finance Minister
Wilson have taken to encourage entrepreneurship and innovation.^
I believe these policies have had much to do with Canada's
impressive economic performance. Canada has led the seven major
industrialized countries in real GDP growth over the past four
years. Since 1984, Canada has created more than one million new
full-time jobs, and reduced the unemployment rate significantly.
Moreover, Canada's prospects for this year — the sixth
consecutive year of expansion — are excellent.

B-1382

-2I hope one of the crowning achievements of the Mulroney
Government will be the Canada-U.S. Free Trade Agreement. I could
expound on what the agreement will mean for Canada, but the Prime
Minister and many members of his government already have stated
that case eloquently and persuasively.
So instead I will focus on some international aspects of the
agreement. I believe Canada and the U.S. can take the lead in
offering the world a model trade agreement. This agreement can
serve not only as a pattern for future bilateral agreements, but
also as a catalyst for action on the multilateral front.
A Perspective from the Past
The postwar achievements of multilateralism create an
understandable caution about any bilateral trading agreement.
But it's useful to recall that the multilateral GATT system grew
out of a bilateral initiative to overcome destructive
unilateralism.
For much of the 19th and early 20th Centuries, the "tariff
question" was a major topic in international and domestic
politics around the world. In the United States, comprehensive
tariff bills were one of Congress' most important products.
This Congressional direction of trade policy culminated in the
infamous Smoot-Hawley bill, the Tariff Act of 1930, the last
general tariff law enacted by Congress. Smoot-Hawley amended
specific tariff schedules for over 20,000 items, establishing
the United States' highest general tariff rate structure.
But only four years later, Secretary of State Cordell Hull
persuaded Congress to enact a very different trade law, the
Reciprocal Trade Agreements Act of 1934. This law authorized the
President to negotiate and implement tariff reductions through
bilateral agreements. In doing so, Congress moved from a rigid
statutory tariff to a "bargaining tariff" that enabled the
Executive to negotiate a cooperative trading system.
Secretary Hull certainly did bargain. During the next
eleven years, the United States entered into 32 bilateral
agreements with 27 nations.
These bilateral achievements set a crucial precedent for the
multilateral negotiations that followed World War II. Indeed,
even the architects of GATT began with a bilateral model. They
expected that the new trading structure would be built upon a
U.S.-U.K. foundation, or later, a U.S.- European base.
The GATT system has enjoyed enormous success in lowering
tariffs and reducing direct barriers to trade. GATT also has
been relatively successful in defending these gains.
Nevertheless, new forms of protectionism have arisen —
subsidies, restrictive government procurement rules, marketsharing schemes, voluntary export curbs, and discriminatory
product standards, among others. The specialized, technical,
and indirect nature of these barriers makes it harder to package
reciprocal national concessions.

-3In the Tokyo Round, GATT responded with a "minilateral"
solution: Some, but not all, GATT members agreed to special
rules governing countervailing and antidumping duties, subsidies,
government procurement, licensing, customs valuation, and product
standards. These codes have helped create international
standards — which are effective as long as they are enforceable.
The Present Challenge
The success of the multilateral trading system has raised
expectations — and led to more difficult challenges. There are
five major threats to the multilateral system today.
First, the changing patterns and volatility of capital flows
have had an enormous and sometimes destabilizing effect on trade.
Both short- and long-term capital now move relatively easily
around the globe to locations or securities offering more
attractive mixes of risk and return. These flows affect currency
values, which, in turn, influence the competitiveness of exports
and imports.
Second, technology and industrial processes can now be
transferred around the world with relative ease. As a result,
there are many highly competitive newly industrialized nations.
Unfortunately, some of the new titans of production have been
slow to expand consumption commensurately, thus helping to
create international imbalances.
Third, many of the successful exporting nations do not have
a special affinity for the postwar liberal trading regime. Their
"logic," labeled by some as the "New Mercantilism," is that
exports are good and imports are bad. This perspective poses a
serious threat to a trading system based on the presumption that
expanded trade — measured in terms of both imports and exports —
will increase world prosperity in a mutually satisfactory and
sustainable fashion.
Fourth, the "rules" of the trading system do not adequately
protect some sectors of growing importance — services,
investment, intellectual property, and high technology, among
others. These sectors are areas of comparative advantage for
some of the key sponsors and promoters of the multilateral
system.
Fifth, domestic political support for the liberal trading
system has been eroding in a number of nations. In the U.S.,
this political trend can be traced to stiffer foreign competition,
caused in part by the inevitable rise of productive efficiency in
reconstructed or developing nations.

-4There are some notable positive developments. The most
prominent is the initiation of the Uruguay Round. These
negotiations presage breakthroughs in the areas of services,
intellectual property, agriculture, and trade-related investment.
But many of these beneficial results, if they can be achieved,
are years from full fruition. Moreover, the ultimate success of
these negotiations depends on the creation of incentives for
many nations to conform. In the meantime, we need examples of
productive government activism that invigorate internationalists,
reawaken businesses and consumers to the gains of open trade,
and present possible models for arrangements with other nations.
Charting a Future Course
There is no assurance, however, that we will meet this
present challenge with a constructive vision of the future.
As you are all well aware, many in the U.S. Congress are
frustrated by the persistent trade imbalance and are trying to
legislate the problem away. One of their approaches is to return
to straightforward legislative protection for industries, for
example, through direct restrictions on imports. Other nations
are relying on similar barriers, frequently dressed up with local
political justifications.
A second counterproductive approach, perhaps more popular,
has been termed "process protectionism." This type of
legislation tries to conceal itself as nothing more than
seemingly modest adjustments in trade laws. But each tightening
twist of law chokes off trade a little more, with little or no
regard for GATT rules, international standards, or the likelihood
of triggering retaliatory trade wars.
The United States is not the only nation contending with
powerful internal factions advocating policies that will weaken
the open trading system. Some nations with large trade surpluses
are disinclined to remove protection for politically powerful
groups — despite the obvious gains to their consumers and other
businesses. Indeed, an odd Calvinist ethic of the trading system
seems to inspire the belief in some of these nations — whether
in Asia or Europe — that continuing surpluses are a sign of
national superiority and a justification for inaction.
There is, however, an alternative approach to the future.
This approach is idealistic in aim, but realistic and often
incremental in method. It seeks to move nations toward a more
open trading system through a strategy of consistent,
complementary, and reinforcing actions on various international
fronts, bilateral and multilateral. As some of these actions
bear fruit, they should enhance domestic political support for
other actions.

-5This is the approach embodied in the Canada-U.S. Free Trade
Area agreement. While the international trading system has been
subject to increasing stress and strain, the Canadian-U.S.
economic relationship has been growing and strengthening.
Indeed, after over a century of failed efforts, our governments
have a sterling opportunity to complete a North American economic
accord. This would cap an historical journey from hostility,
based on two long-distant wars, to a high degree of economic
interdependence and common purpose, while maintaining national
identities.
Given similar challenges of adjustment in the face of
heightened international competition, businesses in both nations
will profit from secure access to a home-base market of about
270 million people. Most economists expect the benefits of this
open market to be greater for Canada because its opportunities
for larger scale production will grow much more. By way of
example, the 1965 Auto Pact produced a rationalization that led
to fewer models, much greater volume, and a sizable boost in
Canada's manufacturing trade, employment, and output. And the
increased income generated from more efficient production on both
sides of the border should prompt additional economic activity.
If both nations accept the final agreement, this achievement
will grow in stature and importance over time. Its geopolitical
potential is significant. A successful economic arrangement
should enhance our ability to work together on other common
problems. In the 20th century, we have maintained the longest
peaceful border in the world and served with one another as
allies in a common defense. In the 21st century, we will also
need to work closely together to better address questions
concerning the environment, wildlife, ocean borders, the Arctic,
outer space, disease and medical science, terrorism,
communications frequencies, bank and securities regulation,
taxation, and immigration — to name a few topics.
In addition, the accord accommodates and enhances future
trade liberalization efforts in six ways.
First, the agreement respects GATT and is careful not to
undermine the successes of the multilateral approach. Canada and
the U.S. are lowering barriers between themselves, not raising
barriers to others. We are seeking a healthy, dynamic linkage
between bilateral and multilateral initiatives so as to prod and
reinforce the GATT.
Second, the Canada-U.S. agreement extends the reach of an
open, cooperative system by negotiating solutions in the areas of
services, investment, and technology — while respecting national
sovereignty. These arrangements demonstrate what can be achieved
and offer conceptual approaches to which others may turn.

-6Third, we have lowered the cost of initiating international
liberalization in these new areas by breaking ground with only
one nation at a time. When more nations are involved, it is
often harder to arrange a satisfactory compromise.
Fourth, the rewards of this agreement offer an incentive
to other governments. If possible, we hope this follow-up
liberalization will occur in the Uruguay Round. If not, we might
be willing to explore a "market liberalization club" approach,
through minilateral arrangements or a series of bilateral
agreements. In this fashion, North America can build steady
momentum for more open and efficient markets.
Fifth, this agreement is also a lever to achieve more open
trade. Other nations are forced to recognize that we will devise
ways to expand trade — with or without them. If they choose not
to open their markets, they will not reap the benefits. By
employing this lever together, the U.S. and Canada may be able to
dislodge obstacles in special areas of common concern — such as
agriculture.
Sixth, this Canadian-U.S. accord could prove to be an
attractive counterweight to protectionism in both our countries.
It attracts those who want government to foster growth and
opportunity by breaking down obstacles to achievement and fair
competition, not by creating barriers to protect special
interests.
Conclusion
The Canada-U.S. FTA agreement is not yet law. In the months
to come, there will be ample opportunities for naysayers to
criticize the agreement. I hope they will be persuaded by logic
and vision.
We need to enhance the resiliency of the trading system
by promoting liberalization on a number of fronts. While we
associate a liberal trading system with multilateralism,
bilateral or minilateral regimes may also help move the world
toward a more open system.
Indeed, different agreements may be complementary, each
fitting a special situation and together creating a liberalized
network of mutually reinforcing systems. If activity on one
frontier of trade negotiation slows, we may be able to maintain
momentum and achieve solutions worthy of imitation through other
agreements. If all nations are not ready to liberalize trade,
we will begin with those that are and build on that success.
The Free Trade Agreement provides economic opportunities for
both Americans and Canadians — and could be the catalyst for a
new trade policy strategy. The inquiries it already has elicited
for similar agreements are encouraging. This interest gives both
our countries an opportunity to set trade policy on a creative,
positive, and pragmatic international course — one that will
earn Thank
a gold you.
medal for everyone associated with it.

TREASURY NEWS
Bpartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE

April 22, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of March 1988.
As indicated in this table, U.S. reserve assets amounted to
$43,186 million at the end of March, up from $43,064 million in
February.

U.S. Reserve Assets
(in millions of dollars)

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing
Rights 2/3/

Foreign
Currencies 4/

Reserve
Position
in IMF 2/

43,064
43,186

11,063
11,063

9,761
9,899

11,795
11,579

10,445
10,645

1988
Feb.
Mar.

1/ Valued at $42.2222 per fine troy ounce.
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
selected member countries.
The U.S. SDR holdings and reserve
position in the IMF also are valued on this basis beginning July
1974.
3/ Includes allocations of SDRs by the IMF plus transactions in SDRs.
4/ Valued at current market exchange rates.

B-1383

TREASURY NEWS
•partment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 20, 1988
Statement by
David C. Muiford
Assistant Secretary for International Affairs
U.S. Department of Treasury
at the Conclusion of the
Yen/Dollar Working Group Meeting
April 20, 1988
Vice Minister Gyohten of the Japanese Ministry of Finance and
I have just concluoed a meeting of the Yen/Dollar Working Group.
During the meeting, I noted the progress made by the Japanese
Ministry of Finance during the three-year program of financial
market reform set out in the 1984 Yen/Dollar Report. Important
achievements nave been made in the internationalization of the yen
through the development of the Euroyen market. In addition, access
by foreign financial institutions to Japanese financial markets has
significantly improved, including membership in the Tokyo Stock
Exchange, trust banking activities, and participation in the
Japanese government securities market. The deregulation of Japan's
domestic financial markets is also proceeding in a step-by-step
fashion, most recently with measures to further liberalize interest
rates on large time deposits.
These developments represent an important phase in the
development of open, liberal capital markets in Japan. Given
Japan's status as a major world economy, these steps contribute in
an important way to the free movement of capital globally and are
important to the operation of an effectively functioning
international monetary system. Although we are encouraged by the
actions taken to date, it is important that progress continue to be
made in line with Prime Minister Takeshita's recent statement
regarding an acceleration in financial market liberalization in
Japan.
We spent an equal amount of time discussing Japanese issues
of concern about U.S. markets. Two new members were added to the
U.S. delegation — one from the Securities and Exchange Commission
and one from the domestic institutions policy part of the Treasury
Department. We focused in particular on issues related to
interstate banking; financial market deregulation connected with
possible changes in the Glass Steagall Act; and regulatory issues
resulting from last October's stock market events.
B-1384

- 2 I believe the time has now come to move beyond the Yen/Dollar
Talks to reflect the changes that have occurred in each of our
markets and in the global financial markets. I have proposed that
we rename our group "U.S.-Japan Working Group on Financial Markets"
and continue the type of broadened consultations we have had today
on financial market issues of mutual concern. These issues, among
other things, include such topics in both countries as:
The functioning of government securities markets;
The restructuring and deregulation of the banking and
securities industries;
Tne functioning and regulation of global and domestic
capital markets; and,
Foreicn access to domestic financial markets.

TREASURY NEWS
•partment of the Treasury • Washington, D.c. • Telephone 566-2041
April 25, 1988
JEANNE S. ARCHIBALD
Appointed Deputy General Counsel
Secretary of the Treasury James A. Baker, III today
announced the appointment of Jeanne S. Archibald as Deputy
General Counsel.
As Deputy General Counsel, Ms. Archibald will assist in
administering and coordinating all of the legal activities
of the Department.
Prior to joining the Department in 1986 as Deputy Assistant
General Counsel (International Affairs), Ms. Archibald
served as Associate General Counsel at the Office of the
U.S. Trade Representative from 1980 to 1986.
Ms. Archibald received her B.A. in 1973 from the State
University of New York at Stony Brook, and her J.D. from the
Georgetown University Law Center in 1977. She is a member
of the D.C. Bar Association.
A native of Sag Harbor, New York, she and her family reside
in Reston, Virginia.

B-1385

rREASURY NEWS
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
ipartment
of
the
Treasury
•
Washington,
D.c.
• Telephone 566-2041
April 25, 1988
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,406 million of 13-week bills and for $6,412 million
of 26-week bills, both to be issued on
April 28, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13- week bills
maturing
Discount
Rate

Low
High
Average
a/ Excepting 1
b/ Excepting 1
Tenders at the
Tenders at the

26- week bills
maturing
Discount
Rate

October 27, 1988
Investment
Price
Rate 1/

96.830
6.27%^/
6.57%
5.89%^
6.06%
98.511
96.825
5.93% '
6.10%
6.28%
6.58%
98.501
96.825
98.504
6.28%
6.58%
5.92%
6.09%
tender of $200,000.
tender of $580,000.
high discount rate for the 13-week bills were allotted 22%
high discount rate for the 26-week bills were allotted 38%
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received

Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury

July 28, 1988
Investment
Rate 1/
Price

Accepted

22,025
18,666,065
23,120
41,720
47,560
29,425
1,887,395
12,625
10,855
24,670
32,065
971,435
383,240

$
22,025
5,147,065
23,120
41,720
46,000
29,425
375,895
12,625
10,855
24,670
22,065
267,655
383,240

$
29,260
22,658,535
29,845
31,170
35,055
26,135
1,597,540
7,095
14,370
32,990
32,130
1,274,975
448,430

29,260
5,591,915
27,845
31,170
35,055
24,950
58,540
7,095
9,370
31,745
22,130
94,175
448,430

$22,152,200

$6,406,360

$26,217,530

$6,411,680

Competitive
Noncompetitive
Subtotal, Public

$18,978,905
926,135
$19,905,040

$3,233,065
926,135
$4,159,200

$22,504,990
986,540
$23,491,530

$2,699,140
986,540
$3,685,680

Federal Reserve
Foreign Official
Institutions

1,757,360

1,500,000

489,800

1,226,000

$22,152,200

$6,406,360

$26,217,530

$6,411,680

TOTALS

IZ£e

TOTALS

1/ Equivalent coupon-issue yield.

B - 1 l R fs

TREASURY NEWS

tpartment of the Treasury • Washington, D.c. • Telephone 566-2
W^Lff

°° P-"' CONTACT: Office of Financing

April ^o, 1988

202/376-4350

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice. Invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued May 5, 1988.
This offering
will result in a paydown for the Treasury of about $425
million, as
the maturing bills are outstanding in the amount of $13,222 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m.. Eastern Daylight Saving time, Monday, May 2, 1988.
The two series offered are as follows:
91 -day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
August 6, 1987,
and to mature August 4, 1988
(CUSIP No.
912794 PY 4 ), currently outstanding in the amount of $16,274 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be dated
May 5, 1988,
and to mature November 3, 1988
(CUSIP No.
912794 QS 6 ).
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing May 5, 1988.
Tenders from Federal Reserve
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to Federal Reserve Banks,
as agents for foreign and international monetary authorities, to
the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. Federal
Reserve Banks currently hold $1,534 million as agents for foreign
and international monetary authorities, and $3,593 million for their
own account. Tenders for bills to be maintained on the book-entry
records of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series).
B-1387

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
10/87
tenders
for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of
the circulars, guidelines, and tender forms may be obtained
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 10:00 A.M., DST
April 27, 1988
TESTIMONY OF THE HONORABLE
CHARLES 0. SETHNESS
ASSISTANT SECRETARY FOR DOMESTIC FINANCE
U.S. DEPARTMENT OF TREASURY
BEFORE THE SENATE
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
APRIL 27, 1988
Mr. Chairman, Senator G a m , and Members of the Committee:
I thank you for the opportunity to testify before you
today on S. 2073, the "Thrift Charter Enhancement Act of
1988," which was introduced by Senator Karnes. For some time
now, the Treasury Department has supported thrift charter
enhancement as a means of attracting new capital into the
industry, augmenting the profitability of capital already
invested, and reducing the costs of resolving cases to the
Federal Savings and Loan Insurance Corporation (FSLIC).
In fact, thrift charter enhancement has been one of the
components of our three-pronged strategy for assisting the
troubled thrift industry and shoring up the FSLIC. Permit me
to refresh the Committee's memory of that proposal. Our first
prong called upon the Federal Home Loan Bank Board (Bank
Board) to create new incentives for the industry to increase
its capital and, concurrently, to halt the growth of the
industry's problems through increased supervision.
Significant steps were taken in this direction when the Bank
Board issued new regulations concerning capital and
examinations beginning in the summer of 1986. More work
continues in this area.
The second prong of our strategy consisted of a $15
billion recapitalization plan for the FSLIC. Although a
recapitalization plan was enacted last August — after a long
delay from our introduction of the proposal — the amount was
reduced to $10.0 billion net of the mandated return of FSLIC's
secondary reserve on the advice of some rather less than
objective parties. Since then, the situation in the industry
has at least not improved. It should be pointed out, however,
that the thrift industry's recent losses stem largely from the
realization of costs that Treasury, the Bank Board, the
General Accounting Office, and many members of Congress
expected. That is, after all, why the recapitalization
legislation was necessary and also why it was designed to
B-1388
expand or contract, depending upon what the situation warrants

- 2 — with the clear recognition that the FSLIC cannot create
commitments (of whatever sort) that exceed its available
resources to honor over time. In addition, the industry's
problems cannot be solved overnight, because there are
capacity constraints on the amount of funds the FSLIC can
utilize effectively.
This makes thrift charter enhancement — the final prong
of our strategy — a vital means of expanding the capital base
of the thrift industry and protecting depositors without
dipping into the public coffers. In a 1986 legislative draft,
Treasury proposed specific measures to enhance the thrift
charter, many of which were eventually incorporated into the
1986 "Deposit Insurance Reform and Competitive Enhancement
Act," which was introduced by Senator Garn. In general, we
favor efforts that will attract outside capital while
maintaining the safety and soundness of the industry and
ensuring that to the extent that the powers of banks and
thrifts become more similar, the regulation and supervision of
the two industries are also made more similar. Thrift charter
enhancement should not provide thrifts with bank-like powers
and then subject those activities to less rigorous criteria in
terms of capital, accounting, disclosure, supervision, etc.
This could exacerbate instabilities in the financial services
market, place banks at a competitive disadvantage vis-a-vis
thrifts, and create undue risks.
In particular, we very much support the provisions in
S. 2073 which repeal the cross marketing restrictions on
thrift holding companies that purchase failing thrifts;
replace the FSLIC's "conflict of interests" regulations with
those promulgated by the federal bank regulators to make more
uniform the regulation of banks and thrifts; and subject
thrifts' affiliate transactions — including the purchase,
sale, or lease of property or assets — to the "arm's length"
restrictions applicable to commercial banks.
Charter enhancement legislation must not only serve as an
incentive to attract needed, new capital into the thrift
industry, from as broad a variety of sources as possible, but
also be designed: (1) to reward only those thrifts which are
well-capitalized, well-managed, and which meet the Bank
Board's safety and soundness regulations; and (2) to make
more uniform the regulation of thrifts, banks, and their
respective holding companies in those cases where the
activities of these entities are made more uniform.

- 3 The Karnes Bill (S. 2073)
Treasury supports most of the concepts proposed in
S. 2073, but believes several changes are necessary to ensure
that charter enhancement cannot be exploited by troubled
thrifts and thereby expose the FSLIC to increased risk of
loss. I have provided the Committee with a detailed
presentation of Treasury's positions on the various sections
of S. 2073 in an appendix to my testimony. At this time,
however, I would like to comment briefly on several of the
bill's more important provisions.
Additional Powers
S. 2073 would augment the powers of thrifts or thrift
holding companies in several areas, either placing them on
more of a par with banks or bank holding companies or simply
enhancing authority unique to thrifts. For example, S. 2073
would permit federally chartered thrifts to increase their
commercial loan limits from 10 to 20 percent of assets,
provided they are in compliance with the Bank Board's capital
requirements. We believe that thrifts that increase their
commercial lendinq above the 10 percent threshold should also
hold capital reserves in an amount equal to those held by
banks. Such additional capital would help to offset any risks
created by increased commercial lending and serve to protect
the FSLIC.
Under the bill, savings and loan holding companies would
be permitted to acquire up to five percent of the stock of
non-affiliated savinqs and loans or savings and loan holding
companies. Notwithstanding this limitation, securities
subsidiaries of savings and loan holding companies would be
allowed to underwrite and deal in these securities without
regard to the five percent limitation. Under the Bank Holding
Company Act, all shares of non-affiliated banks or bank
holding companies must be included under the five percent
limitation applicable to bank holding companies, regardless of
where within the holding company such shares are technically
held. We do not object to the securities subsidiary of
savings and loan holdinq companies enqaging in the activities
proposed, but we believe such activities should be included
under the five percent limit.

- 4 Holding Company Regulation
We support the bill's proposals to permit thrift holdinq
companies to capitalize on some of the synerqies available
within the holding company framework and allow their
subsidiaries to interact with each other under less onerous
affiliation restrictions. For example, S. 2073 would replace
the thrift industry's "conflict of interests" regulations with
those applicable to banking institutions. In addition, mutual
holding companies would be permitted to acquire stock
FSLIC-insured institutions and to issue up to 49 percent of
their common stock to the public. This authority will attract
more capital into mutual holding companies and further foster
their ability to convert to stock form.
We also favor allowing nondiversified savings and loan
holding companies to incur debt in excess of 15 percent
without prior approval. However, we would prefer raising the
limit from 15 to 30 percent, rather than simply deleting the
limit as proposed in the bill. Raising the limit would
eliminate the prior approval requirement for a substantial
number of debt transactions while at the same time ensuring
the health of the thrift industry and the FSLIC.
Safety and Soundness Provisions
A few of the bill's safety and soundness provisions —
those affecting de novo institutions, net worth maintenance
agreements, and management interlock exemptions — may, in our
judgment, serve not only to attract new capital, but also,
unless amended, to increase the industry's risk of loss for
the sake of short-term goals. As I have stated, both
additional capital and the health of the thrift industry are
of paramount importance, and any enhancement of the thrift
charter must protect the industry, the FSLIC, and the
taxpayer.
Under S. 2073, de novo institutions would be permitted to
shed their special regulations after three years under certain
conditions. Such a change appears reasonable on its face, but
one result could be to permit de novo institutions to reduce
their capital level below the six percent level. Current Bank
Board procedures require de novo or newly insured institutions
to maintain a seven percent capital level for one fiscal year
and a six percent level thereafter. S. 2073 could allow such
thrifts to adhere to those capital requirements below six

- 5 percent that currently pertain to other insured thrifts.
Although competitive equity may argue for such a change,
common sense surely does not. Treasury supports at least a
six percent capital requirement, and last year's CEBA
legislation strongly urged the Bank Board to move thrifts
towards that goal. I see no reason why de novo institutions
should be able to hold less capital in the interim, rather
than lead the industry toward a healthier environment.
Nevertheless, if any changes are to be made in this policy,
they should be made by the Bank Board through the regulatory
process.
The net worth maintenance provisions of S. 2073 would
impose statutory requirements on the Bank Board to relieve,
after three years, a savings and loan holding company which
has acquired a thrift from its guarantee to maintain the net
worth of the acquired institution. We believe that an
acquiring institution should manage an acquired thrift so as
to maintain capital at an appropriately hiqh level. We also
believe that there should be room for reasonable flexibility
— but the determination and scope of such flexibility should
be made through the regulatory, rather than the legislative,
process.
Treasury supports revising the restrictions of the
Management Interlocks Act, but not as broadly as S. 2073. We
would prefer that acquisitions made pursuant to the emergency
acquisition provisions of the Garn-St Germain Act (but not any
bank or thrift) be exempt, but only if the relevant federal
regulator determines that no substantial conflict of interests
or substantial lessening of competition would result. This
would reduce S. 2073's burden on the federal regulators to
review innumerable cases and preserve a concern for safety and
soundness, while also attracting capital into the troubled
sector of the thrift industry where it is most sorely needed.
Conclusion
In conclusion, I want to reiterate Treasury's support for
thrift charter enhancement for a siqnificant number of
S. 2073's provisions, and for all of them if amended to
reflect our concerns. Private solutions to the thrift
industry's travails must be emphasized, especially when
proposals for a taxpayer bailout are emanating from some
quarters in the savings and loan industry.
That concludes my prepared remarks, Mr. Chairman. I thank
the Committee again for the opportunity to testify on this
subject, and I will be happy to answer any questions the
members of the Committee miqht have.

APPENDIX
Treasury Position on S. 2073,
the "Thrift Charter Enhancement Act of 1988"
Section 101 - Commercial Lending. Treasury supports
increasing from 10 to 20 percent of assets the commercial
lending authority of thrifts, but only if those thrifts which
engage in commercial lending in excess of 10 percent of assets
also hold capital reserves in an amount equal to those
required to be held by commercial banks.
Section 102 - Investment in Service Corporations. Treasury
supports expanded authority for thrifts to invest in service
corporations, but prefers the approach taken in S. 2592, the
1986 Garn bill. S. 2592 provided for a more equitable
distribution of such authority between the banking and thrift
industries by permitting banks with $250 million or less in
assets to invest to the same extent as thrifts in service
corporations with the same powers as thrift service
corporations, including real estate development and general
insurance agency powers. This same service corporation
investment authority would also have been extended to any bank
holding company which acguired a troubled thrift. In
addition, the 1986 Garn bill stipulated that thrifts not in
compliance with their capital requirements at the time of
enactment would have to phase in the expanded service
corporation investment authority upon attaining the minimum
capital level.
Section 103 - Small Business Investment Companies. Treasury
supports modifying the limit on investments in small business
investment companies from no more than one percent of assets
to no more than either one percent of assets or five percent
of capital, but only if such additional authority is limited
to well-run, well-capitalized thrifts.
Section 104 - De Novo Institutions. Treasury opposes a
legislative limit of three years on the requirements placed on
de novo and other newly insured thrifts, particularly the six
percent capital requirement. Treasury favors higher capital
requirements overall for the sake of safety and soundness. In
addition, any such changes (like the reguirements themselves),
should be addressed through the regulatory, rather than the
legislative, process.
Section 201 - Definition of Affiliate. Treasury does not
oppose permitting the service corporation subsidiaries of
state-chartered multiple thrift holding companies to engage in
state-authorized activities to the same extent as the service
corporation subsidiaries of other state-chartered thrifts.
The amendment would provide for competitive equality, given
the likelihood that, without the amendment, a state-chartered
institution which becomes part of a multiple thrift holding
company may have to restrict substantially the activities of
its service corporation subsidiaries.

- 2 Section 202 - Unitary Thrift Holding Company. Treasury
supports allowinq unitary thrift holding companies to own two
healthy thrifts without additional restrictions if they have
acquired at least one troubled thrift, but only if the second
healthy thrift is acquired in conjunction with (or after) the
acquisition of another troubled thrift. That is, any unitary
thrift holding company that currently owns one healthy and one
troubled thrift should not be permitted to purchase another
healthy thrift, unless it also purchases another troubled
thrift.
Section 203 - Affiliate Transactions. Treasury supports
subjecting thrifts' affiliate transactions regarding the
purchase, sale, or lease of property or assets and the
contracting of management, advertising, or consulting services
to the "arm's length" restrictions applicable to commerical
banks. This would not only make bank and thrift regulation
more uniform, but also serve to prohibit subsidiary thrifts
from upstreaming funds under the guise of paying for services
rendered. More in keeping with our general policy would be to
apply Sections 23A and 23B of the Federal Reserve Act to all
transactions between the holding company and the affiliate.
Section 204 - Activities of Thrift Holding Companies.
Treasury supports permitting thrift holding companies to
acquire directly up to five percent of the voting shares of a
non-affiliated thrift or thrift holding company and allowing a
securities firm subsidiary to underwrite and trade in such
voting shares. However, Treasury opposes exempting the
securities firm subsidiary's holdings of these voting shares
from the five percent limit on safety and soundness grounds.
Section 205 - Interlocking Directorates. Treasury supports
repealing the interlocking directorate provision of the
National Housing Act. Director or officer interlocks of
thrift holding companies are also governed by the Depository
Institutions Management Interlocks Act, and the amendment
would eliminate the unnecessary redundancy.
Section 206 - Amendment to the QTL Test. Treasury opposes
increasing the amount of liquidity and loan oriqination
investment which can count towards meeting the QTL test. The
QTL test imposed by the Competitive Equality Bankinq Act
(CEBA) intended to permit only those thrifts primarily enqaged
in housing finance to take advantage of expanded activities.
Treasury holds that thrifts not primarily engaged in housing
finance should become more, rather than less, like banks.
Section 207 - Cross Marketing. Treasury supports repealinq
the cross marketing restrictions on thrift holding companies
that purchase failing thrifts.

- 3 -

Section 208 - Affiliate Investment. Treasury does not oppose
permitting any thrift or other subsidiary of a thrift holding
company which has acguired a troubled thrift to engage in
those transactions permissible under Sections 23A and 23B of
the Federal Reserve Act without regard to the activities of
the affiliate. This will draw capital toward troubled
thrifts.
Section 209 - Mutual Holding Companies. Treasury supports
allowing mutual holding companies to acquire a stock thrift
and empowering a mutual subsidiary to issue up to 49 percent
of its stock to the public to increase the amount of capital
available to mutual holding companies.
Section 210 - Debt Approval. Treasury opposes eliminating
completely the current restriction on nondiversified thrift
holding companies which prohibits them from incurring debt in
excess of 15 percent of their consolidated net worth without
advance approval from the FSLIC. However, Treasury supports
increasing the limit to 30 percent, thereby effectively
eliminating the prior approval requirement for a substantial
number of debt transactions without increasing risk. On the
other hand, eliminating the 15 percent debt limit with neither
a phase-out nor a ceiling, and without limiting debt in excess
of 15 percent to well-capitalized institutions, may increase
the risk of loss to the FSLIC.
Section 211 - Net Worth Maintenance. Treasury does not oppose
the concept of limiting to three years the perpetual guarantee
by a thrift holding company to maintain at a certain level the
net worth of newly acquired thrifts. However, we oppose
making such changes through the legislative, rather than the
regulatory, process.
Section 212 - Transactions With Affiliated Persons. Treasury
supports replacing the FSLIC's "conflict of interest"
regulations with those promulgated by the federal bank
regulators to make more uniform the regulation of banks and
thrifts.
Section 301 - Management Interlocks Act. Treasury opposes
adding two new sections to the Depository Institutions
Management Interlocks Act which would exempt companies which
become holding companies upon acquiring thrifts pursuant to
the emergency acquisition provisions of the Garn-St Germain
Act and any bank or thrift whose interlock would not
substantially lessen competition or lead to a substantial
conflict of interest, as determined by the appropriate federal
depository institution regulator. Treasury favors

- 4 expanding the interlock exemptions, but only to induce the
acquisition of troubled thrifts. Accordingly, companies which
acguire thrifts pursuant to the emergency acquisition
provisions of the Garn-St Germain Act and thereby become
holdinq companies should be exempted, but only if the
appropriate federal depository institution regulator
determines that the interlock would not substantially lessen
competition or lead to a substantial conflict of interest.

TREASURY NEWS

Department of the Treasury e Washington, D.C. e Telephone 566-204
FOR RELEASE UPON DELIVERY
Expected at 9:00 A.M., DST
April 27, 1988

Statement by the Honorable David C. Mulford
Assistant Secretary of the U.S. Treasury
for International Affairs
before the
Bankers' Association for Foreign Trade
Boca Raton, Florida
Wednesday, April 27, 1988
The Debt Strategy: Innovation and Evolution
I welcome the opportunity to share once again my thoughts
on the evolving debt strategy with this broadly representative
association of world banks. The international banking community
has a continuing vital stake in perhaps the single most important
challenge of this decade: how best to restore sustained growth and
with it creditworthiness among heavily indebted developing nations.
When I last spoke to this group two years ago in Phoenix, the
"Baker Initiative" was only six months old. The banking community
had broadly endorsed the key elements of the "Program for Sustained
Growth", which focused on the need for stronger growth in the debtor
nations through the adoption of market-oriented reforms, supported
by adequate international finance. There was considerable debate
then about whether the needed commercial bank support would be
forthcoming; whether the banking community would galvanize itself
to streamline syndication procedures; and whether debtor nations
would summon the political will to undertake politically difficult
structural reforms necessary to strengthen their economies. These
issues remain at the heart of the process now well underway.
The strategy which we embarked upon in the fall of 1985
has proved itself to be both evolutionary and innovative. In
my remarks this morning, I would like to review progress during
the past two years and consider with you the key issues we now
have to address. I will also touch on the part being played by
creditor governments, including both regulatory and tax innovations
that help support this process.
B-1389

- 2 -

Progress to Date
The current growth-oriented strategy remains the only apprc
which is accepted by all parties. While some countries such as
Brazil or Peru have tried "shortcuts" to avoid needed policy
reforms and conserve resources through debt moratoria, such
policies have not worked — indeed, have been counterproductive.
Admittedly there is fatigue among both debtor countries anc
commercial banks, but contrary to those who would argue that
wholesale debt relief is the only solution, I believe the preser
strategy i£ producing results and moving us toward resolution
of this difficult problem. Allow me to draw your attention to
the following facts:
o According to World Bank data, 8 of the 15 major debtor
countries grew at 4-5 percent or better last year,
compared with only three countries in 1985. We should
bear in mind that growth for the 15 countries was negatj
by 3% in 1983.
o Debt service ratios for the group have fallen by
one-fourth and interest service ratios by one-third
in the past few years. This is largely due to the
substantial decline in interest rates since 1982.
o Aggregate current account deficits have been sharply
reduced from a peak of $50 billion in 1982 to $15 billi<
in 1986, and $8 billion in 1987.
o Export earnings rose by 13 percent to near record highs
last year, while imports this year should be the highessince 1982.
o The adoption of debt/equity swap mechanisms in some
countries, as well as broader policy reforms, has
encouraged the return of flight capital, while also
helping to reduce debt and debt service burdens.
Perhaps the most important change during the past two year
has been in the attitudes towards macroeconomic and structural
policy reforms in the debtor nations. While some are doing bet
than others, virtually all of the major debtors accept the
need to focus on market-led growth, restructuring their economi
and removing impediments to trade and capital flows. Let me
cite a few examples.
Mexico has liberalized its trade regime and continues its
privatization of state enterprises. Through a market-based
approach, the country has diversified its export base to the
point where, for the past two years, non-oil exports have
exceeded oil revenues. It has recently adopted a special

- 3 program to* reduce inflation, although stronger efforts are
still needed to bring its fiscal deficit under control.
Chile's comprehensive reform program, including a strong
reliance on market mechanisms and a favorable business climate,
has increased economic efficiency, kept inflationary pressures
in check, attracted foreign direct investment and enabled
strong growth. In the past two years Chile has also swapped
$3.3 billion of its foreign debt into domestic equity investment,
equivalent to approximately 23 percent of Chile's bank debt.
If this could be accomplished in other countries, we would be
well on our way to resolving debt problems.
Colombia has carried out a program of broad structural
reforms supported by the World Bank and an "enhanced surveillance"
arrangement with the IMF. Increased coffee revenues have been
effectively utilized to finance development while avoiding
inflationary pressures. However, despite its successful adjustment program and avoidance of debt rescheduling, the commercial
banks failed to reward this performing country by rapidly
assembling a new financing package of the size Colombia required.
Finally, Bolivia has arguably produced the greatest measure
of internal reform. It is also implementing an imaginative plan
for accomplishing a substantial reduction in its stock of debt.
On a more general basis, the concentration of resources on
the debt problem has been impressive. Since October 1985, the
World Bank has agreed to provide nearly $14 billion in new loans
to support reform efforts in the major debtor nations, while
the IMF has provided $5 billion in temporary balance of payments
assistance to these nations. Official creditors have rescheduled
some $18 billion in outstanding debt, including interest payments.
Commercial banks have committed some $13 billion in new finance,
or $19 billion if we were to count the new Brazilian package.
Banks have also rescheduled over $220 billion in outstanding
debt, reduced spreads, and provided longer grace periods and
maturities.
Creditor Governments' Role
In Tokyo last week, I was advised by a nucleus of banks
representing the broader banking community that creditor governments are not doing enough under the current debt strategy.
Despite summarizing the broad contribution that creditor governments make, I was left.with the impression that some bankers
believe that the only thing that counts for the creditor
governments is money on the table.
Let me respond directly to this position, because I strongly
disagree. It is not the role of governments to take the banks
out of their LDC exposures, or to assume for their taxpayers part
of the risk on commercial bank LDC loans, or to put up massive

- 4 amounts of funds from their budgets through a new international
debt facility to purchase existing commercial bank debt ai:
what, I am sure, would turn out to be a very modest discount.
Furthermore, it is not the role of the international financial
institutions to offer credit enhancements more routinely;
specifically World Bank guarantees are exceptional and their
use will remain limited.
Commercial bank numbers in terms of reschedulings may look
impressive, but we must remember that commercial banks lent more
to begin with and therefore have much more debt to reschedule.
Commercial banks have been rescheduling principal, while creditor
governments, through the Paris Club, have rescheduled interest
as well as principal.
Creditor governments have also been contributing in many
other ways. First, the major industrial nations have maintained
a sound international economic environment with sustained growth,
low inflation, and open markets. This is especially true for
the United States, which took over 50 percent of the increase
in non-oil LDC exports between 1982 and 1986.
Second, the United States has provided leadership in
international efforts to address the problems of various debtor
countries, often providing bridge financing at key moments.
This has involved helping a number of countries to resume normal
relations with financial institutions and reestablish fruitful
negotiations with the IMF and World Bank. Third, we have helped
to remove regulatory obstacles to new loans and innovative
financing techniques.
Fourth, the United States has provided sustained support
for the international financial institutions. In 1983 we
provided our share of a quota increase for the Fund of
$33 billion and recently have agreed to support a $75 billion
general capital increase for the World Bank, which we still
must steer successfully through the U.S. Congress. Finally,
the U.S. has also proposed and in some cases secured the
implementation of important innovations to strengthen the debt
strategy generally.
Recent Innovations and New Resources
Last fall Secretary Baker proposed the creation of a new
IMF External Contingency Facility to help cushion the effect
on IMF standby programs of unforeseen external developments,
such as weaker commodity prices, natural disasters, or sustained
higher interest rates that might force a performing country off
its economic course. Our efforts to initiate these reforms
resulted, in part, from discussions with debtor nations, who
advanced the view that longer programs with stronger structural
reform content and greater recognition of unforeseen contingencies are essential to the long term resolution of the debt
problem.

- 5 -

At the IMF Interim Committee on April 14, it was agreed in
principle to establish a combined Compensatory and Contingency
Financing Facility to address such external contingencies while
retaining the essential features of the existing Compensatory
Financing Facility and improving both its conditionality and
its operation. We expect the new facility to expand potential"
access for the fifteen major debtors by more than 25 percent,
or, potentially, more than $12 billion, depending of course
upon external developments. The Interim Committee also agreed
to revitalize the IMF's Extended Fund Facility for use on a
case-by-case basis to enhance the focus on structural reform.
Here again there is potential for a significant increase in
resources for selected countries.
Creditor countries have also taken a number of significant
measures to assist low-income developing nations. The IMF's
new Enhanced Structural Adjustment Facility will provide concessional resources totalling SDR 6 billion to low-income
countries facing protracted balance of payments problems that
are engaged in economic and structural adjustment. Donor
governments have pledged $6.4 billion of financing to be used
in cooperation with the World Bank for low-income African
countries with severe debt problems that have undertaken adjustment programs. Likewise, the Continuing Resolution passed by
Congress in December gives the U.S. Agency for International
Development (AID) additional funds for development assistance
to Africa, and greater flexibility in allocating these funds.
Finally, as you all know, we have encouraged the development
of a "menu" of alternative financing options to help meet the
diverse interests of both debtor nations and the banking community
in devising new financing packages. Financing innovations that
are developed for the mutual advantage of banks and debtors
are key to the resolution of the debt work-out. But so far it
seems to be the debtor governments that have taken the lead in
developing menus and orchestrating new transactions. This was
true in the case of the Mexican debt/bond conversion, Philippine
Investment Notes, and Argentine exit bonds. In the case of
Ecuador, where the government left the menu up to the banks, a
great deal of time was wasted and the resulting menu showed
little adaptation for Ecuador's situation, basically being
warmed-up Argentinian left-overs.
I would contend that if bank involvement had been more
energetic, these deals would have had more appeal and been more
heavily subscribed. It follows, I believe, that bankers should
become more involved in developing spin-offs of these techniques
— to better assure palatable alternatives for banks seeking to
"exit" from new money obligations, or to improve the credit
quality of those loans on their books.

- 6 With regard to new money packages, banks have articulated
their "wish list," but it is up to you to develop the modalities
to achieve your goals. For example, new money bonds which have
some of the characteristics of senior debt — non-reschedulable,
liquid instruments — should be workable. "Bells and whistles"
adding appeal and marketability to new money bonds could include
provisions for conversion into local equity, or linkage to
commodity prices, depending upon the interests of debtor countries
and the appetite of commercial banks, and market conditions.
As you know, Treasury has been a strong advocate of debt/
equity conversions. Two years ago in Phoenix I urged commercial
banks to give active consideration to the potential for debt/equity
swaps — and I recall speaking off the record on this issue
because of the sensitivities regulators and accountants might
have about changes to facilitate such swaps. We've come a long
way since then with both debt/equity swaps and supportive
regulatory changes. It is my view that we've barely seen the
tip of the iceberg for both debt/equity swaps and other kinds
of debt conversions and securitization.
Greater resort to equity financing can help strengthen
the corporate sectors of many developing countries, while also
enabling both domestic and foreign investors to provide risk
capital to generate needed growth and development. This alternative to debt financing has, of course, the added sweetener
of reducing debt service burdens and the stock of debt. All
told, it is a win-win situation that helps to get countries onto
the growth path. Some $7.5 billion in debt/equity swaps have
taken place in five countries since 1985.
Given the scope of the benefits, it is difficult to understand
why debtor countries have not moved more aggressively in this area;
a major resource is being underutilized while the overall stock
of debt is allowed to grow. Developing countries need to wake
up to the advantages of debt/equity conversions and be much more
aggressive in opening their financial markets and investment
regimes, not only to foreigners but nationals as well. It is
heartening to see the new Brazilian program off and running,
and we hope the Mexicans will be back in the game once they get
their fiscal, and consequential inflation, problems under
control. It is true that the monetary effects of these swaps
must be closely watched, but they can be controlled with
appropriate policies in place, as we have witnessed in the
case of Chile.
Other conversion techniques, such as the Mexican bond swap,
also have their place. Even this idea stemmed originally from
Mexico — and probably would not have seen the light of day if
it had not been taken up by a bank willing to exercise leadership
outside Mexico's banking advisory committee format, and if the
the U.S. Treasury had not been willing to make 20-year Treasury
zero-coupons available as collateral.

- 7 I know other alternatives are now being looked at, including
some that would provide for partial collateralization of interest.
The key to success of these efforts is countries performing well
enough to generate resources for this purpose, or alternatively,
acquiring funds through the sale of state enterprises and placing
the proceeds in a separate fund for this purpose. Those countries
that do not have foreign reserves immediately available, nor
public assets they are willing to use for such collateralization,
should incorporate a plan in their medium term programs, and in
the meantime focus their debt conversion efforts primarily on
debt/equity swaps.
Regulatory and Tax Support for "Menu" Items
Treasury and the bank regulators have also discussed
regulatory and accounting impediments to the development of
"menu" options, with a view toward removing or reducing
barriers while not sacrificing safety and soundness concerns.
The Federal Reserve Board has subsequently broadened the scope
of opportunity for banks to engage in debt/equity swaps through
modifications to Regulation K. Commercial bank holding companies
are now permitted to own, through debt/equity swaps, up to 40
percent of the voting shares of non-financial firms and up to
100 percent of those firms which are being privatized in troubled
debtor countries. The holding period for such exchanges also
has been extended.
In a less well-known development, last November the Comptroller
of the Currency approved the application of a Miami bank to
exchange sovereign debt for an equity position in a privately
owned hotel through the "debts previously contracted" provisions
of the National Bank Act. This action may open up a whole new
window of opportunity for debt/equity swaps at the bank, versus
the holding company, level.
Accompanying the Mexican exchange offer were two other
important initiatives on the regulatory/accounting front. The
OCC issued an opinion letter which indicated that banks could
hold the new Mexican bonds within their legal lending limits
under an extension of a preexisting lending relationship or
under certain conditions as Type III securities. At the same
time, the OCC letter clarified the "contamination" issue, by
indicating that the sale of Mexican paper at a discount does
not require a bank to mark to market the remaining portfolio
if it intends to hold the loans to maturity.
An IRS revenue ruling issued last fall, and a follow-up
letter to Senator Chafee in March of this year, helped to clarify
the tax implications of debt conversions, as well as debt
"donations" to U.S. non-profit organizations. We hope this will
help facilitate "debt/charity" swaps so as to advance health,
education and conservation programs in developing countries.
In early April of this year, the Treasury Department submitted

- 8 a report to Congress on possible initiatives to support debt-fornature swaps. In May, Treasury will participate in an AID
sponsored conference entitled "Debt-for-Development", which will
discuss a broad range of swaps. We hope that BAFT will support
this effort.
This is a long and impressive accounting of creditor
government efforts to help heavily indebted developing nations.
As you can see, there is substantial money on the table and
much more as well — leadership in innovation, the concentration
of human talent on these problems in both the creditor governments
and in the international organizations. The banks should take
note of this contribution, stop complaining in ignorance about
the role of creditor governments and get more firmly behind
the cooperative effort to find new ways and means for making
progress on a practical basis in solving this burdensome problem.
Generalized Debt Forgiveness
Our support for debt conversion techniques should not be
read as support for debt forgiveness generally, or for efforts
by the debtor governments to assure that they can "capture"
the secondary market discount on debt paper. The Mexican
exchange offer clearly indicated that such exchanges will not
take place at the depressed secondary market prices we often
see quoted, and that the number of banks interested in debt
exchanges involving any significant discount from nominal
value will be limited. Nevertheless, such exchanges can be
significant at the margin, and a number of small exchanges
over time can serve the interests of both debtor nations and
individual commercial banks. In particular, there is a
considerable advantage in enabling uncooperative banks with
relatively small exposures to exit from syndicates, taking
a loss in the process.
To be successful, such conversions must be voluntary,
privately financed, and developed within the market. In
contrast, we and other major industrialized nations strongly
oppose approaches which are generalized, global in scope,
financed by creditor governments or mandatory in nature. This
includes creation of an international debt facility under the
auspices of the IMF or World Bank aimed at providing a global
"quick fix" of the debt problem via debt purchases or securitization of commercial bank loans.
Schemes to provide a "gold card" for debt relief are both
impractical and counterproductive. They would shift the risk
on debt originally contracted with the commercial banks to the
international financial institutions and their member governments.
Creditor governments are not prepared to accept such solutions
both as a matter of principle and because of the severe bugetary
implications and public perceptions of bailing out commercial
banks. Moreover, such facilities would not achieve the adoption
of necessary policy changes in debtor countries, but instead

- 9 would delay needed adjustment, discourage new private financing,
undermine the restoration of access to markets, and in effect
assure a political confrontation between debtor and creditor
governments.
Commercial Bank Role
What is the role of the commercial banks' at this point in
the long-term workout of the debt problem? You have two basic
options. You can operate solely on individual interests and
concerns, wait for options to be offered by debtor governments,
and judge whether you want to accept them or not. You can
call on creditor governments and the international financial
institutions to "enhance" new commercial bank credits through
guarantees or other mechanisms as the only way to improve the
quality of new loans. This is a reactive, passive posture
which does not advance the process. I fear it constitutes the
present position of most banks.
Or banks can challenge the most creative minds among their
executive leaders to develop financing options that can advance
common interests in dealing with the debt problem. You can
discuss with the international financial institutions and debtor
governments those areas where you believe policy reforms can
best assist debtors' return to creditworthiness. You can consider
ways to provide more diversified financial support, particularly
for those countries such as Argentina whose heavy debt service
burdens will require imaginative financing techniques together
with credible reforms applied in a medium-term timeframe. You
can address the "free rider" problem in your ranks with more
imagination and vigor.
You can also work to improve communication and to further
streamline new lending processes within the banking community
to help assure that new financing is made available in a more
timely fashion. In short, you can lead, rather than react;
work cooperatively rather than individually; support innovation
while recognizing your broader interest in staying in the game.

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
For Release Upon Delivery
Expected at 2:00 P.M. EDT

Remarks by Thomas J. Berger
Deputy Assistant Secretary - for International Monetary Affairs
U.S. Department of the Treasury
before the
American Bar Association
Washington, D.C.
April 26, 1988
Foreign Investment in the U.S.:

A View from the Treasury

Introduction
Mr. Chairman, ladies and gentlemen, I am pleased to have this
opportunity to share my views with you on the subject of foreign
investment in the United States.
Americans are of two minds when it comes to foreign
investment. On the one hand, we favor foreign investment because
it creates jobs and lowers the cost of capital. On the other
hand, we are concerned that foreign investment not threaten vital
U.S. interests. In light of this dual perception of foreign
investment, we can sympathize with the difficult job facing
lawmakers trying to be responsive to the wishes of their
constituents.
Indeed, this situation reminds me of the case of a certain
southern Congressman who got a letter from a constituent
demanding to know where he stood on the issue of whiskey. The
Congressman asked his staff to check the files for any hint of
how the interested voter might feel on this divisive issue, but
drew a blank. However, our distinguished statesman was
undisturbed, and promptly dictated his. reply:
B-1390

- 2 -

"Sir, you raise one of the most important issues of our time,
and one about which I feel deeply, and on which my position
is clear.
"If, by whiskey, you mean the devil's brew, the poison
scourge, the bloody monster that defiles innocence, dethrones
reason, destroys the home, creates misery and poverty — yes,
literally takes the bread from mouths of little children —
if you mean the evil drink that topples Godfearing men and
women from the pinnacles of righteous and gracious living
into the bottomless pit of degradation, despair, shame, and
hopelessness — then I am against it with all my power.
"But, if you speak of whiskey as the elixir of life that is
consumed when good fellows get together, that puts a song in
their hearts, laughter on their lips, and the warm glow of
contentment in their eyes — the stimulation that puts a
little spring into the step of an elderly gentleman — if you,
mean the drink that enables man to magnify his joy and
happiness, and to forget, if only for a little while, life's
heartbreaks and sorrows — if you mean the drink whose sale
pours into our treasuries untold millions of dollars that
provide tender care for our crippled children, our blind, our
aged and infirm -- that builds our hospitals and highways and
schools — then certainly I am in favor of it.
"My stand is unequivocal, and I will not compromise."
In a more serious vein, the current public debate has
demonstrated that there are a number of misconceptions concerning
foreign investment in the United States, not the least of which
is the belief that the Government is not active in pursuing U.S.
interests in this area. If you will allow me, what I would like
to do this afternoon is to first summarize my views concerning
foreign investment and the need for any changes in U.S. policy
toward such investment, and then to describe briefly U.S.
Government efforts to liberalize restrictive investment practices
abroad.
A Perspective on Foreign Investment
Open capital markets in the U.S., which invite rather than
discourage investment, have been our economic trump card for over
two hundred years. These open markets have played a key role in
U.S. growth and development by providing a valuable supplementary
source of savings. Foreign capital was important for the great
industrial ventures of the 19th century — and will be just as
vital to the technological advances of the 21st century. This
foreign investment has never involved a loss of either our
economic or political independence.
In addition, fre^r investment flows produce many obvious

- 3 benefits, but these are sometimes overlooked by those who want to
restrict foreign investment. For example, it:
Creates jobs for Americans, particularly in
manufacturing;
Keeps interest rates and the cost of equity capital
lower than would otherwise be the case;
-- Benefits American consumers by promoting competition
and efficiency among manufacturers;
Encourages transfers of new technology to the U.S.,
giving us an edge in building industries for the
future; and
Expands U.S. access to foreign markets by giving us
the chance to exploit — through subsidiaries in the
U.S. — the business ties of foreign parent
companies.
Clearly, both technology from abroad and expanded market
access are highly desirable in a world where the U.S. is striving
to maintain its competitive edge.
Internationally, the U.S. itself is a major foreign investor
with more to gain than to lose from freer investment regimes
around the world. The international economy is not a zero-sum
game: both the global economy and the U.S. domestic economy
stand to benefit from the growth effects of freer, more efficient
capital allocation. In our efforts with developing debtor
nations, we have emphasized again and again the many merits of an
open investment policy that creates an hospitable environment
for foreign capital. A retreat from this position at home would
severely undercut our efforts with these countries abroad.
The U.S. and other developed nations do not have completely
free foreign investment regimes — although our regime is
relatively free. We prohibit certain sectors to foreigners for
national security reasons, as do all nations. Also, we have
legal and administrative powers through which we can further
protect our national interest and preserve competition. These
measures include:
— Export control laws to protect sensitive technology;
The defense industrial security program to protect
classified technology, research, and production;
Individual statutes restrict foreign ownership of
specific industries for national security reasons, e.g.,
air transport, shipping, nuclear energy and
communications;

- 4 The Committee on Foreign Investment in the United States
(CFIUS) to provide an opportunity for critical appraisal
of transactions that may have adverse implications for
the United States; and
The Hart-Scott-Rodino review process and other antitrust laws to deal with potentially anti-competitive
mergers and acquisitions.
Let me say a word about the CFIUS, which the Treasury
Department chairs. In CFIUS reviews, we start with the premise
that foreign investment (or, indeed, investment in general) is
beneficial to our economy. We identify and deal with those few
specific cases which may adversely affect our national interest.
The existing review process is, by design, quiet, objective and
apolitical. It has, I believe, served U.S. interests well.
There is, in my opinion, no policy logic to discrimination
against investment of foreign origin. We live in an
interdependent world. Discouraging foreign investment by making .
it unwelcome — in fact or in appearance — hurts us at home and
makes us vulnerable to retaliatory action abroad. Being
pro-American — wanting our nation to be safe and our economy
strong -- doesn't mean being anti-foreign.
From this standpoint, sound investment in additional future
productive capacity (as opposed to current consumption) should be
viewed as beneficial. If our goal is increased investment in
productive capacity — with a larger share of this investment
from domestic sources — the,n policies should concentrate on
increasing the domestic savings rate, not arbitrarily limiting
foreign investment. Regardless of one's views on the savings/
investment allocation in the United States, or on the best way to
reduce the budget deficit, it won't help to choke off investment
by scaring away foreign capital.
Should We Change U.S. Policy Toward Foreign Direct Investment?
By this point I think it should be clear that my view is that
our policy with respect to foreign direct investment should not
be changed. We believe that our current policy is appropriate
and that it is sufficient to protect our national interest.
The current policy provides ample safeguards for national
security. The Trade Bill's Exon provision alleviates any
lingering concerns about the ability of the United States to meet
real threats to the national security. To have gone further, for
example to block investments on grounds of "commerce essential to
the national security," would be counterproductive. It would
scare off investors and undermine our efforts in the OECD and the
GATT to bring greater discipline to international investment.
In this context, *i should also note that we would continue to

- 5 reject legislation that imposes further reporting burdens on
investors solely on the basis of their nationality. Such a
provision as the Bryant Amendment was not acceptable to us in
conference and is" not acceptable to us as stand-alone
legislation.
Confidentiality underlies all American data gathering systems
and makes them among the best in the world. While reporting is
mandatory, the quality of the information collected depends upon
voluntary compliance and assurances of confidentiality, when
businesses provide sensitive information they require
confidentiality to protect themselves from official probes and to
avoid revealing to competitors information concerning sales,
finances, and industrial strategies. If we did not guarantee
confidentiality we could not be sure that information would be
correctly reported, nor could we rely on any analysis based on
that information.
In a broader perspective, further attempts to change our
investment policy by creating a more activist role for the
government would only have us repeat the failed experiments
undertaken by Western governments some 10-15 years ago. We
should learn from history and from their mistakes. We could
expect no better outcome in our case. It is the market, not the
government, that, should direct investment flows.
U.S. Efforts to Liberalize Restrictive Investment Practices
Let me now turn to the third subject: U.S. efforts to
liberalize restrictive investment practices. We have
traditionally been in the forefront of liberalization efforts in
the OECD, the GATT and bilaterally. We are now engaged in two
mutually reinforcing efforts to further liberalize investment
regimes. These are the inclusion of Trade-Related Investment
Measures, or TRIMS, in the Uruguay Round of the GATT and the
initiative to strengthen the OECD's so-called National Treatment
Instrument.
The launching of the Uruguay Round offered the most recent
opportunity for the GATT to address the impact of government
interference with foreign direct investment on international
trade. We believe that a number of existing GATT disciplines are
relevant to the growing use of investment measures that distort
trade. We are also obliged to look at new measures if existing
measures are inadequate. Through the negotiations, we intend to
reach an agreement which will discipline the use of these
measures by governments.
In addition to our efforts through the GATT, we have been
active in the OECD, expressing our concern about growing
protectionism
here
and abroad
investment.
The OECD has
mov^d
rapidly in
to international
focus on a work
program to

- 6 include:
— A strengthened National Treatment Instrument;
— Better support for GATT negotiations on Trade-Related
Investment Measures; and
-- More analytical support to understand positive and
negative factors affecting investment flows to the LDCs
and to encourage a healthier investment climate in
developing countries.
Let me also mention some operations that are under my
specific responsibility. The Treasury has continued to work in
the OECD for the progressive strengthening of the OECD Codes of
Liberalization of Capital Movements and Invisible Operations. We
have participated actively in the two seminal OECD studies on
International Trade in Services in Banking, and in Secur ities
aimed at identifying obstacles in member financial markets.
On a bilateral basis, Treasury has had the lead role in
preparing the National Treatment Study in 1979 and the two
updates in 1984 and 1986. These have successfully pressed for
greater liberalization and access for U.S. financial firms in
foreign markets.
The Treasury also led the negotiations resulting in the
Financial Services and the Investment Chapters that are part of
the Free Trade Agreement with Canada. I have just returned from
Tok^o, where, last week, Treasury held another round of
Yen/Dollar talks seeking greater liberalization and transparency
in Japanese financial markets.
We have been successful and seen identifiable progress from
these efforts.
Conclusion
Let me close my remarks by noting that the current debate
concerning foreign investment in America is based on several
largely unfounded concerns.
Some argue that foreigners are "buying up America." It is
true that foreign investment in America has increased
substantially in recent years. Such investment helps to finance
our current account deficit. The key point, however, is that
those who wish to halt or restrict foreign investment are
generally motivated by a hidden agenda of protectionism.
Another concern is that our national security is not
protected. This is clearly not the case. Foreign investors must
not only comply with the same laws affecting domestic investors,
but they are also subject to a number of additional restrictions.
In addition, a variet'y of mechanisms and presidential powers

- 7 exist to protect the national security.
A third fear is that the government lacks the data necessary
to understand foreign investment's impact on our economy.
Actually, the data currently collected are ample for analytical
and policy purposes and avoid imposing burdensome and unnecessary
requirements on investors, whether domestic or foreign.
Finally, some believe that the government is not actively
pursuing an agenda in the area of international investment. The
record indicates otherwise. We have consistently worked to
liberalize laws governing investment, and are currently pursuing
this approach both multilaterally and bilaterally.
We have long been the beneficiary of foreign investment.
That experience — and our need for an internationally
competitive economy — are the strongest arguments in favor of
keeping the doors open, not closing them.
Thank you very much.

TREASURY NEWS
apartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
April 27, 1988
*

Office of Financing
202/376-4350
RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $8,526 million
of $26,083 million of tenders received from the public for the
2-year notes, Series Z-1990, auctioned today. The notes will be
issued May 2, 1988, and mature April 30, 1990.
The interest rate on the notes will be 7-5/8%. The range
of accepted competitive bids, and the corresponding prices at the
7-5/8% rate are as follows:
Yield
Price
Low
7.63%*
99.991
High
7.65%
99.955
Average
7.64%
99.973
*Excepting 1 tender of $10,000.
Tenders at the high yield were allotted 18%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
Totals

CONTACT:

Received
43,355
22,632,935
37,830
68,400
116,940
49,935
1,770,425
92,950
40,275
127,955
25,575
1,066,965
9,080
$26,082,620-,
$

Accepted
$
43,355
7,283,175
37,830
64,300
96,440
43,375
566,605
63,930
39,975
125,305
21,475
131,325
9,080
$8,526,170

The $8,526
million of accepted tenders includes $975
million of noncompetitive tenders and $7,551 million of competitive tenders from the public.
In addition to the $8,526 million of tenders accepted in
the auction process, $1,235
million of tenders was awarded at
the average price to Federal Reserve Banks as agents for foreign
and international monetary authorities. An additional $1,4 34
million of tenders was also accepted at the average price from
Government accounts and Federal Reserve Banks for their own
account in exchange for maturing securities.

B-1391

TREASURY NEWS
department of the Treasury e Washington, D.C. e Telephone 566-2041
Embargoed For Release Until Delivery
Expected at 10:00 a.m. EDST

STATEMENT OF THE HONORABLE
JAMES A. BAKER, III
SECRETARY OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON FOREIGN OPERATIONS
OF THE
COMMITTEE ON APPROPRIATIONS
U.S. HOUSE OF REPRESENTATIVES
APRIL 28, 1988
Mr. Chairman and Members of the Committee:
I welcome this opportunity to discuss with you the Adminis
tration's budgetary proposals for the multilateral development
banks (MDBs) for fiscal year 1989.
Last year, as part of a bipartisan effort to reduce the federal
budget deficit, the Administration and the Congress agreed on
fairly tight guidelines for drawing up the FY 1989 budget
request. The Bipartisan Budget Agreement stipulated an aggregate request for the Foreign Affairs (Function 150) Account of
$18.1 billion in budget authority for FY 1989. The agreement
also specified that the starting poinj. for the individual
Function 150 Account components would be actual FY 19 88 appropriations, not the Administration's FY 1988 budget request.
Secretary Shultz, Jim Miller, and I have worked hard on the
function 150 budget request which the President approved. It
should be noted that the MDBs received $1.2 billion in FY 1988
appropriations and that our request for MDB funding in FY 1989
is $1,324 million. This is an increase of 9.8 percent over
our FY 1988 appropriation, whereas the 150 account overall
received around a two percent increase.
In arriving at the $1,324 million MDB allocation, the
Administration decided to fund fully all of this year's regularly scheduled MDB installments and not request resources
to make up funding shortfalls. It is our intention, however,
to seek all MDB funding shortfalls in the FY 1990 budget
request.
D

1 1ftS

- 2 The largest single item in our budget request ($958 million)
is for the second installment for the eighth replenishment
of the International Development Association (IDA-8). This
is extremely important because IDA is the world's single
largest source of concessional assistance to the world's
poorest countries. IDA-8 resources support economic growth
and development in countries where we have strong strategic,
economic, and humanitarian interests. During the course of
IDA-8, Sub-Saharan Africa — where most of the world's poorest
countries are located — will receive 45-50 percent of total
credit commitments.
The Administration's FY 1989 budget request also is meeting
scheduled installments for the other MDBs. Details of these
requests are described later in my testimony.
The World Bank General Capital Increase
Although it only requires a relatively small annual appropriation, a very important component of our request is funding for
the General Capital Increase (GCI) of the World Bank (IBRD).
After carefully reviewing the current and future demand for
World Bank lending, we agreed with Bank President Barber
Conable's assessment that a GCI is now necessary to assure that
the Bank can continue to provide the necessary support for
economic growth in the developing countries. The overall size
of the GCI is $74.8 billion, with a three percent paid-in
component. The United States has an 18.75 percent share of the
GCI, which implies a budget appropriation request of $70.1
million annually over a six year period. The callable capital
program limitation would be $2.3 billion annually.
Already there has been considerable discussion and speculation
in the press and here in Congress regarding U.S. participation
in the GCI. One theme is that the Administration's strategy
for dealing with the high level of foreign debt in developing
countries has failed, and that a new approach should be agreed
upon before Congress appropriates resources to allow U.S.
participation in the GCI. We strongly disagree with both
suggestions.
Our backing of the GCI goes far beyond simply supporting the
debt strategy. While it is certainly true that a healthy and
vibrant World Bank is important to our debt strategy — as it
would be for any approach to this problem — the reasons to
support the GCI are broader than the debt issue.
Let me explain why this proposal should have your support.
The main role of the World Bank continues to be supporting
economic development through sound project lending. At

- 3 least 75 percent of World Bank lending is for projects to
promote human and capital infrastructure in areas such as
energy development, development finance corporations,
agriculture and rural development, urban development, and
transportation.
Energy is clearly essential to development, and becomes
increasingly so as economies expand. But expansion of this
sector can be very expensive, often requiring large-scale
investment. In its last fiscal year (1987) the World Bank
made commitments of $3.5 billion for energy development
projects including support for the generation and distribution of electric power to households, schools, hospitals,
and industry.
In contrast to direct support for large-scale projects,
the World Bank also supports small and medium-scale
productive enterprises through local development finance
companies (DFCs). Most DFCs lend to manufacturing enterprises, though some also specialize in particular sectors
or activities, such as tourism. In FY 1987 these financial intermediaries received IBRD commitments of $2.2
billion.
The reasons for World Bank lending to agriculture and rural
development are compelling. Approximately six out of every
ten people in developing countries depend on agriculture and
related pursuits for their livelihood. Bank projects help
developing countries expand irrigation systems, provide more
effective extension services, make credit available to small
farmers, adopt appropriate technology, increase storage, and
improve marketing and distribution facilities. The Bank
committed $1.9 billion of its resources to this sector last
year.
Urban development was the fourth largest recipient of IBRD
commitments in Bank fiscal year 1987, receiving $1.2 billion.
Urban areas now contain nearly one-third of the total population in developing countries. Urban projects usually contain
major components to upgrade slums and squatter development,
or to create sites for additional low-income housing.
The transportation sector received the fifth largest amount
of World Bank commitments last year, $1.1 billion. These
projects support the construction of thousands of miles of
main, secondary, feeder, and rural access roads; railway
reconstruction; and expansion of seaports, riverports, and
inland waterways.
Together, these five areas account for $9.9 billion out of
a total annual lending program of $14.2 billion. On a
regional basis, the largest allocation went to Asia ($5.3
billion), followed by Latin America and the Caribbean ($5.0

- 4 billion). A more modest allocation ($3.9 billion) went to
the Middle East and Africa.
Furthermore, much of the Bank's lending program supports
countries that are strategically important to the United
States. Table 1 below compares last year's (FY87) World Bank
commitments to U.S. bilateral economic assistance (Development
Assistance, ESF, and PL-480). As an example, Turkey received
commitments of $1.1 billion from the World Bank, compared to
U.S. commitments of $100 million.
Even more striking is the level of World Bank support to
countries who are very important to us but where there is
the virtual absence of U.S. bilateral assistance. As an
example, Argentina, Brazil and Mexico received $3.9 billion
from the World Bank in 1987 and virtually nothing from the
United States. In total, for all of the countries listed
in Table 1 below, World Bank commitments in 1987 amounted
to $7.7 billion compared to $1.1 billion in U.S. commitments.
Table 1
Fiscal Year* 1987 Loan Commitments
World Bank U.S. Bilateral
($millions)
Country

(Smill
**4
**2

Mexico
Brazil
Argentina
Turkey
Pakistan
Philippines
Morocco
Tunisia
Thailand
Indonesia

$1,678
1,262
965
1,069
397
342
577
334
21
1,058

$100
325
340
87
84
21
128

Totals

$7,703

$1,091

* U.S. and World Bank fiscal years differ by three months.
** Country share of regional development programs.
The U.S. portion of the paid-in capital (which is actual budget
authority) that supported this $7.7 billion IBRD lending program
was approximately $60 million as compared to the $1.1 billion
dollar-for-dollar cost for the U.S. bilateral assistance.

- 5 -

These figures vividly illustrate how we cannot begin to duplicate
bilaterally the amount the World Bank can lend as a multilateral
institution. The cost would be prohibitive.
This funding has been put to good use:
° A $184 million loan will help Turkey improve
environmental conditions in Izmir by promoting
adequate water supply, sewerage, and sewage
treatment facilities, as well as appropriate
industrial waste-treatment policies and
practices.
° A $22.3 million education loan to Morocco will
improve the quality of vocational training and
reduce its costs through improvements to instructor training.
° A $70 million loan will help Pakistan improve
the efficiency of existing power stations, and
add about 200 mega-watts of additional generating capacity.
° A $300 million loan will support Philippine
economic-recovery efforts, including programs of
tax reform, trade-policy rationalization, publicinvestment program restructuring, and rationalization of government financial institutions.
° In Brazil, an $84 million loan will benefit about
73,000 low-income farm families through construction of simple water-supply systems, construction
of two fish hatcheries, provision of extension
services, marketing support, funding for community
subprojects, and demarcation and protection of a
natural reserve.
An important aspect worth mentioning is the procurement contracts U.S. businesses receive from the IBRD. For FY 1987,
the latest figures available, U.S. firms received $1.6
billion in disbursements from the IBRD for foreign procurement. In an effort to increase this amount, personnel from
the Commerce Department, in conjunction with the U.S.
Executive Director's office at the World Bank and Treasury
staff, are working strenuously to increase the number of
contracts on which U.S. firms bid.

- 6 Another important dimension of World Bank operations is the
increasing effort to promote private sector development.
Development finance companies, which I described earlier,
channel considerable resources to the private sector. Bank
projects in other areas often have specific elements to
support the private sector, such as hydroelectric projects
in Turkey which support joint ventures with the private
sector for construction of power plants.
There is also support for the private sector through policybased lending. Consultants financed through World Bank
support are assisting governments in countries such as Kenya
and the Philippines to formulate model agreements and revise
legislation that affect petroleum in order to attract investment by foreign oil companies. Burkina Faso is being helped
to revise mining sector tax and investment codes.
To further enhance the Bank's support for private sector
development, Bank management has established a high-level
task force including representatives of the private sector
to propose policies, procedures, and initiatives. This task
force will begin its review shortly and is expected to complete its report before summer.
As I mentioned, policy-based lending is an important element
of Bank private sector development efforts. Such lending
has become an important component of World Bank activity.
The impact of such lending is broader than project loans,
affecting the borrower's macro-economic policies rather
than a specific activity. This will improve the allocation
of resources, leading to increases in income and employment.
There is normally a requirement to meet pre-conditions before
the loan will be submitted for Board approval. The loans are
tranched, and require additional action by the borrower before
a second or third tranche will be disbursed.
Currently, about three-fourths of all policy-based loans are
experiencing implementation delays. Such delays are fairly
unavoidable given the uncertainties in implementing politically difficult and complex reforms in such areas as public
and parastatal enterprises, which account for the bulk of
the delays. While the reforms that trigger release of a
second tranche may be late, the reforms are only abandoned
less than 10 percent of the time. Some loans have been
cancelled altogether due to lack of agreement between the Bank
and country over economic policy.
Hence, although the Bank has encountered some difficulties with
policy-based lending, the quality of Bank operations has
been quite good. However, while we have watched such lending
closely and approved of the progress being made in many areas,

- 7 -

we still have some concerns. Therefore, as part of the GCI
negotiations we asked the Bank to review policy-based loans.
This review will be completed sometime this summer.
The Debt Strategy: A Progress Report
The World Bank also plays an essential role in the international debt strategy. That strategy is based on four
fundamental principles:
° First, the central importance of economic growth
and capital formation in easing the debt burden
over time.
° Second, the need for market-oriented reforms in
debtor nations to achieve such growth.
° Third, new debt and equity financing, and the
return of flight capital, to help support such
reforms.
° And fourth, a case-by-case approach to address
the individual needs of each debtor country.
I firmly believe that this strategy remains the only viable
long-term approach to solving the problems of development
and debt. These nations need financial resources to grow.
They also require sustained, market-oriented reform of
their economic structures. These adjustments will make
debtor nations more attractive for future investment —
both domestic and foreign. Together with that investment,
the reforms promise stronger growth, higher standards of
living, and more productive and flexible economies. These
elements ultimately imply increased imports from the
United States.
The strategy's key principles are constant, but its execution
is dynamic within this general framework for debtor/creditor
cooperation. Indeed, one of the great strengths of this
approach is its adaptability.
Considerable progress has been made within this general
approach. The debtor countries have made substantial efforts
to restructure their economies along more market-oriented
lines. As a result, the aggregate performance of the fifteen
major debtors is improving:
° Their GDP growth averaged 2.5 to 3 percent in
1986-87 vs. negative growth of about 3.0 percent
in 1983.

- 8 ° Their export earnings rose by 13 percent last
year, and their imports increased by 7 percent.
° Their interest-to-export ratios fell to about
22 percent last year, compared to an average
30 percent in the 1982-86 period. This is a
key measure of their ability to service debt.
° Their reserves totaled about $40 billion in
1987, a 54 percent increase over the 1982 level
of $26 billion.
° Their aggregate current account deficit fell from
$15 billion in 1986 to $8 billion in 1987, well
below the $50 billion deficits they were running
in 1981-82.
° And several countries have made headway in reversing capital flight.
Perhaps the most important change during the past two years
has been in debtor nation attitudes. The debtor nations
are increasingly focusing on the importance of market-led
growth, and adopting the reforms necessary to achieve it.
For example:
o Colombia has been a successful adjuster in the past
several years and has avoided the need for debt
rescheduling or formal IMF agreements. It has
carried out a program of broad-reaching reforms
with the assistance of the World Bank and under the
IMF "enhanced surveillance" arrangement. It has
effectively utilized coffee windfall receipts to
finance development while avoiding inflationary
pressures.
Mexico has opened up its economy to foreign competition by continuing the elimination of import
licenses and the lowering of tariffs. Foreign
investment flows have sharply increased to over
$1.4 billion before the debt/equity swap program was
suspended in November 1987. This compares with
$900 million and $490 million in 1986 and 1985,
respectively.
Uruguay has managed to reverse the economic decline
of the early 1980s through an export-based economic
strategy and a competitive exchange rate. The current account of its balance of payments is expected
to improve in 1988, and the inflation rate is expected
to continue downward; growth prospects have also
improved.

- 9 ° The Philippines has liberalized imports, is implementing a comprehensive tax reform program, and
has instituted major agricultural reforms.
All of these countries, with the exception of Mexico, had
growth of 4 to 5 percent in 1987. Mexico's growth improved
substantially from the 3.5 percent negative growth experienced in 1986 with the oil price decline.
The World Bank has provided strong support for these reforms,
through both fast-disbursing, policy-based loans to support
structural reforms and project loans to enhance production
and development. Its loans have also helped to catalyze
additional private financial flows. Together, the IMF and
the World Bank have provided approximately $17 billion>in
new loans for these countries since October 1985.
The commercial banks have also committed some $17 billion
in new finance during this period, while rescheduling
some $220 billion in outstanding debt, reducing spreads, and
providing longer grace periods and maturities. Official
creditors have also rescheduled some $18 billion in both
principal and interest payments.
Clearly, more still needs to be done. Nevertheless, the
debtor countries are increasingly committed to reforms and
are making progress toward sustained economic growth. We
must continue to support these efforts, recognizing that a
careful balance between reforms and new financing is essential to assure that debt does not increase at a faster pace
than the debtor's ability to service it. While this is
undoubtedly a difficult task, I believe the debt strategy
now in place is the only viable approach to reach this goal.
I recognize, of course, that some critics urge another path —
the development of large scale debt forgiveness schemes. We
should not be misled by the false promise of "global solutions" of one sort or another. To be direct, I believe this
path leads both debtors and creditors off the cliff.
This approach would irreparably politicize the debt problem,
distracting debtors and creditors alike from the difficult
but fundamental economic adjustment tasks. It would encourage
counterproductive debt repudiations to maximize debt forgiveness. And it would shift the risk on commercial loans to
taxpayers in creditor countries, including U.S. taxpayers.
I simply cannot endorse such schemes. They are also strongly
opposed by the Finance Ministers of the other major industrial nations, as reflected in the April 13 G-7 communique.

•

- 10 -

Finally, we have Encouraged the development of a "menu" approach
to.enhance the flexibility of commercial bank financing packages in meeting the diverse interests of both debtor nations
and the banking community. Such "menus" can provide a variety
of options for new financing, including traditional balance of
payments loans, trade credits, project loans, on-lending facilities, new money borfds, and even limited, voluntary interest
capitalization. They can also include a range of new instruments, including debt/equity swaps, debt/conservation swaps,
and "exit" bonds. Debt conversion instruments help to reduce
both outstanding debt and debt service burdens. Banks would
choose among these options in supporting debtor reform efforts,
as they have been able to do in last-year's Argentine new
money package.
The recent Mexican debt/bond exchange provides an example of
an innovative, voluntary debt conversion technique worked out
between the debtor government and the commerical banks, with
the principal amount of the new Mexican bonds in this case
collateralized by the purchase of U.S. Treasury zero-coupon
bonds. We believe the results of that exchange demonstrate
that several commercial banks are interested in this kind of
market-driven technique, but that most banks will only entertain such exchanges at rates well above thin secondary market
values for such debt. We expect further market development
of these kinds of debt conversion options in the period ahead.
World Bank and Regional MDB Environmental Lending Practices
The last issue of mutual interest I wish to address is the
role of MDBs in the environment. One of our most important
objectives in GCI negotiations has been to strengthen Bank
policies and programs on a broad range of environmental
issues. I have taken a personal interest in those issues.
They are crucial to the protection and preservation of our
natural resource base in all parts of the world. They are
critical if we are to achieve successful and sustainable
development and growth in developing countries over the
longer term.
In his address at last year's annual meeting, President
Conable put particular emphasis on the protection of
renewable resources and pledged a substantial increase
in staffing and financial resources for these purposes.
Subsequently, he has sought to integrate environmental
concerns more effectively into the mainstream of the Bank's
work.
In negotiating the terms of the General Capital Increase,
we have sought to reinforce President Conable's efforts
and to extend their effectiveness for years into the future.

- 11 The report on the General Capital Increase, now adopted by
the Bank's Board of Directors, calls for:
° additional emphasis on the need for better
management of human and natural resources
so that countries can achieve fully sustainable development;
° integration of environmental work into country
development strategies, policies and programs;
° evaluation of the environmental costs of bank
projects;
° mitigation or elimination of adverse effects of
bank projects; and
° support for national and regional programs to
improve environmental management.
Getting this language into the Report on the General Capital
Increase is an important step. It commits the institution's
shareholders from both developed and developing countries,
not just the President of the Bank, to an overall framework
for environmental work over the next several years. Our
job now is to see that this commitment is turned into a
series of strategy papers, policy decisions, and lending
programs that will have the impact that we seek.
Let me turn now to the general issue of environmental reforms
in the multilateral development banks. As you know, legislation now requires us to submit a report on progress in
implementing a series of specific reforms in the Banks. The
first of these reports was forwarded to the Congress in
January. Follow-up reports are to be made each year hereafter.
I am pleased to report that significant progress has been
made in the area of organizational and staffing reforms,
especially at the World Bank. The regional MDBs have implemented reforms, but still require further strengthening in
the area of staffing. This issue is being addressed through
the Board of Directors and upcoming annual meetings. We
also would like to see a more systematic accounting of the
way the Banks report on environmentally beneficial projects
as described in the legislation. To address this concern,
follow-up environmental reports will seek to measure actual
increases or decreases in lending devoted to energy conservation, forestry, light capital technologies and other
environmentally beneficial projects.

- 12 I would like to call your attention to progress which has
been made in the provision dealing with environmental staff
and staff training. During 1987, the World Bank carried
out a major reorganization of its management staff. One of
its primary aims was strengthening the Bank's capacity to
deal more effectively with environmental issues. A Central
Environmental Department was created as well as environmental
units in each of the Bank's four regional offices. Thus far,
45 full time permanent positions have been authorized for
environmental purposes.
In addition, funds have been authorized for the equivalent
of 18 full time consultants to work on various environmental
issues. Use of consultants provides the Bank with greater
flexibility and access to expertise on a broader range of
environmental issues. Training on environmental issues is
continuing in the Economic Development Institute and special
training courses for staff are being introduced.
In the Inter-American Development Bank, two senior environmental experts have been added to the Bank's permanent staff,
an ecologist and an expert on rainforests. A three-day
seminar on environmental issues was held last December for
40 members of the Bank's project analysis staff. Additional
seminars for other members of the Bank staff are planned
for later this year. A one-day briefing on environmental
issues is also being planned for all of the Bank's representatives in borrowing countries.
As I indicated earlier, the World Bank has established a
Central Environmental Department. The Inter-American
Development Bank has set up an Environmental Affairs
Committee in place of a line unit. Small line units have
also been set up in the Asian Development Bank and the
African Development Bank. Clearly, both of these units will
need to be examined and strengthened. However, a start has
been made.
A start has also been made on promoting participation of
non-governmental organizations in the project preparation
cycle. The World Bank, the Inter-American Development Bank,
and African Development Bank have issued instructions to
staff to seek participation of non-governmental groups and
indigenous peoples in project preparation. The Asian
Development Bank has commissioned a report on how it should
work with local non-governmental organizations. The World
Bank and the Inter-American Development Bank have held meetings with non-governmental organizations here in Washington
to facilitate the exchange of information. I readily admit
however, that we need to do more to encourage improvements
in the area of NGO involvement.

- 13 Within the U.S. Government we are working to improve the
ability of the early warning system to monitor MDB projects
with potential adverse effects. This is helping us to
weigh in with bank management at an early stage and try to
mitigate or correct adverse environmental effects. We are
also taking a tougher stand against unsatisfactory loan proposals that reach the board, abstaining on environmental
grounds on the AFDB loan to Botswana in August, on AFDB
loans to Mali and Benin in October, on a World Bank loan to
Sudan in December and on an AFDB loan to Burkina Faso in
February. We are also beginning more systematic consultations on environmental issues with other member countries.
I, myself, participated in the Development Committee's
discussions this month on environmental matters.
In sum, I think we are making appreciable progress toward
our objectives. Obviously, we are not where we want to be,
and we will need to put continuing emphasis on all of these
issues. Our priority now should be to implement the provisions of legislation already in place. I look forward
to working with you in that process in the upcoming months.
Fiscal Year 1989 Budget Request
We are requesting $1.3 billion for the MDBs in FY 1989.
These funding requests reflect both the need for budgetary
restraint and the financial requirements for effective
development programs. The stringency of the cap on international affairs funding in the Bipartisan Budget Agreement
prevents the administration from requesting U.S. funding
shortfalls on earlier scheduled MDB payments. Our MDB
request is comprised, therefore, of MDB funding requirements
currently due for payment.
These requests are composed exclusively of funding requirements negotiated by the Administration in close consultation
with this Committee.
International Bank for Reconstruction and Development (IBRD)
For the IBRD (also known as the World Bank) in fiscal year
1989, the Administration is requesting $70.1 million in
budget authority and $2,293 million under program limitations for subscriptions to the first installment of the
1988 GCI.
The Bank's principal role today is making long-term credit
available for productive projects, at market-related interest
rates, which will lead to economic growth and social development in its less developed member countries. In addition to
providing project finance, the IBRD also provides policy advice
and technical assistance and serve as a financial catalyst and
institution builder.

- 14 International Development Association (IDA)
For fiscal year 1989, the Administration is requesting $958.3
million for the second installment for the $2,875 million U.S.
share of the eighth replenishment of IDA. IDA, an affiliate
of the World Bank, is the single largest source of multilateral
development assistance for lending on concessional repayment
terms to the world's poorest countries; over 96 percent of
IDA lending goes to countries with an annual per capita
income of $400 or less. We intend to seek the U.S. funding
shortfall of $43.3 million in FY 1990.
International Finance Corporation (IFC)
For fiscal year 1989, the Administration is requesting $35.0
million for the third of five installments on the U.S. subscription to the $650 million IFC capital increase. The
IFC provides risk capital as well as long-term loans; plays
an important role as a catalyst in attracting private capital;
and provides technical assistance to developing countries that
want to encourage domestic and foreign private investment.
We intend to seek the U.S. funding shortfall of $49.8 million
in FY 1990.
Inter-American Development Bank (IDB)
There is no request of funds for the IDB in fiscal year 1989
because it has not been possible to reach agreement on a seventh
replenishment for the Bank. The only outstanding U.S. funding
necessary for the IDB ordinary capital is for a shortfall of
$31.6 million for the sixth replenishment. The Administration
is not requesting that shortfall in FY 1989 because the Bipartis
Budget Agreement forced the Administration to choose between
providing resources for U.S. funding shortfalls or currently
scheduled MDB payments.
The Administration has decided that not funding the shortfalls will have less programmatic impact. For this fiscal
year the IDB has adequate reserves to meet its lending
requirements based on the list of projects now being prepared by the Bank. Contingent upon resolution of a question
relating to an internal investigation in the Bank, we intend
to seek the U.S. funding shortfall of $31.6 million in
FY 1990. The Bank promotes economic development among
developing countries in the Western Hemisphere by extending
loans for specific projects on market-related terms.
Fund for Special Operations (FSO)
There is no funding request in fiscal year 1989 for the FSO
through which the IDB extends concessional loans to the poorest
countries of Latin America and the Caribbean. The reasons
for not making a request are the same as for the IDB's ordinary

- 15 capital operations. Sufficient funds remain from IDB-6 to
provide a credible concessional lending program for the region's
really poor countries. Contingent upon resolution of a question
relating to an internal investigation in the Bank, we intend to
seek the U.S. funding shortfall of $63.7 million in FY 1990.
Inter-American Investment Cooperation (IIC)
The Administration is not requesting budget authority for the
IIC for FY 1989. Sufficient funding has already been provided
to enable this new organization to begin operations this year.
The IIC is linked to the IDB, and is designed to support private sector activities in Latin America through equity and
loan investments that focus primarily on small- and mediumscale enterprises. We plan to resume payments to the IIC in
FY 1990.
Asian Development Bank (ADB)
The ADB is currently making lending commitments on the basis
of a capital stock that is fully subscribed by Bank member
countries, including the United States. Hence, there is no
need to request funding for the ADB in fiscal year 1989.
The Bank makes loans at market-related rates to developing
member countries of the region to help bring about conditions
necessary for political stability in a region of the world of
key importance to U.S. strategic and economic interests.
Asian Development Fund (ADF)
For fiscal year 1989, the Administration is requesting $146.1
million to make a regularly scheduled installment to the fourth
replenishment of ADF resources. The Bipartisan Budget Agreement
prevents us from requesting the funding shortfall of $191
million to the ADF until FY 1990. However, because of exchange
rate changes and lower than expected lending levels, it is
expected that the $146.1 million request will enable the Fund
to complete its project lending programs in calendar year 1988.
The ADF is a source of concessional finance to the poorest
member countries of the ADB. Pakistan, Bangladesh, Sri Lanka,
and Nepal are the major borrowers from the Fund.
African Development Bank (AFDB)
For fiscal year 1989, the Administration is requesting $9.0
million in budget authority for subscriptions to paid-in
capital and $134.9 million under program limitations for
callable capital for the second of five installments to
increase the Bank's capital base. The Bank makes loans on
market-related terms for the economic and social development
of fifty African member countries, individually and through
regional cooperation. Membership and support of the AFDB is

- 16 an important part of the U.S. commitment to work with the
countries of Africa for the achievement of their long-term
development objectives.
African Development Fund (AFDF)
For fiscal year 1989, the Administration is seeking $105
million in budget authority for the first of three installments for the U.S. contribution to the fifth replenishment
of AFDF resources. The Fund complements AFDB operations
by providing concessional financing for high priority
development projects in the poorest African countries. The
United States has a strong humanitarian interest in aiding
the poorest countries of the world's least developed continent
through its support for the AFDF.
Conclusion
In conclusion, Mr. Chairman, I want to emphasize this Administration's commitment and full support for the MDBs.
As you know, Mr. Chairman, the Administration has made an
earnest effort to consult closely with you and members of this
Committee regarding the MDB replenishments it has negotiated.
Moreover, President Reagan, in various fora and through letters
to you, has repeatedly stressed U.S. commitment to these institutions. Now we urge your support for the Administration's MDB
request so that these institutions will benefit the people for
whom they were intended -- both abroad and here in the United
States.

TREASURY NEWS
lepartment of the Treasury e Washington, D.c. e Telephone 566-2041
FOR RELEASE AT 12:00 Noon
April 29, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S 52-WEEK BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for approximately $8,750
million of 364-day Treasury bills
to be dated May 12, 1988,
and to mature May 11, 1989
(CUSIP No. 912794 RX 4). This issue will result in a paydown for
the Treasury of about $1,300 million, as the maturing 52-week bill
is outstanding in the amount of $10,041 million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau
of the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m.,
Eastern Daylight Saving time, Thursday, May 5, 1988.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. This series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for
Treasury bills maturing May 12, 1988.
In addition to the
maturing 52-week bills, there are $13,980 million of maturing bills
which were originally issued as 13-week and 26-week bills. The disposition of this latter amount will be announced next week. Federal
Reserve Banks currently hold $3,181 million as agents for foreign
and international monetary authorities, and $7,077 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. Tenders from Federal Reserve Banks for their own account and as agents for foreign
and international monetary authorities will be accepted at the
weighted average bank discount rate of accepted competitive tenders.
Additional amounts of the bills may be issued to Federal Reserve
Banks, as agents for foreign and international monetary authorities,
to the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. For
purposes of determining such additional amounts, foreign and international monetary authorities are considered to hold $426
million
of the original 52-week issue. Tenders for bills to be maintained
on the book-entry records of the Department of the Treasury should
be7Qsubmitted
on Form PD 5176-3.
R_1
7

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million
This information should reflect positions held as of one-half hou
prior to the closing time for receipt of tenders on the day of th
auction. Such positions would include bills acquired through "wh
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previousl
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Ban
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate ten
for each customer whose net long position in the bill being offer
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreeme
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained o
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the differenc
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit c
2 percent of the par amount of the bills applied for must accompc
10/87
tenders for such bills from others, unless an express guaranty oi
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY NEWS

Department of the Treasury e Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
For Release Upon Delivery
Expected at 8:00 p.m. E.D.T.

Remarks by Secretary of the Treasury
James A. Baker, III
General Graves B. Erskine Lecture Series
United States Marine Corps Education Center
in Quantico, Virginia
Friday, April 29, 1988
The Marines are a proud organization. And I am equally proud
that you've given this former Marine lieutenant a chance to
participate in the General Graves B. Erskine Lecture Series this
evening. General Erskine was called the "Big E", and he truly
was a giant of a man — not only physically but in intellect and
in spirit. His courage in war was matched by his vision of
peace. He knew his men had what it took to wage war; he made
sure they had what it took to wage peace. In providing
educational facilities for his men, in preparing them for life
outside of the service, he attracted the attention and admiration
of President Truman. In all that he did, whether as a leader in
Washington or on the battlefield, General Erskine represented the
very best qualities of the United States Marine Corps.
General Erskine knew that a Marine's field of vision referred
not only to battlefield tactics, but to his knowledge of the
world. As a former Marine who has traveled, symbolically at
least, from the Halls of Montezuma to the Halls of High Finance,
I'll do what I can to give you a brief perspective on the link
between national security and the economy. I think we would all
agree that a strong economy and a strong defense are key elements
in a great nation. We cannot have one without the other.
Today I want to make two points: First, that a changing
world economy poses new challenges for America's national
security. And second, that our military must be supported by a
strong national economy. And I'd like to add some thoughts on
what the Administration has been doing to achieve economic
strength.
B-1394

-2U.S. Defense and the Integration of the World Economy
Anyone on a routine inspection tour of the parking lots a
Quantico would soon discover one thing — that the U.S. can't
wait to mount a defense of its real interests until enemy troi
ships are spotted off the coast of Virginia. We have real
interests all over the world. All those Hondas and Volkswagei
and the foreign oil that keeps them running — should tell us
the days when we saw ourselves as an "island nation" — eithei
economically or militarily — are receding rapidly into the p<
The world economy is steadily becoming more interdependent —
the United States is on the leading edge of this change.
This trend may or may not lead to more formal military
commitments. I am not the one to judge that. But at the verj
least, it seems that certain national responsibilities will
increase. As America becomes more and more dependent on trade
to power its economy... as more Americans look for jobs
abroad...and as more American businesses buy property abroad there will simply be a lot more for U.S. forces to protect.
Let me illustrate this trend. Consider an ordinary but
essential consumer product — the shirt:
The typical shirt has probably seen more ports in a year's
time than most Marines do in a five-year hitch — and that's
before it ever gets worn on the back of its owner. A typical
shirt might have been designed in New York City, its materials
made in Japan, using German machine tools and Saudi Arabian
petroleum products and cotton from the state of Georgia. It n
then be cut and sewn in Taiwan, with cardboard backing coming
from Canada and buttons coming from practically anywhere, befc
being sent back to the United States for pressing and marketir
These global possibilities are endless — and certainly this i
true for many other products as well.
American companies produce as much as one-fifth of their
output outside of our borders. According to Financial World
magazine, if the overseas operations of General Motors were a
separate company, it would rank 22nd among America's largest
corporations. And American companies are not the only ones wi
this world view. I understand that Honda, for example, is nov
making cars here in the United States and exporting them to
Japan.
Recently, the Environmental Protection Agency — which
determines gas mileages of cars — found it could no longer
determine whether a car was "foreign" or "domestic." It was
difficult to tell whether all of the parts that made up a
car came predominantly from one country or another.
Today's reality is that America's businesspeople, its
workers, and its consumers all have a share in the internatior
economy. A simple number tells the story: the overall value
our trade is equivalent to one-fifth of everything produced ii
this country.

-3Millions of jobs and businesses depend on stable and secure
markets overseas. We also need reliable suppliers overseas
because many other jobs here in the United States depend on
imports — the longshoremen who unload them, the truckers who
transport them, and the people who sell them.
And our imports are not all Mercedes, wines, or fancy
video-tape recorders. Over a third of our imports are industrial
supplies, machinery or other items used by our factories. And
that doesn't include such a strategic raw material as petroleum.
America now relies on imports for 35 percent of its petroleum
supplies. About 40 percent of the oil that the free world
imports goes through the Persian Gulf — and most of it goes to
our allies.
That's one reason, of course, why brave Marines now patrol
the Gulf.
They are patrolling the Gulf and other areas of the world not
only to make the world safe for democracy — but to protect the
livelihoods of millions of Americans whose jobs depend on a safe
and secure world economic system.
America needs to stand by our allies and trading partners
in Europe and Asia. We need to take a strong stand against
terrorism. We need to keep our shipping lanes open and
communication networks secure. And to get those big jobs done,
we need to maintain a strong defense.
Crucial to our National Security: A Strong Economy
But how do we pay for the defense we need?
If you took seriously some of the stories in the media or on
Capitol Hill you'd think the defense budget is about to bankrupt
the country. That's simply not true.
Let's put the defense budget into perspective. Defense
spending under President Reagan is not going through the roof —
nor is it the burden on the economy that people have made it out
to be. It has averaged about 6 percent of the Gross National
Product since the President's first budget in 1982. This
proportion is higher than in the late 1970's — but is lower
than the early 1970's, and much lower than in the 50's and 60's.
Moreover, our economic prospects compare well to others.
Sure other countries are getting larger. But we are still by
far the largest economy in the world — and over twice the size
of Japan. And we should be for the indefinite future — not
least because we have tremendous resources. A recent essay in
the Washington Post listed some of the advantages that we have
over Japan — our number one economic competitor. We have 30
times as much land that can be cultivated, 1,300 times its oil
reserves, 327 times its coal deposits, 170 times the iron ore
reserves, and a much larger population.

-4In addition, America has certain legal freedoms and vast
spaces that no other country has. It is generally easier to
create businesses here, to hire workers, and to market new id<
As a result, investors from smaller, more crowded, and more r
societies are pouring money into the United States.
The bottom line is that America has the physical and humai
resources to sustain a strong national defense. But many gre<
nations have squandered their resources and forfeited their
position in the world. The test of America's greatness will 1
its ability and willingness to maintain its responsibilities
long into the future.
That puts a premium on far-sighted economic policies. In
1981, President Reagan set an important economic principle inl
motion. This principle was simple but powerful — put the fr<
market back to work. Let big government stand aside and let 1
genius of the American people flourish. Cut tax rates, trim
unnecessary regulations, restrain the growth of federal spend:
and restrain inflation. And finally, don't let up!
Record Growth and Low Inflation: Highlights
Let me give you a few highlights:
America's economic recovery began in 1982 — 65 months ag<
Since then, the U.S. has had one of the fastest growing econoi
in the industrial world. Growth has averaged 4 percent a yeai
That's slightly faster than Japan's growth and much faster th<
Europe's. This expansion is the longest peacetime period of
growth since we began keeping records. And that was before tl
Civil War!
I'd like to think that the landmark tax cuts for the Amer:
people have had something to do with all this. In 1980, who
would have thought that low tax regimes were the wave of the
future! In 1980, when the top federal rate was 70 percent, wl
would have thought that it would be reduced to 28 percent bef<
Ronald Reagan left office!
A low tax rate was not the only impossible dream in 1980.
So was a low inflation rate. When was the last time we've hat
an economic expansion with a low rate of inflation? I know y<
all remember inflation — it was economic enemy Number One!
Nobody felt that it could be controlled. The key wasn't to
control inflation; it was simply to survive it.
But during this latest expansion, the U.S. inflation rate
averaged less than 4 percent. That has been a truly remarkab
achievement.
And this expansion has been accomplished in the face of
almost monthly predictions of gloom. The "wheels were coming
off," the critics said; the economy was going into the tank.

-5But the economy didn't go into the tank — in part because
interest rates came down and stayed down. The prime rate has
declined nearly a dozen points from the rate we inherited that
cold January 20, 1981, when we walked into the West Wing of the
White House. And that's been a big help to young couples
struggling to buy that first home, or families hoping to
refinance a mortgage.
The American economy has also become the job-creating envy o
the world. Since 1982, America's unemployment rate has fallen b
more than five points — to 5.5 percent. We have created more
than 15 million jobs since 1982 — more than all of Europe and
Japan combined.
At the end of last year, the percentage of the working-age
population that was employed was at an all-time high —
62.3 percent.
I'd also like to correct a bit of economic mythology on this
subject of jobs. You may have read reports that suggest that in
creating jobs our economy is merely trading steel workers for
hamburger flippers.
Well, the facts show otherwise. U.S. manufacturing
employment has remained remarkably constant over the past
20 years. Last year, in fact, employment in manufacturing rose
by 407,000.
And these 15 million new jobs are for the most part good,
productive jobs. Yes, many of these new jobs are in the service
sector, but nearly two-thirds of the new employment growth has
been in managerial, professional, technical, sales or
precision-production occupations- (And anyway I find it more
than passing strange to argtsite that we were somehow better off
without those so-called "inferior"" jobs in the service sector
and the paychecks they generate. I doubt if the holders of
these jobs would agree.)
Furthermore, these basic industries are not "bedraggled
dinosaurs" as commentators have alleged in recent years. In
fact, manufacturing productivity has been growing at a rate of
almost 4 percent a year since we came to office. That's nearly
twice as fast as the average of the previous three decades.
There's other good news for our industries. Because of
changes in currency exchange rates in the last three years, our
exports are now much cheaper overseas. In addition, foreign
economies are growing faster and demanding more American goods.
As a result, you have an all-American export boom — which
was inconceivable just a couple of years ago. We're shipping
steel to Japan. That used to make as much sense as shipping
sand to the Sahara desert. We're also sending machine tools to
Germany^and shoes to Italy.

-6International Cooperation and Economic Growth
A strong domestic economy is important to our national
security. So is the domestic strength of our allies. Certain
the North Atlantic Treaty Organization is stronger if the
economies of its members are healthy as well.
The major industrial nations are now joining together to
promote world growth. Recent agreements are paving the way fo
more balanced growth among these nations. Balanced growth is
an important goal because it serves to reduce the huge trade
surpluses and deficits that cause so much political trouble.
We are having success. These trade imbalances are coming
down in volume terms. Economic growth is accelerating in othe
industrial nations and the United States is meeting its
commitment to reduce the federal deficit.
What's more, all of us are doing what we can to promote
economic growth in developing countries. These countries acco
for one third of America's annual trade.
Three years ago we proposed a new partnership between the
developing nations, commercial lenders, and the international
financial institutions. The aim of the partnership was to
strengthen the free market economies of the developing nations
And the strategy is working. Fifteen major developing nations
have grown in the 2 to 3 percent range in the last two years.
That's good progress compared to the negative growth rates in
1982 and 1983. While problems do remain, we believe our polic
represent the most promising road to real and lasting economic
and political reforms.
Conclusion
Ladies and gentlemen, this evening I have discussed two ba
points. First, the growing complexity of the world economy.
cannot exist apart from the larger economic sphere, and we mus
be ready to defend our growing economic interests in the world
Second, a healthy American economy is necessary for a stro
defense. Under President Reagan there has been a new focus on
the free market and growth with low inflation. Now we must
continue these efforts. Those who recognize the value of a
strong defense must also recognize the value of a strong econo
I appreciate the opportunity I have as Treasury Secretary
help develop policies for a strong American economy. But I am
just as appreciative and just as proud to have served this
country as you do — as a United States Marine.
Thank you for inviting me, good luck, and God bless you.

TREASURY NEWS

Department of the Treasury e Washington, D.C. e Telephone 566-2041

TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 9:45 a.m. MDT
Remarks by
Secretary of the Treasury
James A. Baker, III
at the First Strike Ceremony
1988 United States Olympic Coins
United States Mint
Denver, Colorado
May 2, 1988
Thank you, Kay [Ortega], I'm just delighted to finally meet
this distinguished group of American athletes. You are
champions, and you inspire all of us with your determination and
your skill. You represent our American diversity and our passion
for excellence. You embody the Olympic motto: "Citius, Altius,
Fortius" — "Faster, Higher, Stronger."
Americans respond to you with enthusiasm and affection
because you represent something that binds all of us together —
our tradition of meeting challenges and overcoming obstacles.
Your fans all over our great country feel intimately involved in
your efforts — the hard training, the sacrifices you and your
families have made along the way, the discipline and endurance
you've achieved, and — perhaps most of all — your joy in
winning.
*
That's what's so great about the Olympic Coins that we are
about to strike. They give those who own them a sense of being
members of the team, a sense of sharing in its trials and in its
triumphs. And at virtually no cost to the taxpayer, the 1988
Olympic Coins give each of us the opportunity to support
America's athletes.
You know, many other countries underwrite the training of
their young athletes. But that has never been the American
approach. Here it is that great engine of freedom — the
voluntary energies of private citizens — that powers our
efforts.
B-1395

-2Like our athletes, we have set an ambitious standard for
ourselves. We hope to meet or even exceed a goal of $49 million
in selling these Olympic Coins. That income will be the largest
single source of contributions to the U.S. Olympic Committee this
year. Congress has mandated that these funds are to be dedicatee
to one use only — the training of present and future Olympic
athletes.
The proceeds of the sale of the coins will have both
short-term and long-term benefits. First of all, we'll all get
a lot of pleasure from seeing our investments in these coins
returned in gold, silver, and bronze medals this summer.
But that's just the beginning. The performance and the
example of the Olympic athletes have a continuing effect on all
of us. From the time when poets wrote of the first Olympic
feats, right up to this year's Winter Games, we have drawn
inspiration from your strength, your endurance, and your good
sportsmanship.
And that leadership won't end when the Summer Games are over.
We will continue to count on your leadership in American society
in the years to come. Your achievements fire us up to stretch
just a little further, to try just a little harder, and to attain
just a little more.
It's that spirit of American enterprise and stamina that
these coins symbolize. So let's get right down to business and
get the process started. How about it?
And now, Therese [Andrews], over to you there at the newly
re-designated West Point Mint. And let me just take a second
here to congratulate those of you there on West Point's new
status. Are you all set?
Thank you, all, very much.

TREASURY NEWS
Department
of the Treasury e Washington, D.c. e Telephone 566-2041
FOR IMMEDIATE RELEASE
May 2, 1988

CONTACT

Office of Financing
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $6,405 million of 13-week bills and for $6,410 million
of 26-week bills, both to be Issued on May 5, 1988,
were accepted today.
RANGE OF ACCEPTED
13-veek bills
COMPETITIVE BIDS: maturing August 4, 1988
Discount Investment
Rate
Rate 1/
Price

26-week bills
maturing November 3, 1988
Discount Investment
Rate
Rate 1/
Price

Low
6.08%a/ 6.26%
High
6.13%
6.31%
Average
6.13%
6.31%
a/ Excepting 1 tender of $3,000,000.

6.35%
6.42%
6.41%

98.463
98.450
98.450

6.65%
6.73%
6.72%

96.790
96.754
96.759

Tenders at the high discount rate for the 13-week bills were allotted 77%.
Tenders at the high discount rate for the 26-week bills were allotted 56%,

TENDERS RECEIVED AND ACl:EPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
36,730
22,647,830
35,285
53,125
44,415
25,200
1,657,875
29,485
8,605
42,045
37,855
863,755
381,510

$
36,730
5,597,930
35,285
47,440
38,115
25,200
58,370
25,485
8,605
42,045
27,855
80,005
381,510

: $
23,890
: 19,567,330
s
22,345
:
36,655
:
34,700
23,535
1,521,140
20,995
6,210
38,915
j
28,245
•
1,116,810
426,290
:

$
23,890
5,481,330
22,345
34,455
34,700
23,535
135,940
18,555
6,210
38,915
21,045
143,010
426,290

$25,863,715

$6,404,575

: $22,867,060

$6,410,220

$22,849,325
1,041,830
$23,891,155

$3,390,185
1,041,830
$4,432,015

: $18,800,210
:
916,985
: $19,717,195

$2,343,370
916,985
$3,260,355

1,850,225

1,743,000

122,335

1,406,865

$25,863,715

$6,404,575

: $22,867,060

$6,410,220

An additional $45,065 thousand of 13-veek bills and an additional $486,635
thousand of 26-veek bills will be Issued to foreign official Institutions for
nev cash.
1/ Equivalent coupon-issue yield.
B-1396

rREASURY NEWS
iportment of the Treasury e Washington, D.c. e Telephone 566-2041
FOR RELEASE. APRIL 30, 1988

CONTACT:Charles Powers
566-8773

PANAMA SANCTIONS - LIMITED PAYMENTS PERMITTED
The Treasury Department today announced that it would permit
"certain limited payments in Panama by U.S. persons. Executive
Order 12635 of April 8, 1988, which imposes economic sanctions
against Panama, prohibits direct or indirect payments to the
Noriega/Solis regime from the United States and from U.S. persons
(including U.S. corporations and subsidiaries) in Panama. It also
blocks all assets of the Government of Panama in the United
States.
The Department will issue regulations specifying the permitted
payments in detail. All other payments continue to be required to
be made into a specially-designated account at the Federal Reserve
Bank of New York to be held for the benefit of the Panamanian
people.
Permitted payments include:
o Payments by individuals other than income tax payments.
Individuals who make their own social security payments
may continue to do so.
o Travel-related payments by individuals, including
departure fees and ticket taxes, or by U.S. firms in
connection with the provision of travel services to
individuals, e.g., landing fees and fuel.
o Payments for postal services and for telephone, telegraph
and other telecommunications services.
o Payments for utilities including electricity, water, and
similar municipal services.
o Payments of indirect taxes (i.e., those normally
collected in the purchase of goods and services such as
sales and excise taxes) and certain administrative fees
paid in connection with basic business activity.
Treasury regulations will specify which administrative
fees can be paid.

- 2 -

Payments other than the
specified in the regulations as
permitted must not be n, e to the Noriega/Solis regime. They m
be made to the specially-designated account at the Federal Rese
Bank of New York. Treasury regulations will provide guidance o
the method for making payments to this account.
Payments that must be paid into the accour at the Federal Rese
Bank of New York include: corporate and i. dividual income taxe
social security taxes (when paid by corporations or U.S.
Government agencies, but not by individuals who ordinarily pay
such taxes directly); direct taxes and fees (e.g., port fees,
export fees, import duties and related expenses); direct paymen
of excise taxes collected as agent for the Government of Panama
and rental fees. Additionally, individuals may not make paymen
directly or indirectly, for or on behalf of U.S. firms.
Violations of the Panamanian sanctions are punishable by crimin
penalties of up to ten years imprisonment and a $50,000 fine, o
by civil penalties of up to $10,000 per violation.
Questions about procedures or payments should be directed to
Treasury's Office of Foreign Assets Control at 202/376-0392.

o 0 o

TREASURY NEWS

Department of the Treasury e Washington, D.c. e Telephone 566FOR RELEASE AT 4:00 P.M. CONTACT: Office of Financing
May 3, 1988
202/376-4350
TREASURY*S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued May 12, 1988.
This offering
will result in a paydown for the Treasury of about $1,175 million, as
the maturing bills are outstanding in the amount of $13,980 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Daylight Saving time, Monday, May 9, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
February 11, 1988, and to mature August 11, 1988
(CUSIP No.
912794 QH 0), currently outstanding in the amount of $7,087 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be dated
May 12, 1988,
and to mature November 10, 1988 (CUSIP No.
912794 QT 4).
The bills will be Issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be Issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be Issued for cash and in exchange for Treasury
bills maturing May 12, 1988.
In addition to the maturing
13-week and 26-week bills, there are $10,041 million of maturing
52-week bills. The disposition of this latter amount was announced
last week. Tenders from Federal Reserve Banks for their own account
and as agents for foreign and international monetary authorities will
be accepted at the weighted average bank discount rates of accepted
competitive tenders. Additional amounts of the bills may be issued
to Federal Reserve Banks, as agents for foreign and international
monetary authorities, to the extent that the aggregate amount of
tenders for such accounts exceeds the aggregate amount of maturing
bills held by them. For purposes of determining such additional
amounts, foreign and international monetary authorities are considered to hold $2,752 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $3,178 million as
agents for foreign and international monetary authorities, and $7,077
million for their own account. These amounts represent the combined
holdings of such accounts for the three Issues of maturing bills.
B-1398 for bills to be maintained on the book-entry records of the
Tenders
Department
ofseries)
the Treasury
should
be submitted
on Form
PD 5176-1
(for 13-week
or Form
PD 5176-2
(for 26-week
series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own accounEach tender must state the amount of any net long position in th<
bills being offered if such position is in excess of $200 millioi
This information should reflect positions held as of one-half hoi
prior to the closing time for receipt of tenders on the day of tl
auction. Such positions would include bills acquired through "wl
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previous:
offered as six-month bills. Dealers, who make primary markets ii
Government securities and report daily to the Federal Reserve Bai
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tei
for each customer whose net long position in the bill being offe]
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreem<
nor make an agreement to purchase or sell or otherwise dispose o:
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained <
the book-entry records of the Department of the Treasury. A casl
adjustment will be made on all accepted tenders for the differen
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit
2 percent of the par amount of the bills applied for must accomp
tenders for such bills from others, unless an express guaranty o
payment by an incorporated bank or trust company accompanies the
10/87
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may*
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
the
Public Debt.
10/87

TREASURY NEWS

department
of the Treasury e Washington, D.c. e Telephone
566-2041
FOR RELEASE WHEN AUTHORIZED AT PRESS CONFERENCE
May 4, 1988
TREASURY MAY QUARTERLY FINANCING
The Treasury will raise about $9,475 million of new cash
and refund $16,527 million of securities maturing May 15, 1988, by
issuing $8,750 million of 3-year notes, $8,750 million of 10-year
notes, and $8,500 million of 30-year bonds. The $16,527 million of
maturing securities are those held by the public, including $2,962
million held, as of today, by Federal Reserve Banks as agents for
foreign and international monetary authorities.
The three issues totaling $26,000 million are being offered
to the public, and any amounts tendered by Federal Reserve Banks
as agents for foreign and international monetary authorities
will be added to that amount. Tenders for such accounts will be
accepted at the average prices of accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $3,563 million
of the maturing securities that may be refunded by issuing additional amounts of the new securities at the average prices of
accepted competitive tenders.
The 10-year note and 30-year bond being offered today will
be eligible for the STRIPS program.
Details about each of the new securities are given in the
attached highlights of the offering and in the official offering
circulars. The circulars, which include the CUSIP numbers for components of securities with the STRIPS feature, can be obtained by
contacting the nearest Federal Reserve Bank or Branch.
Financial
institutions should consult their local Federal Reserve Bank or
Branch for procedures for requesting securities in STRIPS form.
oOo
Attachment

B-1399

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
MAY 1988 QUARTERLY FINANCING
Amount Offered to the Public
Description of Security;
Term and type of security
Series and CUSIP designation

$8,750 million

10-year notes
Series B-1998
(CUSIP No. 912827 WE 8)
Listed in Attachment A
of offering circular
Issue date May 16, 1988
May 16, 1988 (to be
dated May 15, 1988)
Maturity date May 15, 1991
May 15, 1998
To be determined based on
Interest rate
To be determined based on
the average of accepted bids
the average of accepted bids
To be determined at auction
Investment yield
To be determined at auction
Premium or discount
To be determined after auction To be determined after auction
November 15 and May 15
Interest payment dates
November 15 and May 15
$1,000
Minimum denomination available... $5,000
To be determined after auction
Amount required for STRIPS
Not applicable
Terms of Sale:
Yield auction
Method of sale
Yield auction
Must be expressed as
Competitive tenders
Must be expressed as
an annual yield with two
an annual yield with two
decimals, e.g., 7.10%
decimals, e.g., 7.10%
Noncompetitive tenders
Accepted in full at the aver- Accepted in full at the average price up to $1,000,000
age price up to $1,000,000
Accrued interest
payable by investor
None
To be determined after auction
Payment Terms:
Payment by non-institutional
Full payment to be
investors
Full payment to be
submitted with tender
submitted with tender
Payment through Treasury Tax
Acceptable for TT&L Note
Acceptable for TT&L Note
and Loan (TT&L) Note Accounts.
Option Depositaries
Option Depositaries
Deposit guarantee by
Acceptable
Acceptable
designated institutions.
Key Dates:
Wednesday, May 11, 1988,
Tuesday, May 10, 1988,
Receipt of tenders
prior to 1:00 p.m., EDST
prior to 1:00 p.m., EDST
Settlement (final payment
due from institutions):
a) funds immediately
Monday, May 16, 1988
Monday, May 16, 1988
available to the Treasury.
Thursday, May 12, 1988
Thursday, May 12, 1988
t>) readily-collectible check.
3-year notes
Series S-1991
(CUSIP No. 912827 WD 0)
CUSIP Nos. for STRIPS Components. Not applicable

May 4, 1988
$8,500 million
30-year bonds
Bonds of 2018
(CUSIP No. 912810 EA 2)
Listed in Attachment A
of offering circular
May 16, 1988 (to be
dated May 15, 1988)
May 15, 2018
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
November 15 and May 15
$1,000
To be determined after auction
Yield auction
Must be expressed as
an annual yield with two
decimals, e.g., 7.10%
Accepted in full at the average price up to $1,000,000
To be determined after auction

Full payment to be
submitted with tender
Acceptable for TT&L Note
Option Depositaries
Acceptable
Thursday, May 12, 1988,
prior to 1:00 p.m., EDST

Monday, May 16, 1988
Thursday, May 12, 1988

TREASURY NEWS
Department of the Treasury e Washington,
D.C. e Telephone 566-204
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350
May 5, 198 8
RESULTS OF TREASURY'S 52-WEEK BILL AUCTION

Tenders for $8,766 million of 52-week bills to be issued
May 12, 1988,
and to mature
May 11, 1989,
were accepted
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield)
Low - 6.73%
High
Average -

7.19'
7.20:
7.20

6.74%
6.74%

Tenders at the high discount rate were allotted 91%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Accepted
Received

B-1400

16, 160
26 017 735
16 645
44 945
31 460
19 560
730 545
15 600
11 715
24 890
25 040
,438 965
$29,594,825
201 565

16, 160
025, 445
16 645
19 945
27 460
16 560
207 895
11 600
11 715
24 890
15 ,040
170 ,865
$8,765,785
201 ,565

$25,805,575
579,250
$26,384,825
2,900,000

$4,976,535
579,250
$5,555,785
2,900,000

310,000
$29,594,825

310,000
$8,765,785

Price
93.195
93.185
93.185

TREASURY NEWS

Department of the Treasury e Washington, D.c. e Telephone 566-204
FOR IMMEDIATE RELEASE

May 5, 1966

TREASURY AMENDS MAY QUARTERLY FINANCING ANNOUNCEMENT
In yesterday's May Quarterly Financing announcement, the
Treasury offered three new note and bond issues, including
3-year notes of Series S-1991 to be dated and issued May 16,
1988. The new 3-year notes will have the same maturity and
interest payment dates as the outstanding 8-1/8% 5-year 2-month
notes, Series J-1991, issued Maroh 5, 1986. The public currently holds $7,728 million of the outstanding notes.
If the auction of the 3-year notes, in accordance with the
circular offering the notes to the public, results in the same
interest rate as the outstanding 5-year 2-month notes (8-1/8%),
the 3-year notes will be considered an additional issue of the
5-year 2-month notes. If such a consolidation occurs, it would
be effeotive May 16, 1988, and the Treasury circular governing
the notes would be amended accordingly. In the event of a consolidation, accrued Interest of $0.22079 per $1,000 for May 15,
1988, to May 16, 1988, would be payable in addition to the
auction price of the notes. The additional issue of the 5-year
2-month notes would have the eame CUSIP number as the outstanding
notes.
All other particulars of the announcement remain unchanged.
oOo

B-1401

TREASURY NEWS

Department of the Treasury e Washington, D.c. e Telephone 566-204

For Release Upon Delivery
Expected at 10:00 a.m.
May 9, 1988
STATEMENT OF
O. D O N A L D S O N C H A P O T O N
A S S I S T A N T S E C R E T A R Y (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE T H E
SUBCOMMITTEE O N OVERSIGHT
COMMITTEE O N WAYS A N D MEANS
U.S. H O U S E O F R E P R E S E N T A T I V E S
Mr. Chairman and Members of the Committee:
I am pleased to have this opportunity to present 'the views of the Treasury
Department on possible revisions to the unrelated business income tax ("UBIT") that
are contained in the list of "discussion options" released by the Committee on March
31, 1988. Last June, this Committee held five days of hearings regarding the
appropriate tax treatment of income-producing activities of tax-exempt organizations.
M y testimony today builds upon Treasury's prior testimony before the Committee and
reflects our consideration of the hearing record from last June as well as the many
constructive comments submitted by interested parties.
Mr. Chairman, both you and the entire Oversight Subcommittee are to be commended
for undertaking a fresh look at this important area of the law, one that has not been
thoroughly reviewed by Congress since 1969. While tax laws regarding exempt
organizations serve for the most part to regulate the sector rather than to raise
revenue, the importance of these laws to the tax system as a whole should not be
underestimated. Few areas are more important to how the American public perceives
the fairness and success of our tax system. W h o is not taxed - and why ~ is of the
utmost concern to those who are taxed.
Both the hearings of last June and the ensuing public debate have focused a great
deal of attention on the structure and administration of the UBIT. The process has
been a constructive one in which individuals representing all sides of this issue
have been able to express their views fully. At this time the discussion options
have not been presented as a legislative package and we axe not in a position to
B-1402

-2either endorse or oppose the entire options paper. With respect to individual
options, however, m a n y are consistent with m y testimony of last June (the "June
testimony") and others address areas that are of concern to us. Although I indicate
general support for some of these options, our support of legislation reforming the
U B I T would depend on the proposals ultimately contained in such legislation. In
addition, w e believe the administrative burdens such legislation would place on
exempt organizations and the Internal Revenue Service is an important factor to
consider. W e look forward to working with your Committee in producing legislation
that reflects the legitimate concerns of all interested parties.
My testimony will consist of two pans. First, I will describe various tax
policy considerations regarding the U B I T , with reference to m y testimony from last
June. Second, I will comment on each of the discussion options in light of those
considerations as well as administrative and other concerns. M y conclusions, very
generally, are as follows.
° First, the issue of the appropriate structure of the UBIT raises fundamental
questions regarding tax exemption. W e recommend that Congress address these
broader questions, but w e recognize there is a need for improved data before
such questions can be comprehensively analyzed. Thus, w e support the proposal
to collect needed additional data and to mandate the completion of certain
studies.
0

Second, in analyzing the UBIT it is important to recognize that the effort to
limit "unfair competition," although the primary motivation for the original
enactment of the tax, is not the only purpose served by the tax. T h e U B I T
also serves the important goals of enhancing the efficiency, of the
governmental subsidy inherent in tax exemption and. of helping to ensure the
accountability of tax-exempt organizations.

Third, given the need for improved data, I believe the general approach of the
discussion options is sound. The options, for the most pan, would leave the
basic structure of the law intact and make only discrete changes in areas
where information available today permits Congress to make informed judgments.
A number of discussion options reflect suggestions m a d e in m y June testimony
and other options reflect a codification of present administrative practice.^/
W e are generally supportive of those options. Other options would change
present law, in some cases dramatically. While w e would support some of these
changes, w e have reservations about others.

\l With respect to several of the discussion options, I state that the option would
codify present law or administrative practice. In so stating, I recognize that in
some instances the administrative practice of the Internal Revenue Service is being
challenged in court and that our view of present law m a y differ from that of others.

-3Policy Considerations
I. Introduction
The UBIT is an important element of the rules that define and limit the scope and
rationale for tax exemption. A n y comprehensive review of the U B I T thus raises
questions about the policies underlying tax exemption and h o w these policies are
served in practice. A s I stated in m y June testimony, tax exemption is intended to
encourage the production of certain socially beneficial goods and services that would
not otherwise be produced in adequate supply. There are fundamental issues, however,
as to whether tax exemption is the most efficient way to encourage desirable
activities, whether tax exemption continues to be necessary for certain activities,
and whether tax exemption is justified for organizations that rely almost exclusively
on commercial activities for support. Further questions arise as to the effect on
the tax system and the economy of the growing tax-exempt sector, including both
section 501(c) organizations and pension trusts, such as whether the active presence
in the marketplace of exempt organizations with substantial assets and no tax on
their "passive" investments can create undesirable economic distortions/
Full consideration of these issues will require the development of additional
information concerning the activities of the tax-exempt sector. This Committee's
hearings and the discussion options have thus appropriately been focused on the dayto-day application of the U B I T and the practical effect of taxable and exempt
suppliers co-existing in the same industry. I should emphasize, however, that is
important for Congress to review the broader policy issues concerning tax exemption
in order to ensure that the substantial benefits of tax exemption are appropriately
limited. W e , of course, would be pleased to assist in that review.
II. Tax Exemption and Unfair Competition
The ability of exempt organizations to conduct income-producing activities
without incurring tax liability has led to complaints from the small business
community and has provided the impetus for consideration of changes in the U B I T .
While complaints regarding unfair competition must be taken quite seriously, and in
fact gave rise to enactment of the JUBIT in 1950, w e believe that tax policy toward
commercial activities of nonprofit organizations should not be guided solely by such
concerns. The U B I T also serves an important role in enhancing economic efficiency not taxing income from some commercial activities of exempt organizations m a y
represent an inefficient use of an indirect government subsidy. Moreover, the U B I T
helps to ensure the accountability of tax-exempt organizations, both to individual
donors and to society as a whole. Without these other functions performed by the
U B I T , it is possible that increased pursuit of commercial income by tax-exempt
organizations could change the fundamental nature of the nonprofit sector.
As I discussed in the June testimony, the precise effect of income tax exemption
on competition is not entirely clear. There is little empirical evidence regarding

-4either the behavior of exempt organizations in competition with taxable businesses or
the response of taxable businesses to such competition. Even though tax exemption
allows a nonprofit organization to earn a higher rate of return than a taxable
company within a particular activity, s o m e have argued that this does not necessarily
create an adverse effect on the taxable business. Because the nonprofit organization
enjoys a similarly higher rate of return on other uses of its capital, including
passive investments, the relative "opportunity cost" of entering a particular
business (which includes the revenue lost from forgoing alternative investments) can
be equivalent for taxable and exempt organizations. As a result, taxable and exempt
businesses m a y be in the same relative position with respect to the decision whether
or not to enter a particular business. Thus, following this analysis, if income tax
exemption were the sole benefit granted to nonprofit organizations, nonprofit and
taxable organizations might well co-exist in the same business, just as such
organizations co-exist in the stock and bond markets.
Nonetheless, when tax exemption is combined with other governmental subsidies such as the ability of s o m e exempt organizations to issue tax-exempt bonds, access to
lower postal rates, exemption from certain federal excise taxes, and exemption from
certain state and local taxes - an exempt organization's cost of producing goods and
services for sale is further reduced.
Hence, its profit is increased without a
corresponding increase in the return available from alternative passive investments.
Consequently, there exists an additional incentive-to produce such goods or services
as opposed to making a passive investment.
In addition, as a result of their various cost-saving benefits, it is possible
that tax-exempt organizations would reduce their prices in an attempt to drive out
non-exempt competitors. Engaging in this type of "predatory" pricing leads firms to
forego profits in the short run, in the hope that future profits will be large enough
to overcome the near-term losses. There is little agreement, however, a m o n g
economists about whether such pricing is c o m m o n or whether it is likely to be
successful .2/
Thus, although the precise consequences are not perfectly understood, the
combination of tax exemption with other governmental subsidies m a y create a
competitive advantage for tax-exempt organizations.
Such advantage could be
sufficient in certain cases to discourage taxable firms from entering an industry or
could encourage existing taxable firms to leave the industry. This result is of
particular concern if exempt organizations impinge on activities previously carried
on principally by taxable businesses. In such a situation, the taxable businesses
would not have anticipated competition from tax-exempt organizations and would have
m a d e economic decisions ignoring this possibility.

2/ A further complicating factor in assessing the pricing behavior of exempt
organizations is that they will often be motivated primarily by the desire to
maximize the output of their exempt product, not by the desire to maximize profits.
This could result in prices of such exempt products that are lower than those of
their taxable competitors. T h e desire to maximize exempt output would depend, of
course, on whether the organization views those items as part of its primary exempt
function, rather than as part of an ancillary function.

-5III. Economic Efficiency
In addition to limiting unfair competition, the unrelated business income tax
serves the goal of economic efficiency by helping to ensure that the subsidy of tax
exemption is used in the manner that provides the greatest social benefit.
The effect of the UBIT on economic efficiency can best be seen by considering the
impact of a system that exempts from tax all unrelated business income. Such a tax
system would encourage equally the pursuit of exempt and unrelated activities by
non-profit organizations. This would be an inefficient use of the grant of tax
exemption, in that a subsidy is not needed to assure production of appropriate
amounts of most commercial goods and services.
Tax exemption for unrelated business income would also act as an indirect subsidy
to the primary exempt function of a nonprofit organization because the organization
would direct some or all of its unrelated business income towards its exempt
function. Subsidizing the primary exempt function of nonprofit organizations by
means of a tax exemption for unrelated income, however, would simply reward those
organizations that are most successful in pursuing commercial ventures. Such a
system would be unlikely to provide the greatest reward to the most deserving
organizations: Le., those that provide the greatest social benefit.3/
Our current tax system does not, of course, exempt all nonprofit income from
taxation. Nevertheless, the criterion of economic efficiency can be applied to those
particular areas in .which nonprofit commercial activities do, in fact, escape
taxation in order to help determine whether such activities should remain exempt.
IV. Accountability of Tax-Exempt Organizations
A third important function performed by the unrelated business income tax
pertains to the accountability of exempt organizations. As I mentioned in m y June
testimony, the rules limiting the scope of tax exemption require a non-profit
organization to concentrate its activities on those purposes for which it was granted
exempt status .4/ Unrelated business activities can divert an organization from its
primary purpose and, in extreme cases, supplant that primary purpose altogether.
Although the Internal Revenue Service has the authority to revoke an organization's
exempt status in such cases, it can be extremely difficult to establish the primary
purpose of an organization.
3/ The most efficient subsidy would be allocated to various uses so that the social
benefit of the last dollar spent on each use is equalized. If this is not the case,
then a reallocation of the subsidy, from low to high social benefit uses, would
increase total social benefits at the same cost to the government. This goal would
be accomplished by redirecting subsidies from commercial to exempt activities, and
from those exempt activities with low marginal social benefits to those with higher
benefits.
4/ An organization formed under section 501(c)(3) of the Code, for example, must be
organized and operated "exclusively" for one of several designated exempt purposes.

-6Because the Internal Revenue Service does not have the ability to closely monitor
the activities of all exempt organizations, and because it has few enforcement tools
short of revoking exempt status altogether, some complementary form of oversight is
needed to help ensure that public purposes are being served by the grant of tax
exemption. At least in the case of section 501(c)(3) organizations, w e believe that
unrelated donors w h o support the organizations can help perform this function. If an
organization loses sight of its exempt purpose, for whatever reason, donors will
eventually cease to support the organization and they will shift their contributions
to more deserving organizations.5/
If an organization is able to support itself with commercial activities, however,
the role of the donor becomes less critical and the organization becomes less
accountable to the very persons w h o are best situated to evaluate its activities. T o
the extent these commercial activities are central to the organization's exempt
purpose — such as education — there is perhaps less cause for concern because
Congress has determined that these activities should be subsidized by the tax system.
But to the extent such income-producing activities are merely tangential to the
organization's exempt purpose, w e believe Congress has cause for concern and that the
unrelated business income tax can help regulate the extent of such activities.
V. Conclusion
The foregoing description of various purposes served by the UBIT brings s'everal
points into focus. First, the existence of unfair competition is not' always required
in order to conclude that unrelated income from a particular activity should be
subject to tax: considerations of economic efficiency and of accountability m a y
independently justify such a result. Second, although tighter tax laws regarding
unrelated business income m a y be desirable, on either equity or efficiency grounds,
they would undoubtedly reduce the overall level of government support provided to
activities performed by the nonprofit sector.
Congress m a y decide that a
reallocation, not a reduction, of the present subsidy for such activities is
desirable.
Finally, the appropriate scope of the U B I T is part of the more
fundamental issue of whether particular activities should be granted tax exemption.
W h e n the necessary additional information has been gathered with respect to exempt
organizations, w e believe Congress should undertake a comprehensive examination of
this fundamental issue.
5/ The legislation enacted as part of the Revenue Act of 1987, which requires exempt
organizations to make available for public inspection their Forms 990 and application
for tax exemption, helps facilitate an informed judgment by donors in this regard.
State laws requiring other forms of disclosure are also beneficial. Indeed, Congress
m a y conclude that additional disclosure requirements are appropriate if further study
indicates that donors are not sufficiently informed.
W e are concerned, in
particular, that some donors m a y incorrectly view the Internal Revenue Service's
recognition of exempt status as being the equivalent of a governmental endorsement of
the organization's management and operations.

-7Discussion Options
Next, I will comment on the individual discussion options. My evaluation of each
option will in part turn on the purposes of the U B I T I have just described, but will
also consider administrative and other concerns.
I. "Substantially Related" Test:
"Repeal "substantially related" test and replace it with a "directly related"
test."
Under present law, a regularly carried on trade or business is exempt from tax if
the business is substantially related to the exempt purpose of the organization,
aside from the need for funds. Treasury regulations elaborate upon the meaning of
the term "substantially related" by requiring that the business activity have a
substantial causal relationship to accomplishment of the organization's exempt
purposes, a relationship which "contributes importantly" to the accomplishment of
such purposes.
In my June testimony, I stated our belief that the substantially related standard
has conceptual merit as the basis for determining the scope of an exempt activity.
While w e share the concern that the relatedness standard has been applied in an
overly generous manner, w e do nor support replacing "substantially related" with
"directly related." Such a change would generate considerable uncertainty and
confusion without necessarily changing the substance, or the administrability, of the
standard in any significant way.
We remain concerned, however, with administrative and interpretive problems that
the substantially related standard has created. Although w e do not propose changes
in the standard at this time, w e do recommend more detailed reporting, as suggested
in Option IX, in order to improve compliance and to provide a basis for further
review.
"Determine whether each income-producing activity standing alone is tax-exempt."
Unlike the previous option, this option would represent a significant change in
the substance of current law. The option has conceptual appeal in that it would
limit tax exemption to those activities specifically identified by Congress.
Nonetheless, numerous activities of tax-exempt organizations - including the
operation of dormitories, dining halls, and hospital pharmacies - would likely be
taxable under such a test.
W e believe the "substantially related" standard
appropriately exempts m a n y such activities from tax even though the activities would
not warrant tax exemption standing alone. While the provision of food and lodging,
for example, is not an inherently exempt activity, the operation of dining halls and
dormitories contributes significantly to the educational mission of most universities
and in our view is appropriately exempt from tax.

-8Even though w e do not support this option because of its effect on certain
related activities, w e believe the option attempts to address a fundamental problem
— that an organization with exempt status is relatively free to embark on any number
of profitable activities that it deems to be related to its exempt purpose. As m y
June testimony and that of others m a d e clear, the present standard for relatedness
m a y in operation permit activities to be treated as exempt even though their
connection to the original exempt purpose is quite tenuous. Although w e do not have
a specific recommendation to offer at this time, there m a y be alternative approaches
to this problem. For example, Congress could require an exempt organization to
identify all activities for which it is seeking tax exemption so that the
determination letter issued by the Internal Revenue Service would identify which
activities are recognized as exempt, with the letter applying only to such
activities. All other significant income-producing activities would remain taxable.
In line with this approach, the organization might also be required to reaffirm
periodically the accuracy and completeness of its application for exemption.
"Retain "substantially related" test: however, impose UBIT on specified
activities (as listed in A - L below) whose nature and scope are inherently
commercial, rather than charitable."
"A. Apply U B I T to gift shop/bookstore income [with exceptions for (1) on-premises
sales of low-cost mementos, (2) on-premise sales of an educational nature which
relate to the organization visited, (3) in the case of a hospital, articles
generally used by or for inpatients, (4) in the case of a university, articles in
furtherance ot educational programs, or low-cost items (dollar cap), and computer
sales not in excess of one sale per student/faculty per year). In addition,
apply U B I T to income from all catalog and mail/phone order or other "off-premise"
sales (with exception for de minimis sales, in relation to amount of "on-premise"
sales)."
While this option would codify certain aspects of present law, it would, to some
extent, liberalize present law by making available some clearly defined "safe
harbors." With respect to exempt college bookstores, for example, all souvenir items
below a certain dollar level relating, to the organization would be exempt from tax,
but all other non-educational sales would generally be subject to tax. In light of
the substantial administrative difficulties the Internal Revenue Service has had in
this area, w e believe legislative clarification along the general lines of this
option is desirable. W e suggest that the term "educational" in the second exception
be limited to include materials such as explanatory guidebooks or other educational
texts, but not include items of a primarily decorative or functional nature. In the
case of an art m u s e u m gift shop, for example, sales of an exhibition guidebook, a
general text on art history or low-cost prints of exhibited art would be exempt.
Sales of primarily decorative items such as jewelry would be taxable. Similarly, the
sale by an organization devoted to the study of Elizabethan England of an armchair
modeled on one used in that era would be subject to tax because of the functional
nature of the product. Finally, w e suggest that the term "articles in furtherance of

-9education programs" in the fourth exception be limited to exclude c o m m o n consumer
items (such as sporting equipment and cameras).
We have some question as to the appropriateness of a special provision for sales
of computers to students. In addition to administrative concerns regarding the
necessity of defining a "computer" (which is in fact a system of components) and
keeping track of each student's purchases, w e question the policy justification for
such an exception in light of the multitude of small taxable businesses that sell
personal computers. In any event, w e are uncertain as to w h y a student at a four
year college would need to acquire as m a n y as four computers - thus, if this option
is adopted, w e would suggest a lower limit.
With respect to the application of the UBIT to income from all catalog,
mail/phone order, or other off-premises sales, the option as stated m a y reach too
broadly. In certain cases, for example, the use of "off-premises" sales might be the
only feasible way of carrying out the organization's exempt function, such as sales
of scholarly texts by a university press. In other cases, the use of such sales
would be appropriate for events such as a college theatrical performance. Although
w e are sympathetic to the desire to reach mail order sales that have only a minimal
connection to tax-exempt activities, w e believe that, if appropriate limitations are
developed with respect to on-premises sales, these same limitations should be
sufficient with respect to off-premises sales. This is an area where a "bright-line"
rule is needed. Thus, sales of items that have a-primarily utilitarian or decorative
function should be subject to tax whether sold on or off premises.
"B. Apply UBIT to all sales or rental income of medical equipment and devices
(including hearing aids, portable x-ray units, oxygen tanks), laboratory testing,
and pharmaceutical drugs and goods (with exceptions for (1) inpatients,
continuous-care outpatients, or emergency treatment outpatients or (2) items not
available in immediate geographic area.)"
This option would apply the UBIT when the purchaser might just as easily go to a
taxable supplier of the equipment. Although the concept of a "continuous-care
outpatient" is a new one in the tax law, w e assume it is meant to include patients
w h o utilize the particular piece of equipment as part of an ongoing program of
medical treatment. I would emphasize that w e believe the definition of this term
should be carefully developed so as not to discourage efforts by hospitals to control
costs by performing medical procedures on an outpatient basis whenever possible.
Notwithstanding the interpretive issues presented by the new terms, we are
generally supportive of this option, which w e believe represents only a moderate
tightening of present law. W e have reservations, however, about the exception for
items not available in the immediate geographic area. This rule would present
administrative difficulties in determining the meaning of "availability" and
"immediate geographic area." Furthermore, it also would allow an exemption from the
U B I T where the same equipment is available by mail or in certain cases in which
competition from an exempt organization m a y have discouraged or eliminated taxable

-10suppliers in the immediate geographic area -- precisely the situation about which
Congress is most concerned. Thus, w e do not support this aspect of the option,
except, perhaps, to the extent an exempt organization is providing n e w or
experimental products.
"C. Apply UBIT to income from certain health, fitness, exercise and similar
activities unless program is available to a reasonable cross-section of the
general public such as by scholarship or fees based on community affordability."
This option is apparently intended to ensure that health, fitness, and exercise
facilities operated by tax-exempt organizations are in fact fulfilling a charitable
function.6/ While w e agree with this goal, w e are concerned that this option would
pose subltantial administrative problems because of the need to apply terms such as
"reasonable cross section," "community," and "affordability." If a health club costs
$500 per year, for example, h o w would the Internal Revenue Service be able to
determine whether this fee is "affordable" in a community with an average income of
$25,000?
We wish to emphasize that many tax-exempt health and fitness organizations
provide services that are fundamentally different* from those provided by taxable
fitness centers. Exempt facilities are often located in poorer neighborhoods, have
special programs for the young, the elderly, and the needy, and attempt to instill
spiritual and moral values in their members. Such facilities often do not compete
directly with taxablefitnesscenters for the same clientele.
In some instances, however, tax-exempt organizations provide similar services and
do compete directly with taxable organizations.
If a tax-exempt organization
establishes a racquetball or weight-lifting facility in an affluent neighborhood and
it is functionally indistinguishable from taxable fitness centers, for example,
legitimate questions m a y be raised as to what charitable purpose is being served.
The Committee m a y wish to consider modifying this discussion option to provide that
each fitness or exercise facility operated by an exempt organization must
independently serve a primarily charitable purpose in order for that facility to
enjoy tax exemption as a charity. This charitable purpose could be demonstrated by a
variety of factors, including service to the needy, the young, the elderly, and the
community as a whole. The extent to which the facility is integrated with the
charitable activities of the organization as a whole might also be an appropriate
6/ The option does not indicate whether the term "health" includes activities such
as the operation of a hospital. Although hospitals, like health clubs, are eligible
for tax exemption if they are operated exclusively for charitable purposes, w e
suggest that this option not be applied to traditional health care activities of
hospitals. Instead, w e recommend that hospitals and their related organizations be
considered as part of Congress' broader review of tax exemption that w e have
recommended.

-IIfactor in this determination. Under this modification, programs relating to athletic
skills or body-building would not per se demonstrate a charitable purpose, unless
coupled with other factors indicating charitable intent. If a facility does serve a
primarily charitable function, however, all of its income from general membership
would be exempt because its activities would be described in section 501(c)(3). Such
a standard would recognize the very important contributions m a d e by tax-exempt health
and fitness organizations, but would limit tax exemption in those few instances in
which the operation of a fitness center serves primarily to raise m o n e y or to perform
some other non-charitable purpose.
" D . Apply U B I T to travel and tour services (with exception for services provided
by colleges/universities to students/faculty as part of a degree program
curriculum, and de minimis sales to non-students/faculty.)"
This option would be fairly easy to administer and draws a reasonable line
between educational travel and travel that is primarily recreational. Although the
option would no doubt subject to tax some worthy tour programs, w e believe that the
evaluation of travel as "educational" is so inherently subjective that some clear
test is required.
"E. Apply UBIT to adjunct food sales (with"exception for on-premise services
and/or sales provided primarily for students, faculty, employees, members, or
organization visitors)."
We view this option as largely a codification of present law and. administrative
practice. As w e understand the proposed rule, a restaurant inside a m u s e u m would not
be subject to the U B I T for sales of food during m u s e u m hours if its services are
directed to m u s e u m visitors. If it is open to the public when the m u s e u m is closed,
however, or if it caters primarily to the general public, income from such sales
would be subject to the U B I T . Presumably concession stand sales at a football game
or a symphony concert would remain exempt.
"F. Apply U B I T to income from certain veterinary services such as grooming,
boarding, and elective surgery (with exceptions for spaying and neutering,
measures to protect the public health, and measures recommended by a veterinarian
for the health of the animal)."
'
This option largely reflects current administrative practice of the Internal
Revenue Service. W e note that an exception for measures recommended by a
veterinarian for the health of the animal is quite broad and could serve to eliminate
m u c h of the effect of the general rule in that even routine grooming is beneficial to
the health of an animal. Thus, w e would not object to a somewhat tighter formulation
of this option.

-12"G. Apply UBIT to hotel facility income which is patronized by the public (with
exception for facilities operated, but only to the extent necessary, in
furtherance of the organization's exempt purpose). In addition, apply U B I T to
retail sales of condominiums and time-sharing units."
We question the appropriateness of exempting from the UBIT any hotel facility
income. Although the rental of dormitory rooms to students is appropriately exempt
from tax, it is difficult to see h o w the rental of hotel rooms, p_er se, ever would
directly further a tax-exempt purpose. Although an argument can be m a d e that a
school offering a degree in hotel management needs to allow its students to operate a
hotel, a similar argument could be m a d e for the operation of any commercial facility.
If a hospital or a university desires to offer a subsidized rate for families of
patients or students that are unable to afford commercial hotels, such activity m a y
be appropriately exempt from tax as a service to low-income persons, but it would
usually not be exempt as either a health-care or educational activity.
The application of the UBIT to retail sales of condominiums and.time-sharing
units reflects the current administrative position of the Service. W e have no
objection to codifying this rule so long as no inference is created with respect to
the relatedness of other retail sales, which in m a n y instances will similarly be
subject to tax.
"H. Apply U B I T to routine testing income (with exceptions for Federal or State
mandated activity, pre-surgical medical testing, and laboratory testing which is
pan of a student educational training program).
Current Treasury regulations specify that routine testing does not qualify for
the research exception to the definition of an unrelated trade or business. This
discussion option does not similarly modify the research exception, but would
affirmatively tax all routine testing.
W e believe that m a n y organizations
appropriately conduct testing as an integral part of their exempt function and should
not be subject to such a rule. Thus, w e suggest that this option either be directed
at the definition of research or that exceptions be created for organizations whose
principal exempt purpose includes testing. In addition, w e recommend that if this
option is adopted, the broad exception for "Federal or State mandated activity" be
limited. States would have a strong incentive to "mandate," and therefore exempt
from tax, m a n y activities conducted by exempt organizations, particularly
universities. Thus, the exception could to some extent swallow the rule. Also, w £
have a concern, similar to that noted earlier with respect to hotel facility income,
that providing an exception for laboratory testing which is part of a training
program m a y be unduly broad.
"I. Apply U B I T to income from affinity credit card/catalog endorsements."
To the extent income from credit card or catalog endorsements represents the
rental of an exempt organization's mailing list, w e believe it is already taxable

-13under present law.
If such activity reflects other motivations, the proper
resolution is perhaps less clear. If the activity represents the exploitation of an
exempt organization's goodwill for commercial purposes, w e believe it should be
subject to tax. If, however, the activity is more properly viewed as a means of
fostering identification by members with the organization and of facilitating
contributions, and the activity is limited to the accomplishment of those goals, it
m a y be appropriate to exempt from tax the amounts received by the exempt organization
that exceed the fair rental value of its mailing list. W e believe further analysis
of this relatively n e w practice m a y be required in order to determine which
characterization is most accurate.
"J. Apply U B I T to advertising income and allow deductions from U B I T only for
direct advertising costs."
Under current Treasury regulations, organizations that sell advertising in an
exempt journal are not permitted to use the costs of producing the editorial portion
of the journal to create a net operating loss from the sale of advertising. Thus, a
college alumni magazine, for example, m a y allocate the cost of producing the articles
in the magazine against advertising income, but not to the extent such an allocation
would produce a net operating loss that could be offset against the income from other
unrelated businesses.
The discussion option would permit advertising income to be offset only by
"direct" advertising costs. Such costs would presumably include administrative
expenses of selling and designing advertisements as well as a pro-rata portion of the
production and distribution expenses of the magazine, determined by reference to the
percentage of space in the magazine taken up by advertising. Disallowed costs would
include those incurred for the "readership" portion of the magazine — e.g., the
costs of producing the articles and other features.
This option reflects the view that the production of advertising income is of
only secondary importance to the production of a tax-exempt journal. As such, only
direct costs of producing the advertising income are properly allocated to it. W e
recognize that such an allocation rule treats tax exempt journals differently, and
less favorably, than taxable journals with respect to the computation of taxable
advertising income.
Nonetheless, w e believe tax-exempt journals are in fact
fundamentally different from taxable journals and that Congress could appropriately
adopt such a rule as one of the conditions of a journal enjoying the substantial
benefits of tax exemption.
"K. Apply U B I T to theme/amusement parks."
We consider this option to be a codification of present law. While amusement
parks m a y have some educational value, w e believe the educational component is
secondary to the purely recreational component. Consequently, the activity is not
substantially related to an exempt function and the income is appropriately taxed.
Hence, w e have no objection to a codification of this rule.

.14"L. Apply U B I T to additional specified activities determined to be inherently
commercial."
Taxing all activities that are inherently commercial would be a significant
departure from current law and could create widespread confusion ?as to w h o is
affected by the rule. M a n y tax-exempt organizations - particularly1-hospitals and
universities - are "commercial" in that the great majority of theiir income is
derived from the sale of services to the general public.7/ Thus the adoption of a
"commerciality" standard would presumably require Congress to create a number of
exceptions to the rule for traditional exempt activities. Although such an approach
would be possible, w e believe the better approach at this time is for Congress to
identify the particular activities that it considers not to merit tax exemption, as
it did for the sale of commercial insurance products in the Tax Reform Act of 1986,
and as options A - K do.
II. Convenience Exception:
"Repeal "convenience" exception (income from activities carried on primarily for
the convenience of a Section 501(c)(3) organization's members, students"
patients, officers, or employees). Income from activities that are substantially
related to the organization's exempt purpose would remain tax free, subject to
the specific rules listed in Section I. above."
'
In my June testimony, I suggested that the scope of the convenience exception
should be reexamined. W e would support this option because w e are concerned that the
exception in its present form m a y extend to activities not meriting tax exemption
and is not justified by administrative considerations. The convenience exception has
had the effect of significantly broadening the range of activities exempt from the
U B I T and has freed exempt organizations from the responsibility for deciding
whether particular activities are in fact substantially related to the exempt
function of the organization. Subjecting income from these activities to tax would
not, of course, prohibit them from being undertaken. T o the extent they are truly
carried on for the convenience of members, it is unlikely that much, if any, tax
liability would be incurred. In order to ease the administrative burden on exempt
organizations of repealing the convenience exception, w e would suggest creating some
clearly defined safe harbors — such as providing services at cost - t h a t would
obviate the need for detailed tax accounting.
II Overall, approximately 38 percent of non-profit revenue comes from fees, charges,
and dues. Hodgkinson and Weitzman, Dimensions of the Independent Sector (Wash. D . C ,
1986), p.32. Data are for 1984.

-15III. "Regularly Carried O n " Test:
"It

"Repeal "regularly carried on" test. Income from an activity that is not a trade
or business would remain tax-free."

Under current law, the UBIT applies only to income from an unrelated trade ,8r
business regularly carried on by an exempt organization. The U B I T regulations
provide that even an activity taking place only once a year can be "regularly carried
on" and thus subject to the U B I T if taxable businesses are carried on with similar
infrequency. This option would affect activities that are typically carried on by
taxable businesses on a year-around basis but, for whatever reason, are carried on by
tax-exempt organizations only periodically. For example, an exempt organization
under present law could conduct a once-a-year furniture sale and presumably not be
subject to the U B I T . This option would cause such an event to be taxable provided
that other exceptions to the U B I T , such as those for donated property or businesses
operated by volunteers, did not apply. Although w e do not oppose the option, W
suggest that it be modified so as not to apply to periodic fund-raising events where
no clear commercial analogue exists.
'
IV. Tax Treatment of Rovaltv Income:
"Apply UBIT to royalties measured by net or taxable income derived from the
property: or royalties received by an organization for use of property if such
organization, or closely related organization, either: (1) created such property,
or (2) performed substantial services or incurred substantial costs with respVct
to the development or marketing of such property. Retain present law for certain
non-working property interests, and exception for products that are part of the
organization's exempt function."
Royalties are excluded from the calculation of the UBIT along with dividends,
interest, annuities, and rents. As w e noted in our June testimony, the legislative
history of the enactment of the U B I T in 1950 suggests that Congress created these
exceptions because such investments were passive in nature and unlikely to create
competitive problems. If such Congressional intent remains valid today, w e believe
some change in the applicable law is desirable.
Although neither the statute nor the regulations define the term "royalties" for
purposes of the passive income exception, virtually any payment for the right to use
intangible property could be characterized as a royalty for tax purposes. Thus, it
m a y be possible for a variety of fees to be called "royalties" and be treated as
exempt from tax even if they do not in fact represent passive income. Hence, w e
believe there is a need for Congress to specify what the term "royalties" means for
purposes of this exception.
~f
The option would affirmatively subject certain kinds of royalties to the UBtT.
W e believe it would be undesirable, however, for Congress to tax all royalties "riot

-16meeting certain requirements: in some cases such royalties represent exempt function
income and should not be taxed. W e suggest instead that Congress simply delineate
the bounds of the royalty exception to the U B I T . As so modified, this option would
provide that royalties measured by net or taxable income, or royalties received for
use of property created by the organization, not be eligible for the royalty
exception to the U B I T . Other sections of the Internal Revenue C o d e distinguish
between active and passive royalties in a similar fashion. In the case of both
domestic and foreign personal holding companies, for example, certain passive income
can trigger additional tax and thus taxpayers wish to avoid the characterization of
royalties as passive income. In response to such concerns, sections 543 and 954
exclude from the definition of the term "royalties" those royalties derived from the
active conduct of certain trades or businesses.
Similarly, the passive loss
provisions of section 469 distinguish royalties derived in the ordinary course of a
trade or business from other royalties.
Royalties considered active under this test would not necessarily be subject to
the U B I T . Such a royalty would not be taxable if it constituted exempt function
income or satisfied another exception to the U B I T . For example, a university
performing contract research and receiving a royalty as part of its compensation
would not be subject to tax on the royalty so long as the requirements of the
research exception were satisfied.

V. Deduction from Taxable U B I T :

"Increase $1.000 U B I T deduction for certain Section 501(c) organizations to
$5,000 or $10,000, with phase-out beyond $50,000 income level. Limit the
increased deduction to activities directly carried on by the exempt
organization."
As we stated in our June testimony, we recommend that the $1,000 UBIT deduction
for certain section 501(c) organizations be raised to $5,000 to adjust for inflation.
W e also have no objection to a $10,000 figure, with a phase-out, as part of a package
of reforms to the U B I T . A n increase to $10,000 would simplify the system for m a n y
small organizations with relatively small amounts of unrelated income. W e would not
object if the increased deduction were limited to income from activities directly
carried on by the exempt organization rather than, for example, income from a limited
partnership interest. W e would also have no objection to Congress' distinguishing
between section 501(c)(3) organizations and other exempt organizations in setting the
amount of the specific deduction.

-17VI. Unrelated Debt-Financed Income:
"Limit the current law U B I T exception for unrelated debt-financed property to
only those pension funds, educational institutions and title holding companies
that m a k e at least a 20 percent equity investment of their interest in the
property.
Retain character of debt-financed income received from all
pass-through entities."
While we understand concerns about tax-exempt organizations engaging in leveraged
real estate investments, this option adds another level of complexity to an area that
is already tightly constrained. The first rule would be difficult to administer in
the case of joint ventures involving numerous activities. W e believe the present
rules of section 514 are adequate to deal with the kinds of abusive transactions that
prompted the enactment and amendment of the section. Absent a showing that exempt
organizations are in fact engaging in highly leveraged real estate transactions for
tax-motivated reasons, w e hesitate to endorse this proposal at this time.
The part of the option pertaining to pass-through entities may affect the
character of income earned by tax-exempt holders of interests in regulated investment
companies ("RICs"), real estate mortgage investment conduits ("REMICs"), and real
estate investment trusts ("REITs"). Such a provision would represent a significant
change in the treatment of such entities. It would also impose complicated
record-keeping and other administrative burdens. If the intent of the option is to
prevent tax-exempt organizations from avoiding the restrictions of section 514 by
investing through these entities, w e suggest that any such rule be limited to
avoidance situations. For example, the rule could be applied only to those cases in
which a R E I T is highly leveraged or is owned substantially by exempt organizations.
VII. Subsidiaries and Joint Ventures:
"Modify the definition of "control" in the case of exempt organizations having
taxable subsidiaries. Define "control" as ownership directly, indirectly, or by
attribution of at least 50 percent of stock, by vote or value (rather than 80
percent of combined voting stock, under present law)."
Modifying the definition of control from 80 percent to 50 percent is consistent
with our June testimony.
"Extend "control" rules where exempt organizations in the aggregate o w n more than
50 percent of the subsidiary's stock.
We view this option as a reasonable corollary to lowering the definition of
control from 80 percent to 50 percent.

-18"Provide that a controlled taxable subsidiary's income can be no less than its
U B I T would have been if the income-producing activity had been carried on
directly by the exempt parent organization."
We understand that this rule is intended to prevent an exempt organization from
dropping a profitable unrelated business, together with a money-losing related
business, into a taxable subsidiary. The loss from the related activity would thus
offset the profit from the unrelated activity. If both businesses were carried on by
the exempt organization, no such offset would be allowed. Although w e are not aware
that this kind of tax avoidance is in fact being practiced, the enactment of the
option might prevent such schemes in the future. Thus, w e do not see a pressing need
for the current enactment of this option, but w e have no objection to it on
conceptual grounds. If the option is enacted, w e believe it would be appropriate to
clarify that certain payments, such as rents, royalties, and interest, to the parent
organization would remain deductible.
"Aggregate income and activities of controlled subsidiaries for purposes of
determining if primary purpose of parent is a tax-exempt purpose."
As we stated in our June testimony, aggregating controlled subsidiaries when
determining whether the primary purpose of the parent is tax-exempt would be a useful
tool in helping to ensure that unrelated business activities do not supplant an
organization's exempt function. A m o n g the factors that should be considered in
determining an organization's primary purpose are its expenditures for charitable and
unrelated business purposes, income from different activities, reasonable
expectations of earning a profit, and staff time spent on different activities.
VIII. Allocation Rules:
"With respect to facilities used for exempt purposes as well as unrelated
business purposes, allow a deduction against U B 1 tor a proportionate share ot the
direct operating cost of the facility (e.g., maintenance, insurance, and
utilities), but not allow a deduction for a share of the general overhead of "the
organization or for depreciation."
"
In my June testimony, I recommended that Congress clarify the appropriate
allocation of shared expenses between exempt and unrelated activities.
In
particular, I stated that the allocation method endorsed by the Court of Appeals for
the Second Circuit in Rensselaer Polytechnic Institute v. Commissioner, 732 F.2d 1058
(2d Cir. 1984), failed to properly distinguish between an organization's related and
exempt activities. W e continue to believe that the decision in Rensselaer results in
an inappropriate allocation of expenses and that the appropriate rule would be to
allocate fixed costs based on hours of use in the unrelated business compared to the
total time available for use.

-19We have certain reservations about this discussion option, which differs from the
recommendation m a d e in m y June testimony. W e believe that some depreciation and some
portion of general overhead may, in certain cases, be appropriately allocated to the
unrelated business. For example, if a college president in fact spends five percent
of his time attending to an unrelated business, it would generally be appropriate to
allocate five percent of his salary to the activity.
Notwithstanding these reservations, we would prefer either the discussion option
or an allocation method based on total available time to the uncertain state of
current law. W e would welcome legislative clarification in this area because it has
proven extremely difficult for the IRS to administer and there exists evidence of
liberal, and in some cases possibly abusive, allocations. T h e discussion option,
like our June recommendation, would limit the extent to which taxable income from
unrelated businesses can be reduced by means of allocating shared costs that were
incurred principally for exempt purposes. Both approaches recognize that cost
allocation principles applicable to two activities of a taxable business should not
necessarily govern the allocation of costs between related and unrelated activities
of an exempt organization.
Exempt organizations are granted substantial governmental subsidies not so they
m a y engage in unrelated businesses, but so they m a y carry out their exempt purpose
most effectively. T o allow deductions for depreciation and overhead based on the
formula approved by the court in Rensselaer suggests that the various forms of
governmental subsidy were intended to benefit equally the exempt and unrelated
activities. They were not.

IX. Tax Information Reporting/Internal Revenue Service (IRS) Administration:

"Expand Form 990-T reporting requirement to include more reporting on: (1)
activities and income which the organization claims to be exempt or excluded from
U B I T , and (2) revenue sources such as contributions, grants or other fundirTj
sources."

"Provide more detailed reporting of revenue-producing activities and income on
F o r m 990."

"Consider "short form" reporting for small organizations, based on revenues."
We believe that options regarding improved data collection are very important to
the long-term effort to analyze the U B I T and tax exemption in general. In fact, w e
are already working closely with the Internal Revenue Service to improve Forms 990
and 990-T so that w e will be able to collect relevant data for analyzing the
activities and trends in the exempt organization area.
W e believe that a
Congressional affirmation of these steps would be appropriate.

-20"Require affiliated group that includes an exempt organization to file a
consolidated information return."

" R e c o m m e n d that IRS have an integrated examination program for exempt
organizations and subsidiaries (taxable and exempt)."
We believe both these recommendations are sound. The Internal Revenue Service
already has under review the possibility of an integrated examination program, which
w e believe would increase the efficiency of exempt organization audits. In addition,
consolidated reporting should substantially increase the ability of the Service to
accurately understand the business activities of affiliated groups of organizations
in which some organizations are taxable and some are exempt.

" R e c o m m e n d that IRS conduct the following studies and report on: (1) nonprofit
exempt hospital reorganizations (examining the extent, purpose, effect of the use
of subsidiaries): (2) exempt organizations that file Form 990s but do not file
Form 990-T's (examining activities of a sample group to determine compliance with
U B I T ) : (3) the feasibility of requiring State and Federal land-grant universities
to file an information return: (4) the use, purpose and effect of joint ventures':
and, (5) study, after five years, on effect of U B I T changes."
We have no objection to Congress mandating these studies, which we believe would
be valuable resources if Congress intends to revisit this area of the law within the
next five to ten years. W e would hope that similar analyses, based on improved data
collection on the part of the Service, would be undertaken by private groups as well.

X. Miscellaneous:
"Codify IRS position (upheld by some courts) that a social club (or other
organization whose investment income is subject to U B I T ) m a y not, in determining
U B I T , reduce its net investment income by losses on sales to non-members."
The issue presented by this option is similar to that presented by the allocation
rules, discussed above. W e believe it is inappropriate for social clubs to be able
to offset taxable investment income with losses from the use of their facilities in
transactions with non-members. In 1969 Congress affirmatively acted to subject such
investment income to tax. T o permit a social club to avoid such tax by deducting
expenses that, for the most part, would be incurred in any event as part of its
exempt function seems inconsistent with the intent of Congress.
We would emphasize, however, that we have no objection to a social club engaged
in unrelated business activities with non-members being permitted to carry any losses
forward or back to offset income from such activities. Hence, w e believe the scope
of this option is appropriately limited to offsets against investment income.

-21"Exempt from UBIT an organization's contingent rental income received through a
prime tenant, where the prime tenant leases real estate from a tax-exempt
organization, the prime tenant's net profits are based on fixed rents derived
from subtenants, and the prime tenant does not provide services to subtenants
except through an independent contractor."
This option is similar to a rule that already applies to real estate investment
trusts ("REITs") which, like exempt organizations, are entitled to favorable
treatment for rental income only if certain requirements are met. A m o n g these
requirements are that the rent received by the R E I T or the exempt organization not be
based on the net income or profits of the tenant. Under current law, REITs are
allowed to utilize a "prime tenant" to serve, in effect, as a conduit for the rental
of real estate, and to receive a percentage of such prime tenant's net income as
rent, so long as the prime tenant itself satisfies the rules applicable to the REIT.
This option would permit exempt organizations to make similar use of a prime tenant.
Although we do not object strongly to this option, we are uncertain as to the
pressing need to liberalize the UBIT. in this manner. Hence w e propose further
analysis of this option, in order to consider h o w its enactment would further the
exempt purpose of organizations that would utilize the option.
"Exempt from UBIT investment income earned from non-refundable loan commitment
fees."
This option, like the preceding one, is based on the current REIT rules. REITs
must receive most of their income from passive real estate related investments.
Passive real estate income permitted a R E I T includes amounts received or accrued as
consideration for entering into agreements to make loans or to purchase or lease real
property. Thus, under this R E I T provision, it is not necessary that a loan in fact
be m a d e for the income from the commitment fee to be considered passive. Under
current U B I T rules, in contrast, loan commitment fees are not explicitly excluded
from the U B I T . W e are uncertain as to the need to liberalize the U B I T rules in this
area. W e note that R E I T rules and the U B I T rules are not identical and in fact have
quite different policy justifications. REITs exist for the primary purpose of making
real estate related investments, and the applicable rules are designed to encourage
such purpose. Exempt organizations, of course, must have a different primary
purpose.
"Modify rules applicable to organizations "testing for the public safety.""
Congress adopted the "testing for public safety" exception in 1954 after one
organization doing such work had its exemption as a scientific organization under
section 501(c)(3) revoked. The rationale for this exemption was not explained in the
legislative history and is not entirely clear. The treatment of such organizations
is different from that of other section 501(c)(3) organizations. They are expressly
exempted from classification as private foundations, and contributions, bequests, or
gifts to them are not deductible. Since the income of such organizations is not

-22dedicated to traditional charitable purposes, it m a y be appropriate for Congress to
consider taxing their investment income for the same reasons I suggested last June
with respect to social welfare organizations described in section 501(c)(4).
Congress m a y also wish to consider studying the exemption granted these organizations
in order to determine whether it continues to be appropriate in its present form.
"Consider modification of various piecemeal U B I T exclusions enacted since 1969."
Because this option does not specify which piecemeal exclusions are being
considered, it is difficult for us to comment here with any specificity. As a
general matter, however, w e oppose such special exclusions from the U B I T because they
create inequities between different exempt organizations and have the potential for
creating unfair competition.
Nonetheless, just as Congress m a y n o w find it
appropriate to indicate that certain specific activities are subject to the U B I T , w e
realize that in some cases it is appropriate to indicate that certain specific
activities are exempt from the tax. Should the Committee desire to modify any of
these special exclusions, w e would be happy to work with you.
XI. Options not Listed
A. Research
We stated in our June testimony with respect to the "research" exception from the
U B I T that w e believe additional attention should be given to the definition of
research.
Support of research is a national policy that reflects the critical
importance of fundamental research to our economy and future. Although w e are
unaware of significant abuses in the area of research, w e continue to believe some
clarification is appropriate in this area. The U B I T statute, regulations and case
law fail to define precisely the term "research," and without such a definition the
full benefit, or limitations, of the exemption m a y not be understood or realized.
The scope of the term "research" has been delineated for purposes of other Code
sections, such as section 41, the credit for increasing research activities, and
section 174, permitting expensing of certain research and experimental expenditures.
These provisions, like the U B I T exception, are intended to provide an incentive for
research. Thus, w e believe that carefully considering the definition of research
developed in these other contexts m a y prove useful in order to develop a definition
of research for purposes of the U B I T .
B. Charitable Contributions
The most significant income-producing activity of many tax-exempt organizations
is the solicitation of contributions from members and the public at large. Although
such solicitations generally do not constitute a trade or business because they do
not involve the sale of goods or services, w e have some concern about charitable

-23solicitations that effeaively involve a sale or exchange of an item of value. Our
concern, however, is not so m u c h with the taxation of the exempt organization, but
with the availability of the charitable deduction to donors.
Under present law, contributions to certain charitable, educational, scientific,
and other organizations are deductible from the donor's income. If an item of value
is received in exchange for a charitable contribution, however, a deduction is
allowed only to the extent the amount of the contribution exceeds the fair market
value of the item. W e believe this limitation on the amount of the allowable
charitable deduction is often ignored by taxpayers, sometimes with the implicit
encouragement of the charitable donee. Thus, an exempt m u s e u m will charge admission
or a school will sell raffle tickets, but the payments will be described as a
"contribution." Similarly, exempt organizations will conduct fundraising drives in
which increasingly large contributions entitle the donee to receive increasingly more
valuable articles of merchandise in return.
This present state of affairs concerns us for two reasons. First, there is a
revenue loss to the government when donors fail to reduce the amount of their
charitable deduction by the value of goods or services received. Secondhand perhaps
more importantly, such overstated deductions create disrespect for the tax system
because of the perception that "everyone does it."*
Congress acted in 1987 to require that exempt organizations not entitled to
receive deductible charitable contributions must disclose that fact on fundraising
solicitations. W e believe that Congress should, consider enacting a similar rule for
organizations entitled to receive charitable contributions that supply goods or
services as a specific quid pro quo for a contribution to the organization. Under
such a rule, the exempt organization would be required to inform donors that the
deductible amount of any contribution is limited to the difference between the amount
of the contribution and the value of the property or services received.
The
organization would be required to place a reasonable value on such goods or services
for this purpose. A n alternative, or complementary, approach to this same issue
would be to require that non-deductible payments, such as school tuition, to an
exempt organization be paid to a designated account, the n a m e of which would indicate
its non-charitable purpose.
Conclusion
The discussion options and this hearing represent important contributions to the
goal of developing legislation to update and reform the U B I T . As I have noted, it
would be premature to make far-reaching changes to the law at this time.
Nonetheless, some of the discussion options discussed above are quite specific and w e
support a number of them. Also, the discussion options proposing increased data
collection and the completion of certain studies will enable Congress in the near
future to address more fundamental questions about the appropriate scope of tax
exemption as well as the structure of the U B I T . Finally, I would like to emphasize
that m y evaluation of the discussion options has treated each option as a separate,

-24independent proposal. W h e n the proposals are incorporated into a legislative
package, it will be important to assess the overall administrative impact of such
legislation on tax-exempt organizations in order to determine whether the benefits of
the legislation justify the imposition such burdens.
This concludes my prepared remarks. I would be pleased to respond to your
questions.

TREASURY NEWS
Department of the Treasury e Washington, D.c. e Telephone 566-2041
TEXT AS PREPARED
Embargoed for Release Until Delivery
Expected at 12 p.m. E.D.T.
Remarks by
The Secretary of the Treasury
James A. Baker, III
to the Economic Club of Detroit
Detroit, Michigan
Monday, May 9, 1988
A Community of .Generations; Generational Politics in Harmony
Over the last three years, I've spoken to many audiences on
a variety of economic topics — about the five-and-a-half-year
economic expansion in the U.S., budget deficits, exchange rates,
economic summits, trade policy, solutions to the debt problem and
international economic policy coordination. And I would be
pleased to address those topics with this distinguished group
during the question period.
I'd like to talk about a topic from the related but slightly
different discipline of political economy. The topic is
generational politics — a subject which could substantially
affect America's economy in the coming years.
I figured Detroit might be especially alert to this issue.
Clearly the automotive industry has been a pioneer in learning
how to appeal to different generations of Americans.
Automotive companies have made an art of styling their
products for different markets: You know how to appeal to the
adventurous energies of the young; the practical necessities of
the middle-aged; and the desire for comfort and security of the
old.
Advertisers and journalists, politicians and even educators
have learned how to appeal to the separate interests of each
generation. But I'd like to look at the political side of this
issue from a somewhat different angle — a view of generational
politics in harmony, a vision of a community of generations.
B-1403

-2I'm aware that generational politics may not qualify as what
the press likes to call a "new idea." After all, we've heard
about this in one form or another since at least the 1950s, since
the "Beat Generation" and the start of the Baby Boom. Later we
had the "Vietnam Generation," which helped to create the
notorious "Generation Gap," which eventually gave way to the "Me
Generation." And along the way, we are now told, the Baby Boom
Generation has been transformed into the "Baby Boasting"
Generation, and the yippies in beads have become yuppies in BMWs.
On the other side, we have always had the "older generation."
This group has never been as clearly defined as the Baby Boomers,
but to the extent that they have been defined, they tend to be
portrayed either as Ozzie & Harriets (good-natured but slightly
out-of-it) or else as Gray Panthers, the granny-on-wheels types
who will fight fervently to preserve entitlement programs.
Now, if this background tends toward caricature, that's
because I intend it to. I intend it to because I think our
understanding of generational politics in this country has also
tended toward caricature. We've had a tendency to think in terms
of generations at odds with one another — the young versus the
old, the Baby Boomers versus their parents — a zero-sum society.
Unfortunately, this means that in our politics we are too often
told that in order to promote the best interests of this or that
generation, we simply must support this or that policy. Or else,
we are told, we will lose the support of the young, the old, or
whomever.
Not surprisingly, political interest groups have organized to
represent the supposed common demands of different generations.
Some of you may have heard of a new lobbying group in Washington,
Americans for Generational Equity, or, appropriately enough, AGE.
AGE was organized in part to lobby on issues said to concern the
Baby Boomers. A few of its members consider that the lobbies for
the elderly have effectively laid claim to a growing portion of
domestic spending, regardless of need. On the other hand, some
of the lobbies for the elderly accuse the lobbyists for the young
of wanting to undermine Social Security or Medicare. Once again,
we are told, there is a generation gap.
Meanwhile, in the 1988 Presidential campaign, several
candidates have invoked the images of a youthful John F. Kennedy.
They stressed the themes of youthful idealism and commitment in
the hope of appealing to the Baby Boomers — to the majority of
the electorate that is now under 45 years old.
What goes unsaid is their implication that the rest of the
country somehow doesn't share this same idealism or commitment.
It's worth remembering that, if he were alive today, JFK would
not be a Baby Boomer; he would be almost 71 years old, yet still
promoting his ideals.

-3The point I want to stress to you today is that this politics
of the Generation Gap is short-sighted at best, and may even be a
threat to our national prosperity. The politics of generational
envy or warfare is simply inadequate to the task of helping our
country meet the complicated and very difficult issues we are
going to have to confront into the 1990s and beyond. On the
issues of the future (issues like better education for our
children, the cost and quality of health care for the elderly,
and America's political and economic influence in the world) on
these and many other issues, interest-group politics based on age
just isn't up to the task.
Instead of more warfare between generations we need a
stronger alliance across generations — we need a generational
peace offensive that stresses our shared obligations and common
ideals. Far from being a nation of two or more generations
divided, we are really a community of generations with compatible
interests. From our retirees who formed their values in the
Depression, to those like myself who reached adulthood in the
1950s, through the Baby Boom, to the perhaps neglected group of
young people who have followed the Boomers, and even to our
children of the future — still unborn but destined to inherit
our economic and political legacy — the common ideals of these
generations far exceed the differences.
If I can adapt a line from the television ad, none of us can
really "have it all" — at least not if having it all means
having it at the expense of some other segment of American
society. Self-centeredness — whether generational, individual,
or national — simply cannot help us address the problems of the
future. And this may be a particularly good moment to
acknowledge and endorse the notion of shared obligation and
opportunity across generations. Baby Boomers no less than Gray
Panthers seem to me to be in the mood to listen.
A Domestic Agenda for All Ages
Ladies and gentlemen, I think we can see the possibilities
for a community of generations if we examine some of the issues
now coming to the fore in American politics. Consider an issue
that has become a talking point around the country — the issue
of excellence in education.
One of the more encouraging cultural signs has been the
nonfiction best seller list. Last year the diet books, believe
it or not, gave way to a book describing the failures of American
education. And those of you who have read it know that the book
that was for a time the number one best seller (by University of
Chicago Professor Allan Bloom) is no simple list of outrageous
anecdotes. It is a sophisticated, challenging work. His
presence on the list suggests a deep public discomfort at
America's educational performance.

-4Americans have made it clear that they do not like the fact
that, while the average U.S. student spends 180 days in school
each year, the average Japanese student spends 240 days; or that
between the ages of 6 and 18, American children will spend more
hours watching TV than they will attending school; or that young
people can actually finish high school thinking, as a couple of
recent surveys showed, that Herbert Hoover sold vacuum cleaners
and Joseph McCarthy was a famous Communist.
What we are seeing with this phenomenon, I think, is that as
the Baby Boom generation ages it is acquiring more of a stake in
society — in mortgages, in marriages, and in children.
Naturally, these young parents and homeowners are more concerned
about social trends, about cultural mores and public attitudes.
And for people who care about social trends, education will
always be a priority.
You know, my wife Susan learned this first hand when she and
Senator Albert Gore's wife, Tipper, and a few others began to
raise some concerns about rock music lyrics. Frankly, going into
it they expected to be mocked and perhaps ignored. But they
received an overwhelmingly positive response. The voices of the
few critics were simply drowned out by the many others who
agreed.
The rebels without a cause seem to have become rebels with a
very great cause — that is, the care and education of their
children and the improvement of the society those children will
live in. And I think it's worth noting that this suggests more
or less the opposite of the theme expressed in such movies as
"The Big Chill" — in which the Baby Boomers are depicted as
having lost their 1960s idealism in favor of selfish materialism.
Far from it, the Baby Boomers have discovered an excellent
new place to channel that idealism — into the values and
commitments of mainstream American society. On these issues,
the Baby Boom really has finally met — and politically, even
become — the older generation.
All of this, I believe, offers an enormous opportunity
to those of us who want to improve America's educational
performance. And my personal view is that we have little choice
but to improve — in order to compete in the world economy, but
also to ensure that our shared principles and convictions are
passed on to our children. At a minimum, I believe we're going
to have to consider seriously lengthening the school year,
upgrading the curriculum, raising educational standards, and
making schools more accountable to parents and communities.

-5Moreover, I encourage the increasing recognition that
education is an issue that concerns generations other than
parents and their children. All of us need to learn how to
learn, so that we may lead fuller, productive, and more enjoyable
lives. In part, continuing education is a practical necessity
given the rapid pace of change in our increasingly competitive
and interdependent world. And in part, continuing education is a
predicate to the informed citizenry that animates our system of
government. Finally, ongoing education can be the wellspring for
a great deal of personal satisfaction and contentment. So from
my perspective, education is indeed a topic of interest for the
community of generations.
Ladies and gentlemen, I think we also have a generational
obligation, if I may put it that way, on another major issue —
the budget deficit. I've long agreed with those who say that by
tolerating a deficit we Americans have been voting to give
ourselves goods and services that we don't have to pay for;
instead our children will pay for them. In other words, we can
"have it all," but only by giving our children much less.
I believe the deficit habit may even represent a failure of
our constitutional system — living generations are able to vote
themselves benefits, but they can slip the bill to a future
generation that is not only unable to vote but is not even party
to the debate. In that sense, our constitutional system may
contain a bias toward deficits — a bias that, in my opinion
requires a constitutional remedy.
My own view is that this remedy should take the form of both
a balanced budget amendment with some kind of limit on taxation
and a line item veto. Yes, I know that some in the political
community have scoffed at the Reagan Administration for proposing
these ideas. They say they can't be passed by the Congress. But
it's worth keeping in mind that a century ago the income tax was
an issue for 20 or 30 years before it passed, and its reformation
was an issue for many years before we finally succeeded with tax
reform in 1986. I think support for some kind of constitutional
spending discipline will continue to increase as all adults grow
more sympathetic to this obligation to their children's future.
I also think we have some cause for a harmonious
cross-generational approach, even to the difficult issue of
Social Security. Now, I happen to know very well how sensitive
this issue is politically. I have learned this from the three
Presidential campaigns in which I have been involved, and also
when in 1982 and 1983 I was part of an Administration and
Congressional effort to forge a compromise to strengthen Social
Security. I am proud of that effort. It began and progressed in
the basement of my Washington home. Our work guaranteed the
integrity of retirement benefits into the 21st century, and we
juggled a multitude of interests to do it.

-6Yet I think everyone involved in that compromise would admit
that it couldn't solve all of the problems of the elderly. For
one thing, in striking that compromise the payroll tax was
raised, so the financial burden on American workers was
increased. (My own belief is that we had better alternatives
to tax increases, but that was what we had to accept to get a
compromise.) For another thing, we have yet to face the fact
that America's elderly are living longer, and so need retirement
benefits for a growing number of years. When Social Security's
retirement age was first fixed at 65 in the 1930s, most
Americans — to put it bluntly — could be expected to die within
a few years of retirement. Today, the average American lives
well past 70, and (in the future) millions will live past 80.
Clearly, we will have to do more to strengthen Social
Security in the future — and, just as clearly, we will not
succeed if we approach the issue as just one more battle between
generations. Younger workers cannot bear ever increasing payroll
taxes, any more than retirees can be expected to take cuts in
benefits earned over a lifetime of hard work.
Without promoting any specific change, I believe our approach
to this challenge should be to build on the common interests
among various generations.
Because of progress in health care, many Americans now retain
the energy and vigor to contribute significantly to American
society well into their 70s. As a matter of public policy, we
should not coerce these older Americans into retirement. And
when they do retire, we should seek to-ensure ample opportunities
for them to share their wisdom and knowledge with younger
Americans.
Obviously, this cannot be accomplished only with a change in
laws; we will also have to change public attitudes — attitudes
about when people should retire, and stereotypes about what
contributions older Americans can make. They have a wealth of
experience and insight. We must ensure that their wisdom is
passed on to succeeding generations.
A New Generation Abroad, New U.S. Opportunity
I believe this cross-generational approach may also provide
some opportunities for American foreign policy. As Treasury
Secretary, I've been able to observe what amounts to a changing
of the guard in leadership around the world — especially in the
developing countries.
The generation of leaders who came to power in the
anti-colonial wave after World War II is finally, gradually,
leaving power. These leaders, as you know, tended to favor
highly centralized regimes, whether of the left or right. Very
few of them did as well as they had hoped in the task of
development.

-7Among their successors, however, I've seen leaders struggling
to find better ways of doing things — searching for a new
philosophy to guide them, opening to new ideas in a way that
their nations haven't in 30 or 40 years. One prominent example
is India. In 1947, at independence from Britain, India's Prime
Minister Nehru praised Stalin's centralized economic control and
set his country on the socialist path. Yet when his grandson,
Rajiv Gandhi, became prime minister in 1984, he talked about
aiding private industry, cutting taxes, and decentralizing
economic power.
It is true, of course, that some harsh economic realities are
also forcing countries to rethink their policies. I have in mind
in particular the debt burden. The U.S. and other creditors have
tried to ease that unfortunate problem, but the truth is that the
only solution in the long run is for the debtors themselves to
make their own countries more hospitable to private investment
and initiative. Again, that means they'll have to be open to
fresh ways of thinking.
And it's here, I think, where America has its opportunity —
an opportunity to promote its own ideas and project its
principles to new generations around the world who are more
willing than ever to listen. That's one reason, frankly, that,
as part of the U.S. debt strategy, I've stressed that the debtors
make reforms to open their markets and liberate their citizens
from government controls and bureaucracy. Our objective has been
to encourage local support for changes that will spur growth and
create a welcome environment for private investment. And I've
discovered a receptive audience.
As the world economy grows more integrated and
interdependent, we are also going to have to depend more heavily
on other nations for cooperation in promoting our interests —
in defending the West, and in maintaining open trade and steady
growth, to mention only two obvious areas. A national
self-centeredness — a neo-isolationism — will not win anyone's
cooperation, and will not serve our own self-interest. American
foreign policy always has been based at least in part on the
promotion of our guiding principles as a nation — and I believe
that this aspect of our foreign policy may become even more
important in the future.
This is a lesson, I might add, that I think the Baby Boom
generation in America well understands. Raised in the turbulent
Vietnam years, they understand the power of idealism, and its
uses in the world. And now that they are fast becoming the
leadership generation, they no doubt appreciate the value of
unity, of harmony. We have it from a very good authority,
Abraham Lincoln, who said in another context: "A house divided
against itself cannot stand." If America wants to project its
principles abroad, it must certainly be unified at home.

-8I would argue that the Baby Boomers are looking, and even
eager, to put their zeal and commitment to work abroad — so long
as it is put to work on behalf of America's own best ideals —
the ideals of freedom and democracy, with the goal of shared
prosperity.
Conclusion
Let me leave you with this prospect for generational
politics.
There is no doubt that the views of generations are in part
formed by the experiences of their different times. Different
epochs produce distinctive views. And even when experiences do
not diverge greatly, the different expectations, hopes,
responsibilities, and priorities of various stages of life of
course affect attitudes and interests.
Nevertheless, I believe that these differences are far less
significant than our shared values and common interests. And I
believe the richness of various generations' experiences should
enable us to face our mutual challenges with greater strength if
we act in harmony.
Our community of generations can protect and project
America's experiment in democracy — both at home and abroad —
if we acknowlege our shared obligations to one another. That
should be the aim of our political agenda as we move toward the
1990's — so we can build a better country for all current
generations, as well as for those to come.

ASURY N

Department of the Treasury e Washington, D.c. e Telephone 566-2041
FOR IMMEDIATE
May 9, 1988

RELEASE

CONTACT:

Office of Financing
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $6,408 million of 13-week bills and for $6,402 million
of 26-week bills, both to be issued on
May 12, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-week bills
maturing August 11, 1988
Discount Investment
Price
Rate
Rate 1/
6.28%
6.33%
6.31%

6.47%
6.52%
6.50%

26- week bills
maturing November 10 , 1988
Discount Investment
Price
Rate
Rate 1/

98.413
98.400
98.405

6.47% «/
6.51%
6.51%

6.78%
6.82%
6.82%

96.729
96.709
96.709

a/ Excepting 1 tender of $2,840,000.
Tenders at the high discount rate for the 13-week bills were allotted 20%
Tenders at the high discount rate for the 26-week bills were allotted 97%
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
Accepted
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

3-//c/

i $

Received

Accepted

32,845
19,542,060
24,090
33,215
32,830
26.120
1,414,005
25,490
13,635
40,965
30,380
1,065,210
402,990

$
32,845
5,556,040
22,090
33,215
32,830
26,120
68,405
22,460
13,635
40,965
20,380
130,110
402,990

$
42,485
20,364,270
28,940
35,060
55,780
31,355
1,975,755
28,590
8,970
36,735
32,565
805,640
393,965

$
42,485
5,239,270
28,940
35,060
51,780
31,355
327,755
25,590
8,970
36,735
27,565
158,640
393,965

$23,840,110

$6,408,110

. $22,683,835

$6,402,085

$20,299,665
1,080,930
$21,380,595

$2,867,665
1,080,930
$3,948,595

: $17,534,615
:
944,920
: $18,479,535

$1,252,865
944,920
$2,197,785

2,226,715

1,950,000

232,800

2,254,300

$23,840,110

$6,408,110

: $22,683,835

$6,402,085

Equivalent coupon-issue yield.

TREASURY NEWS

Department of the Treasury • Washington, D.c. e Telephone 566FOR RELEASF AT A n« « CONTACT: Office of Financing
M
|
May 10,1988
*

202/376-4350

f TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued May 19, 1988.
This offering
will result in a paydown for the Treasury of about $1,050 million, as
the maturing bills are outstanding in the amount of $13,838 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m.. Eastern Daylight Saving time, Monday, May 16, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
February 18, 1988, and to mature August 18, 1988
(CUSIP No.
912794 QJ 6 ), currently outstanding in the amount of $7,131 million,
the additional and original bills to be freely Interchangeable.
182-day bills for approximately $6,400 million, to be dated
May 19, 1988,
and to mature November 17, 1988 (CUSIP No.
912794 QU 1 ) .
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be Issued for cash and in exchange for Treasury
bills maturing May 19, 1988.
Tenders from Federal Reserve
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to Federal Reserve Banks,
as agents for foreign and international monetary authorities, to
the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. Federal
Reserve Banks currently hold $1,877 million as agents for foreign
and international monetary authorities, and $4,448 million for their
own account. Tenders for bills to be maintained on the book-entry
records of the Department of the Treasury should be submitted on Form
B-1405
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series)c

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
tenders for such bills from others, unless an express guaranty of
payment
by an Incorporated bank or trust company accompanies the
10/87
tenders.

TREASURY NEWS
Department of the Treasury e Washington, D.c. e Telephone 566-204
FOR IMMEDIATE RELEASE
CONTACT: Office of Financing
May 10, 1988
^u^/37b-435U
RESULTS OF AUCTION OF 3-YEAR NOTES
The Department of the Treasury has accepted $8,765
million
of $ 25,908 million of tenders received from the public for the
3-year notes, Series S-1991, auctioned today. The notes will be
issued May 16, 1988, and mature May 15, 1991.
The interest rate on the notes will be 8-1/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-1/8% rate are as follows:
Yield
Price 1/
Low
8.21%* 99.777
High
8.24%
99.699
Average
8.23%
99.725
•Excepting 1 tender of $15,000.
Tenders at the high yield were allotted 30%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Accepted
Received
Location
Boston
$
42,950
$
42,950
New York
22,782,125
7,685,025
Philadelphia
31,280
31,280
Cleveland
93,630
81,630
Richmond
193,685
69,185
Atlanta
54,210
49,510
1,124,530
428,030
Chicago
St. Louis
88.585
73,185
Minneapolis
46,960
45,750
Kansas City
113,725
113,725
Dallas
20,580
20,580
San Francisco
1,309,085
117,970
Treasury
6,490
6,490
Totals
$25,907,835
$8,765,310
The $8,765
million of accepted tenders includes $1,136
million of noncompetitive tenders and $7,629 million of competitive tenders from the public.
In addition to the $8,765 million of tenders accepted in
the auction process, $960 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $2,963 million
of tenders was also accepted at the average price from Government
accounts and Federal Reserve Banks for their own account in
exchange for maturing securities.
Since the interest rate on these notes will be 8-1/8%, the
notes will be considered an additional issue of the 8-1/8% notes of
Series J-1991. The Treasury circular governing the notes will be
amended, effective May 16, 1988, to provide for the consolidation.
1/ In addition to the auction price, accrued interest of $0.22079
per $1,000 for May 15, 1988, to May 16, 1988, must be paid.
B-1406

TREASURY NEWS
department of the Treasury e Washington,CONTACT:
D.c. e Telephone
566-2041
Office of Financin
FOR IMMEDIATE RELEASE
May 11, 1988

202/376-4350

RESULTS OF AUCTION OF 10-YEAR NOTES
The Department of the Treasury has accepted $8,751 million
of $22,886 million of tenders received from the public for the
10-year notes, Series B-1998, auctioned today. The notes will
be issued May 16, 1988, and mature May 15, 1998.
The interest rate on the notes will be 9%.JL/ The range
of accepted competitive bids, and the corresponding prices at the
9%
interest rate are as follows:
Yield
Price 2/
Low
9.05% *
99.675
High
9.06%
99.610
Average
9.06%
99.610
*Excepting 1 tender of $10,000.
Tenders at the high yield were allotted 95%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
$
Boston
11,678
$
11,678
New York
20 ,918,737
8,320,362
Philadelphia
4,818
4,818
Cleveland
12,329
12,329
Richmond
90,724
47,469
Atlanta
17,412
17,362
Chicago
1,026,511
218,511
St. Louis
25,882
14,882
Minneapolis
8,803
8,803
Kansas City
17,820
17,820
Dallas
5,360
3,360
San Francisco
743,849
71,499
Treasury
2,421
2,421
Totals
$22 ,886,344
$8,751,314
The $8,751 million of accepted tenders includes $4 54
million of noncompetitive tenders and $8,297 million of competitive tenders from the public.
In addition to the $8,751 million of tenders accepted in the
auction process, $400 million of tenders was also accepted at the
average price from Government accounts and Federal Reserve Banks
for their own account in exchange for maturing securities.
1/ The minimum par amount required for STRIPS is $200,000.
Larger amounts must be in multiples of that amount.
2/ In addition to the auction price, accrued interest of $0.24 4 57
per $1,000 for May 15, 1988, to May 16, 1988, must be paid.

B-1407

TREASURY NEWS

tepartment of the Treasury e Washington, D.c. e Telephone 566FOR IMMEDIATE RELEASE CONTACT: Office of Financing
May 12, iy»8
202/376-4350
RESULTS OF AUCTION OF 30-YEAR BONDS
The Department of the Treasury has accepted $8,505 million
of $21,693 million of tenders received from the public for the
30-year Bonds auctioned today. The bonds will be issued May 16,
1988, and mature May 15, 2018.
The interest rate on the bonds will be 9-1/8%. 1/ The range
of accepted competitive bids, and the corresponding prices at the
9-1/8% interest rate are as follows:
Yield
Price 2/
Low 9.16% * 99.643
High
9.18%
99.440
Average
9.17%
99.542
* Excepting 1 tender of $15,000.
Tenders at the high yield were allotted 74%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
2,093
$
2,063
New York
19,837,575
7,947,490
Philadelphia
960
960
Cleveland
2,401
2,401
Richmond
4,114
4,114
Atlanta
8,880
7,880
Chicago
1,141,905
480,565
St. Louis
9,568
7,568
Minneapolis
3,487
3,487
Kansas City
6,760
6,760
Dallas
4,461
1,461
San Francisco
670,571
39,471
Treasury
679
679
Totals
$21,693,454
$8,504,899
The $8,505 million of accepted tenders includes $462
million of noncompetitive tenders and $8,04 3 million of competitive tenders from the public.
In addition to the $8,505 million of tenders accepted in
the auction process, $200 million of tenders was also accepted
at the average price from Government accounts and Federal Reserve
Banks for their own account in exchange for maturing securities.
1/ The minimum par amount required for STRIPS is $1,600,000.
Larger amounts must be in multiples of that amount.
2/ In addition to the auction price, accrued interest of $0.24796
per $1,000 for May 15, 1988, to May 16, 1988, must be paid.
B-1408

o
C\i
CO
CD

federal financing bank

mCO
CO

WASHINGTON, D.C. 20220

• *

CM
CO
CO

m
CO
LL

0. LL

May 13, 1988

FOR IMMEDIATE RELEASE

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Acting Secretary, Federal Financing
Bank (FFB), announced the following activity for the month of
November 1987.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $156.8 billion on November 30, 1987,
posting a decrease of $69.7 million from the level on October 31,
1987. This net change was the result of an increase in holdings
of agency debt of $94.3 million, and decreases in holdings of
agency-guaranteed debt of $163.7 million and in agency assets of
$0.3 million. FFB made 70 disbursements during November.
Attached to this release are tables presenting FFB November
loan activity and FFB holdings as of November 30, 1987.

# 0 #

B-1409

CO
CO

Page 2 of 4
FEDERAL FINANCING BANK
November 1987 ACTIVITY
AMOUNT
OF ADVANCE

DATE

BORROWER

FINAL
MATURITY

INTEREST
RATE
(semiannual)

AGENCY DEBT
NATIONAL CREDIT UNION ADMINISTRATION
Central Liquidity Facility
+Note
+Note
+Note
-mote
+Note

#451
#452
#453
#454
#455

11/3
11/3
11/18
11/19
11/25

4,450,000.00
15,000,000.00
23,300,000.00
25,000,000.00
500,000.00

2/3/88
12/1/87
2/18/88
12/1/87
2/23/88

5.985%
5.915%
6.195%
6.075%
6.075%

11/9/87
11/13/87
11/16/87
11/17/87
11/20/87
11/23/87
11/27/87
11/27/87
11/30/87
12/1/87
12/2/87
2/4/88
12/7/87

5.935%
5.875%
5.875%
5.875%
6.135%
6.175%
6.175%
5.965%
6.025%
6.025%
6.025%
6.005%
5.925%

6/15/12
9/1/13
9/12/96
3/12/14
8/25/14
6/15/12
9/1/13
5/15/88
8/25/14
1/15/88
9/12/96
5/15/88
8/25/14
1/15/88
9/12/96
5/15/88
3/12/14

9.135%
9.105%
7.995%
8.991%
8.925%
9.055%
8.995%
8.309%
8.915%
6.025%
8.005%
8.309%
8.915%
6.025%
8.005%
8.309%
9.305%

TENNESSEE VALLEY AUTHORITY
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance

#811
#812
#813
#814
#815
#816
#817
#818
#819
#820
#821
#822
#823

11/4
11/6
11/9
11/9
11/13
11/17
11/17
11/20
11/23
11/23
11/23
11/27
11/30

267,000,000.00
156,000,000.00
40,000,000.00
238,000,000.00
162,000,000.00
200,000,000.00
43,000,000.00
154,000,000.00
104,000,000.00
60,000,000.00
38,000,000.00
209,000,000.00
256,000,000.00

11/2
11/2
11/12
11/12
11/13
11/18
11/18
11/23
11/23
11/23
11/23
11/23
11/23
11/23
11/23
11/23
11/30

585,000.00
544,422.89
287,827.83
45,544,992.71
210,000.00
1,753,065.92
1,360,390.39
299,165.00
3,647,666.00
2,063,710.00
152,863.62
299,165.00
3,647,666.00
2,063,710.00
152,863.62
299,165.00
1,711,482.00

GOVERNMENT - GUARANTEED LOANS
DEPARTMENT OF DEFENSE
Foreign Military Sales
Greece 15
Greece 16
Philippines 11
Turkey 18
Greece 17
Greece 15
Greece 16
Niger 3
Greece 17
Gabon 4
Philippines 11
Niger 3
Greece 17
Gabon 4
Philippines 11
Niger 3
Turkey 18

+rollover

INTEREST
RATE
(other than
semi-annual)

Page 3 of

FEDERAL FINANCING BANK
November 1987 ACTIVITY
BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

DEPARTMENT OF BOUSING & URBAN DEVELOPMENT
Community Development
Toa Baja, PR
Long Beach, CA
Rochester, NY
Jefferson County, MO
Montgomery Co. Dev. Corp.
Baltimore, MD
Florence, SC

11/5
11/6
11/9
11/12
11/18
11/18
11/18

53,200.00
156,400.00
181,075.00
6,260,000.00
113,430.00
137,310.00
63,009.10

5/2/88
8/1/88
8/15/88
11/30/94
5/16/88
1/2/88
7/1/88

6.435%
6.665%
6.825%
8.411%
6.695%
6.195%
6.845%

qtr
12/31/15
12/31/19
12/31/15
11/9/89
12/31/15
11/13/89
12/31/14
1/2/90
11/16/89
1/2/90
12/31/15
11/20/89
1/2/90
12/31/15

9.097%
9.126%
8.883%
7.635%
8.955%
7.735%
8.954%
7.892%
7.875%
7.928%
9.022%
7.855%
7.835%
9.074%

11/1/02
11/1/07
11/1/07
11/1/07
11/1/07
11/1/07
11/1/07
11/1/07
11/1/07
11/1/12
11/1/12
11/1/12

9.015%
9.108%
9.108%
9.108%
9.108%
9.108%
9.108%
9.108%
9.108%
9.165%
9.165%
9.165%

2/29/88

6.035%

6.737% ann
6.907% ann
8.588% ann
6.893% ann

RURAL EIJSCTRIFICATION ADMINISTRATION
•Corn Belt Power #138 11/2 94,000.00 1/2/18 9.107% 9.006%
•Colorado Ute Electric #71
11/4
2,387,000.00
*Corn Belt Power #138
11/4
41,000.00
•Sunflower Electric #174
11/6
15,000,000.00
•Central Electric Power #131
11/9
137,000.00
*Wabash Valley Power #104
11/12
2,687,000.00
•Wolverine Power #234
11/12
3,944,000.00
•Colorado Ute Electric #96
11/13
1,486,000.00
Blue Ridge Electric #307
11/16
4,000,000.00
•Wabash Valley Power #206
11/16
9,028,000.00
•Wolverine Power #101A
11/17
140,000.00
Colorado Ute Electric #152
11/18
1,080,000.00
Cooperative Power #156
11/18
1,639,000.00
Allegheny Electric #255
11/24
1,220,000.00
•Wabash Valley Power #206
11/25
694,000.00
SMALL BUSINESS ADMINISTRATION
State & Local Development Company Debentures
Ccmm. Dev. Carp, of Ft. Wayne
Chicago Industrial Fin. Corp.
Michigan Certified Dev. Corp.
Long Island Development Corp.
Mid City Pioneer Corp.
Opportunities Minnesota, Inc.
Mid City Pioneer Carp.
E. Central Michigan Dev. Carp.
Indiana Statewide CDC
Wilmington Indus. Dev., Inc.
BEDCO Dev. Corp.
S. Cent. Kansas Ec. Dev. Dist.

11/4
11/4
11/4
11/4
11/4
11/4
11/4
11/4
11/4
11/4
11/4
11/4

243,000.00
104,000.00
116,000.00
162,000.00
166,000.00
177,000.00
226,000.00
408,000.00
500,000.00
119,000.00
142,000.00
267,000.00

TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
Note A-88-02 11/30 630,535,957.08

•maturity extension

8.996%
9.024%
8.786%
7.563%
8.857%
7.662%
8.856%
7.816%
7.799%
7.851%
8.922%
7.779%
7.760%
8.973%

qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr
qtr

Page 4 of 4
FEDERAL

Program

November 30, 1987

Agency Debt:
Export-Import Bank
NCUA-Central Liquidity Facility
Tennessee Valley Authority
U.S. Postal Service
U.S. Railway Association +
sub-total*
Agency Assets:
Farmers Home Administration
DHHS-Health Maintenance Org.
DHHS-Medical Facilities
Overseas Private Investment Corp.
Rural Electrification Admin.-CBO
Small Business Administration
sub-total*
Government-Guaranteed Lending:
DOD-Foreign Military Sales
DEd.-Student Loan Marketing Assn.
DHUD-Community Dev. Block Grant
DHUD-New Communities
DHUD-Public Housing Notes +
General Services Administration +
DOI-Guam Power Authority
DOI-Virgin Islands
NASA-Space Communications Co. +
DON-Ship Lease Financing
DON-Defense Production Act
Rural Electrification Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
DOT-WMATA
sub-total* 53,841.2
grand total* $ 156,849.7
*f igures "may not total due to rounding
+doe*5 mil. incline capitalized interest

NANCING BANK HOLDINGS
in millions)
October 31, 1987

Net Change
11/1/87-11/30/87

FY '88 Net Change
10/1/87-11/30/87

$ 12,463.5
122.8
16,688.0
4,353.4
-0-

$ 12,463.5
124.5
16,592.0
4,353.4

-0-

-0-0-

33,627.6

33,533.3

94.3

313.4

64,934.0
84.0
102.2
0.7
4,241.2
19.0

64,934.0
84.0
102.2

-75.0

4,241.2
19.1

-0-0-0-0-0-0.3

-0.8

69,380.9

69,318.2

-0.3

-75.8

18,358.2
4,940.0
325.1
30.6
2,034.9
394.6
33.2
27.2
949.4
1,788.3
-021,214.8
732.3
899.0
1,883.9
52.8
177.0

18,483.1
4,940.0
325.3
30.6
2,074.4
395.5
33.2
27.2
949.4
1,788.3

-124.9

-805.8

-0-

-0-1.7
96.0

-0-

0.7

-011.4
302.0

-0-0-0-0-

-0-

-00.9
-0-

-39.2
-0.8

-0-0-0-0-0-

-0-0-

-0.2

-0-

140.8

-0-0-

21,226.2
736.5
898.5
1,864.5
55.4
177.0

-11.5
-4.2

54,004.9

-163.7

-638.1

-69.7

$ -400.5

$ 156,919.4

0.5
19.3
-3.0
-0-

17.9
-8.3
-0.8
60.2
-3.0

-0-

TREASURY NEWS
Office of Fir.anc.
CONTACT:
Department
of the Treasury
• Washington, D.c.
• Telephone
566-2041
FOR IMMEDIATE
RELEASE
202/376-4350

May 16, 1988
RESULTS OF TREASURY*S WEEKLY BILL AUCTIONS

Tenders for $6,431 million of 13-veek bills and for $6,408 Billion
of 26-week bills, both to be Issued on
May 19, 1988,
were Accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

26-veek bills
maturing November 17. 1988
Discount Investment
Rate
Rate 1/
Price

13-veek bills
maturing August 18, 1988
Discount Investment
Rate
Rate 1/
Price
6.27%
6.28%
6.28%

6.46%
6.47%
6.47%

98.415
98.413
98.413

:
:

6.46%
6.50%
6.50%

6.77%
6.81%
6.81%

96.734
96.714
96.714

Tenders at the high discount rate for the 13-veek bills vere allotted 47%
Tenders at the high discount rate for the 26-veek bills vere allotted 93%

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
36,350
25,426,845
25,525
56,620
66,905
34,275
1,630,975
27,155
13,760
34,320
37,655
879,115
358,010

36,350
692,300
25,525
54.925
40,505
32,680
43,975
22,625
8,760
34,320
27,655
53,855
358,010

$
30,460
21,110,290
18,810
24,700
38,955
35,760
1,870,250
22,880
12,180
54,545
29,415
1,547,010
362.100

$ 30,460
5,690,015
16,810
24,700
38,875
34,635
58,500
18,880
7,180
54,545
24,065
46,760
362,100

$28,627,510

$6,431,485

$25,157,355

$6,407,525

$25,052,400 $2,856,375
1,051,925
1,051,925
$26,104,325
$3,908,300

$20,494,430
861,145
$21,355,575

$1,744,600
861,145
$2,605,745

2,448,110

2,000,000

75,075

1,801,780

$28,627,510

$6,431,485

$25,157,355

$6,407,525

An additional $13,125 thousand of 13-veek bills and an additional $465,920
thousand of 26-veek bills will be Issued to foreign official Institutions for
new cash.
V Equivalent coupon-Issue yield.

R-um

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-204
FOR IMMEDIATE RELEASE

CONTACT;

May 17, 1$88

LARRY BATDORF

(202) 566-2041

RECIPROCAL TAX EXEMPTIONS OF SHIPPING AND AIRCRAFT INCOME
The Treasury Department today announced further bilateral
agreements with Belgium, Jordan and Singapore for the reciprocal
tax exemption of income from international shipping and aviation
(aviation only in the case of Singapore). The exchanges of notes
are in accordance with sections 872 and 883 of the Internal
Revenue Code.
In each case the exemption applies for taxable
years beginning on or after January 1, 1987.
Earlier such
agreements with ten countries were announced in Treasury News
Release B-1294 of February 24, 1988.
Copies of the notes with Belgium and Singapore and .of the
notes with Liberia, announced in February, 1988, are available
from the Office of Public Affairs, room 2315, Department of the
Treasury, Washington, D.C. 20224. The notes with Jordan will be
released when they arrive in Washington and have been processed
by the Department of State.
o 0 o

B-1411

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
10/87
tenders.

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at 10:00 A.M., EDT
May 18, 1988
STATEMENT BY
DAVID MALPASS
DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON INTERNATIONAL DEVELOPMENT INSTITUTIONS
AND FINANCE
OF THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
MAY 18, 1988
Mr. Chairman and Members of the Committee:
I welcome this opportunity to appear before you this
morning in support of the Administration's request for
legislation to authorize U.S. participation in the general
capital increase (GCI) for the World Bank and the fifth
replenishment of the African Development Fund.
African Development Fund
Because the preponderance of my testimony is devoted to
the World Bank GCI, I would like to briefly describe at the
start our legislative request for U.S. participation in the
fifth replenishment agreement of the African Development
Fund (AFDF). The United States would contribute S315 million
over three years, or $105 million annually.
The AFDF plays an important role in the economic
and social development of Africa. During this replenishment, which was agreed to by Member governments last November,
the AFDF will accord particular attention to formulating
comprehensive country programs and coordinating its activities
with other major donors working in Africa.
I understand that a number of Members and staff are planning to attend the annual meetings of the African Bank and Fund
in two weeks. I welcome your close review of the work of these
important institutions. The United States joined the AFDF in
1976 and the African Development Bank in 1983. Throughout our
membership the United States has supported the progress of these
two institutions. The major increase in this replenishment
of the AFDF is justified by the key role this organization
plays in providing development assistance to the poorest
countries in Africa.
B- 1413

- 2 General Capital Increase
The Administration has asked that Congress authorize a
large general capital increase for the World Bank. As with a
stock offering by a commercial bank, this World Bank capital
increase comes at a time of strength for the Bank. There are
a number of reasons why we should subscribe:
° Increasingly, the Bank promotes economic development
in a way which is consistent with U.S. economic ideas.
It promotes private sector development, market-based
economic systems, and market-based pricing mechanisms
even in its project lending.
° The Bank provides progressive leadership by example
in other ways as well, by focusing attention on the
environment, the role of women in development, and
the impact of various development techniques on the
poor.
° The Bank leverages the U.S. contribution many fold
by adding contributions from other countries and
borrowing in world financial markets. In this
capital increase, the $70 million annual U.S. contribution will be multiplied 268 times in the
anticipated lending program.
° The World Bank's lending profile is extremely consistent with U.S. national interests. In fact, it
provides a necessary balance to U.S. bilateral
assistance programs which bypass or underfund important areas such as Mexico and Malaysia.
° Due to its multilateral character, the World Bank
provides effective economic development assistance
to countries which could not work as closely with
the United States alone.
° The modest U.S. investment is returned many times
over in procurement contracts. As Gene Rotberg
pointed out last week, the U.S. cash contribution
over the entire life of the Bank amounts to only
$1.6 billion, whereas last year alone U.S. suppliers
received disbursements from the World Bank of $1.6
billion; since the founding of the Bank U.S. suppliers
have received contracts for goods and services amounting to $12.8 billion.
It is my understanding that Secretary Baker may testify
before the full Banking Committee next month on our two authorization requests. Therefore, I intend to devote the remainder
of my opening statement to policy-based lending — one of the
important techniques the Bank uses to achieve the results I
just described. I will: (1) review the history and objectives

- 3 -

of policy-based lending; (2) describe the importance of such
lending taking place in the context of a broad policy dialogue;
and (3) put such lending into its current context of economic
reform.
Policy-Based Lending
To get a better understanding of the benefits policybased lending provides, it would be useful to look briefly at
the historical antecedents of such lending.
Up until 1980 IBRD lending for other than projects was
called non-project lending or program lending. Program
loans were prepared and negotiated by a country in an acute
balance of payments difficulty and were only made in special
circumstances. Generally such lending fell into four
categories:
— reconstruction or rehabilitation of the economy
after a war or severe natural calamity;
-- a sudden fall in export earnings where the economy
was critically dependent on a single export item;
-- a sharp deterioration in the terms of trade resulting
from a rapid rise in import prices; and
-- cases involving structural constraints or capacity
under utilization.
Program loans were conceived of as one-shot operations with
narrow objectives. The crisis atmosphere that prevailed
while the loans were prepared often caused a focus on shortterm actions to deal with immediate difficulties, leaving
too little attention to underlying long-term problems.
During the 1970s the World Bank concluded that these
underlying structural problems -- such as distorted prices,
administrative controls, and poorly planned and executed
public sector programs —
kept the Bank's projects from
contributing as fully as they might to the economies they
were designed to assist. Senior Bank officials concluded
that sounder macroeconomic policies would improve the performance of project lending, and that the Bank could play a
role in helping borrowers with these policies.
The 1979 oil price increases exacerbated the situation:
it became apparent that commercial lenders -- which generally
provide a sizeable portion of many developing countries'
capital needs — were paring back their lending just when oilimporting developing countries had to devote more resources
to oil purchases. Hence, it became even more imperative that

countries adopt better economic policies to improve the
environment for attracting and making more efficient use of
capital.
The World Bank addressed the problem by altering the
one-shot, episodic aspect of program loans. In 1980, the
IBRD, with board approval, initiated structural adjustment
lending (SAL) to provide a multi-year economic reform program
supported by a succession of non-project loans. The purpose
of SALs was — and is — to help a developing country devise
and implement market oriented reforms that lead to improvements
in economic performance and reduce current account deficits
to sustainable levels.
These policy reforms require significant adjustments in
borrowing country economies and may produce politically charged
dislocations in the labor force and business sectors. Structural adjustment lending is intended to help offset these
effects by providing the borrowing country with the resources
to shift the focus of its economy.
It is important to be clear about this last point: SAL
resource transfers support the country during the adjustment
period; they do not simply pay for government compliance.
Governments can of course make policy reforms on their own.
But important structural changes are more likely to occurwhen disruptions to already fragile economies are lessened
as a result of outside support.
It is in the Bank's interest, our own interest and most
importantly the borrowing country's interest that these policy
reforms be undertaken. The benefits that can ensue from
policy reform may be just as essential to a country's
productive capacity as those stemming from power generation,
roads, and communications projects. Indeed, in certain
circumstances, implementing structural reform may be a sine
qua non for good project development and implementation,
to which 75 percent of Bank resources are devoted.
2. Incorporating Pertinent Views when Designing Policy-based
Loans
An important aspect of the SAL program at its inception
was that no country would be required to use such lending.
It was broadly understood that this type of lending would
only be possible where a government accepted the need for
such adjustments and was prepared to collaborate with the
Bank in a review of its policies and the formulation of a
program. Indeed, a government that does not genuinely
endorse "agreed" reforms can easily thwart them. Therefore
such loans are normally disbursed in tranches that are tied
to meeting certain conditions. Successive loans in these
multi-year programs are only arranged and disbursed pending
successful completion of prior loans.

- 5 While it is essential that the Bank be able to suspend
loan disbursements when loan conditions are not being honored,
it is certainly not a profitable situation for the Bank or
the country to have the loan fall out of compliance. Hence,
it is incumbent on the Bank to make every effort to assure
that government officials are "on board" before going ahead
with a loan.
Designing good adjustment programs requires the contracting
parties to be mindful of the views of other interested parties,
including NGOs. The discussions leading to the signed contractual agreement must be limited to the Bank and the borrowing
government. But it is not possible to develop a fully effective program without the Bank, and more importantly, the
borrower taking considerable account of the views and priorities of affected groups.
I believe that the World Bank has internalized this
view and is implementing it. Senior Bank staff have indicated
both publicly and privately that more involvement by NGOs in
the Bank's loan development process will improve the Bank's
understanding of the loan's effect on the poor and its environmental aspects. According to Bank staff, such economic policy
discussions become especially important when a government wants
NGOs to help implement social components of an adjustment
program.
It will take time to evaluate the results of this effort.
I would like to say, Mr. Chairman, that we have welcomed your
work and that of your Committee in this regard. I believe
that we have a clear policy direction in this area, one which
is consistent between the Congress, the Administration and the
Bank. I look forward to monitoring its implementation, keeping
this Committee informed, and initiating modifications when they
are necessary.
3. Current Status of Policy-based Lending
Roughly eight years has elapsed since the inception of
policy-based lending. In the earlier part of the period,
broad structural adjustment loans dominated adjustment
operations. With time, specific sector adjustment loans
grew in number and total value so that in recent years they
have accounted for roughly 85 percent of total policy-based
lending. Last year, the Bank's lending of this type reached
$3.5 billion, 24 percent of its total program.
The Bank has attempted to improve the design, conditionally, and monitorability of adjustment lending. Yet, measuring
the impact of such lending is complicated by several factors:
(1) the benefits take several years to be felt because of
their medium to long-term character; (2) exogenous shocks
make it difficult to isolate the effect of the adjustment

- 6 program; (3) in many countries, the process of adjustment is
not continuous; and (4) adjustment programs contain many
different policy initiatives, making it difficult to evaluate
the affect of specific policy changes.
Substantial progress has been made in a few countries,
while others have shown sporadic progress. The process is
certainly not perfect. The Bank is learning every day and
can improve its expertise in this area. The key to success,
however, is the borrowing country itself.
While much progress has been made by the developed
countries to make financial resources available, borrowing
countries have had a difficult time actually implementing
reforms. As we know from the experience in our own government, reforms in governmental systems take Herculean efforts.
Such is the task at hand for many of those governments —
reforming the trade system, selling off or closing parastatals,
deregulating interest rates, and reforming agriculture to rely
less on subsidies and more on profit and fair markets. We are
prepared to strongly support such efforts in both our bilateral
and multilateral programs. The World Bank has been at the
forefront of these efforts and is rapidly increasing its
expertise.
We and other members requested, in the context of GCI
negotiations, a thorough review of policy-based lending. We
expressed a firm view to the Bank in this regard:
— the need for more tranches;
— more flexibility to adjust conditionality in subsequent tranches due to changing economic conditions;
and
— the need to more effectively integrate the Bank's
conditionalty with that of the IMF.
The Bank is now engaged in a very comprehensive review
of adjustment lending. It will gain new insights in the
course of preparing this report — insights that will
materially enhance the effectiveness of adjustment lending
and bolster the ability of the Bank's borrowers to achieve
sustainable growth. In particular, and in accordance with
last year's MDB authorization legislation, we have instructed
the Bank to assess the impact on the poor of structural
adjustment lending and to specify what steps will be taken
to mitigate adverse effects.
Conclusion
A prime objective of the World Bank is to foster sustainable growth and development in the third world. Policy-based
lending is a growing area of the Bank's operations to help

- 7 achieve this objective. In my view major structural reform
is the only viable approach for the developing countries to
break out of the circle of poverty that results in continued
stagnation. In this regard, I am happy to say, sound economic
attitudes and efforts are spreading across the developing
world as countries more and more recognize the importance of
market-led growth. It is all the more incumbent on us in
the industrialized countries, therefore, to ensure that the
World Bank has sufficient resources to support the meaningful
structural reform being undertaken by developing countries.
I understand that some members may suggest changes to the
current debt strategy in the course of this Committee's
deliberations. One of the reasons that we have not supported
these efforts is that we remain unconvinced that the proposals
made to date will encourage economic reforms. This Committee
has an opportunity to endorse the work of the World Bank and
AFDF, including the promotion of economic reforms through
policy-based lending programs. I hope that it will do so.
I look forward to discussing it with you today and
working with you in the coming months on these issues.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
May 18, 1988

CONTACT: Larry Batdorf
(202) 566-2041

UNITED STATES AND THE COMMONWEALTH OF DOMINICA
SIGN AGREEMENT TO EXCHANGE TAX INFORMATION
The Treasury Department announced today that the United
States and the Commonwealth of Dominica have signed an agreement
to exchange tax information that satisfies the criteria set forth
in the Caribbean Basin Economic Recovery Act of 1983. The
Agreement was signed in Washington, D . C , on October 1, 1987, and
it entered into force on May 9, 1988 by virtue of an exchange of
notes between the two governments.
As a result of signing the Agreement, the Commonwealth of
Dominica will be considered part of the "North American Area" for
purposes of determining the deductibility by U.S. taxpayers of
expenses incurred in attending conventions, business meetings,
and seminars. Therefore, convention expenses incurred by U.S.
taxpayers for meetings in the Commonwealth of Dominica beginning
on or after May 9, 1988 that are otherwise deductible as ordinary
and necessary business expenses will be allowed without regard to
the additional limitations otherwise applicable to foreign
convention deductions.
In addition, because of the signing of the Agreement, the
Commonwealth of Dominica qualifies as a foreign country in which
a foreign sales corporation may incorporate and maintain an
office as provided in the foreign sales corporation provisions of
the Tax Reform Act of 1984.
Finally, because of the Agreement, the Commonwealth of
Dominica qualifies as a jurisdiction in which Puerto Rican
financial institutions may make eligible investments of funds
derived from U.S. section 936 companies. Such funds may be used
to finance investments in active business assets and development
projects in the Commonwealth of Dominica.
A limited number of copies of the Agreement are available
from the Treasury Public Affairs Office, Treasury Department,
Room 2315, Washington, D.C. 20220.
oOo
B-1414

Interim Report of
The Working Group
on
Financial Markets

Submitted to
The President of the United States

M a y 1988

Interim Report of
The Working Group
on
Financial Markets

Submitted to
The President of the United States

M a y 1988

For sale by the Superintendent of Documents, U. S. Government Printing Office
Washington, D. C. 20402

213-632 0 - 8 8 - 1

The Working Group on Financial Markets

George D. Gould, Chairman
Under Secretary for Finance
Department of the Treasury
Wendy Gramm, Chairman
Commodity Futures Trading Commission
Alan Greenspan, Chairman
Board of Governors of the Federal
Reserve System
David S. Ruder, Chairman
Securities and Exchange Commission
May 16, 1988
The Honorable Ronald W. Reagan
The President of the United States
Washington, D.C.
Dear Mr. President:
We respectfully submit to you an Interim Report of the
Presidential Working Group on Financial Markets, created pursuant
to your Executive Order dated March 18, 1988.
For the past sixty days, we have reviewed and consulted together
on the numerous recommendations made in the wake of last
October's market decline. The Working Group has viewed its
primary mission as focusing on specific actions that would
substantially lessen systemic dangers to the U.S. financial
system.
We are pleased to report that the Working Group has reached
agreement and is making recommendations on a number of critical
issues, including:
o agreement on coordinated circuit breakers to
allow for a cooling-off period during times
of high market volatility;
o conclusions and recommendations on the
credit, clearing, and payments systems to
ensure the necessary coordination within and
between markets and to avoid systems
gridlock;

- 2 -

agreement that current minimum margin
requirements provide an adequate level of
protection to the financial system, although
they do not cover all possible price
movements, and that prudential margins
appropriate for carrying an individual stock
should be significantly higher than those
for a stock index futures contract; and
o agreement on contingency planning, including
the continuation of the Working Group, to
facilitate coordination and consultation in
the event of future market disturbances.
The collective actions recommended to you in our interim report
are consistent with your mandate to us to enhance the integrity,
efficiency, orderliness, and competitiveness of our Nation's
financial markets and to maintain the confidence of investors,
both large and small. In addition, our report recognizes and
commends a number of significant actions taken by private market
participants, self-regulatory organizations, and the regulatory
agencies.
Sincerely,
George D. Gould, Chairman
Under Secretary for Finance
Department of the Treasury

?n
Wendy Gramm, Chairman
Commodity Futures Trading

0mk

Alan Greenspan, Chairman
Board of Governors of the Federal
Reserve System

David S. Ruder, Chairman
Securities and Exchange
Commission

Interim Report
Of the
Working Group on Financial Markets
Table of Contents
Page
Introduction and Summary 1
Continuing Coordination 3
Coordinated Trading Halts and Reopenings 4
Margin Requirements 5
Clearing and Settlement Recommendations 7
Contingency Planning 11
Summary of Actions Taken on Capital Adequacy 12
and Systems Capacity Enhancement

Appendices
Coordinated Trading Halts and Reopenings
Adequacy of Prudential Margin Requirements
Report of Staff Subgroup on Credit, Payment
and Settlement System Issues
Clearing and Settlement Recommendations
I. Clarify Clearing and Settlement
Obligations
II. Facilitate Timely Payments
III. Explore Methods to Reduce Cash Flows
and Simplify Settlement Systems
IV. Refine Relevant Legal Frameworks
Market Report Actions Taken (or Planned) by Federal
Agencies, Self-Regulatory Organizations, Clearing
Agencies, and Market Participants as of May 16, 1988
Working Group Participants

INTERIM REPORT OF THE WORKING GROUP ON
FINANCIAL MARKETS
I.

INTRODUCTION AND SUMMARY

On March 18, 1988, the Working Group on Financial Markets
was established by Executive Order to provide a coordinating
framework for consideration, resolution, recommendation, and
action on the complex issues raised by the market break in
October of 1987. The Working Group was charged with developing
effective mechanisms to enhance investor confidence, to protect
the quality and fairness of markets for all participants, and to
preserve the continued orderliness, integrity, competitiveness,
and efficiency of our nation's financial markets. This is an
interim report on our progress, actions, and recommendations.
From the beginning, the Working Group has had the benefit
of a number of useful studies, notably the Report of the
Presidential Task Force on Market Mechanisms (Brady Report) and
separate studies by the Securities and Exchange Commission
(SEC), Commodity Futures Trading Commission (CFTC), General
Accounting Office (GAO), and others.
The Working Group reached early agreement on a number of
important premises for our deliberations:
o The existence of large debt and equity portfolios held
by institutions and the increased level of principal
activities by investment firms have led to increased
demand for portfolio hedging strategies and market
liquidity.
o It is unrealistic (and perhaps counterproductive) to
try to undo the changes in financial markets or market
strategies brought about by improvements in
telecommunications and computer technology.
o The role of fundamental economic forces should be
emphasized when evaluating the October decline. Stock
prices prior to the collapse had reached levels that
seemed to be in excess of those justified by real
earnings potential and reasonable discount factors.
The inevitable reassessment of economic fundamentals by
market investors was an important part of the selling
pressure and price decline in October.
o The size and speed of the decline initiated by
fundamental reevaluation of equity values was
exacerbated on October 19 by a number of factors:
volume overwhelmed trade processing capacity;

- 2 -

many participants pulled back from the markets
because of fear and shock — and because of
uncertainties and concerns over (i) the accuracy
and timeliness of information, (ii) counter-party
solvency, (iii) credit availability, and (iv) de
facto, ad hoc market closures or other market
disruptions.
the financial system came under great stress in
the credit, clearing, and settlement area.
o The Working Group agrees with the Brady Report
conclusion that the stock, options, and futures markets
are closely linked.
o The priority goals of the Working Group, therefore,
have been to address the major uncertainties and to
focus on reductions in possible systemic risk. In this
respect, the Working Group followed the agenda
established by the Brady Report, which also assigned
first priority to the systemic risks identified during
the market break.
As a result, the Working Group was able to concentrate its
initial efforts on developing the most important system
protections, in close consultation with self-regulatory
organizations and market participants. The Working Group's
conclusions and recommendations, more fully described in the body
of the Report and its appendices, are as follows:
1. A "circuit-breaker" mechanism should be put in place
that operates in a coordinated fashion across all
markets, using pre-established limits broad enough to
be tripped only on rare occasions, but which are
sufficient to support the ability of payment and credit
systems to keep pace with extraordinarily large market
declines.
2. A significant number of important initiatives should
be implemented in a timely fashion to improve further
the operation of the credit, clearing, and settlement
system — beyond the notable and valuable changes the
markets have made already. Although these initiatives
are complex and technical, they would result in highly
significant improvements in the vital linkages within
the credit markets.
3. Current minimum margins for stocks, stock index
futures, and options provide an adequate level of
protection to the financial system. Prudential

- 3 -

maintenance margin percentages required for carrying an
individual stock should be significantly higher than
the percentage margin required for a futures contract
on a stock index.
4. Contingency planning, including the continuation of the
Working Group, is an important, ongoing responsibility
that the Working Group members are implementing.
5. Capital adequacy is being addressed in material ways by
the markets and should continue to be reviewed and
improved whenever necessary.
6. Markets already are making — and should continue to
make — significant efforts to enhance the operational
capacity of trade-processing systems and to improve the
fairness and quality of order executions for all
investors, large or small.
7. The Working Group should continue to function as a
coordinating and consulting mechanism for intermarket
issues.
The Working Group can continue to be effective by
monitoring the progress of its recommendations, by serving as a
consultative and coordinating forum, and by expediting resolution
of the remaining issues. The Working Group also believes that
the structural weaknesses exposed by the October break can be
overcome through cooperative efforts of the relevant government
agencies, self-regulatory bodies, market participants, and the
Congress.
II. CONTINUING COORDINATION
The Working Group believes that its continuation, in its
existing configuration, is an excellent way to continue the
process of addressing intermarket issues. Much has been
accomplished in a short time frame, but work on a number of
issues has not been completed. The Brady Task Force and others
have recommended that some additional regulatory mechanism be
established to resolve these continuing issues. Recognizing this
concern for coordination, the Working Group believes that
cooperative efforts under the existing regulatory structure will
be more effective and less disruptive than more formal,
additional legislated structure.

- 4 -

The Working Group believes that private market solutions,
where feasible, are preferable to legislation because the private
sector is closer to the problems and can address them in a more
flexible manner. The Working Group has established a cooperative
framework in which regulators, self-regulatory organizations
(SROs), and market participants can work together to resolve
intermarket issues.
The Working Group already has made progress on the issues
deemed most critical to the market's smooth functioning and
investor confidence. Equally important, it has created a process
for (i) further interagency cooperation on intermarket issues
such as clearing and settlement and contingency planning, (ii)
monitoring implementation of its recommendations, and (iii)
resolving the remaining issues — and that process is working.
Continuation of the Working Group would be consistent with
the spirit and intent of the intermarket coordination bills
introduced by Senators Proxmire and Leahy. Both bills are
designed to achieve coordinated resolution of intermarket issues
by the appropriate agencies. That is precisely what the Working
Group is doing, while avoiding the divisive and difficult
questions of legal authority, structure, and independence
presented by the current bills. The Working Group believes its
efforts are succeeding and should be allowed to continue.
There are a number of additional intermarket issues that
have been identified that the Working Group believes deserve
attention. These issues, as well as continued work on the
conclusions and recommendations already reached, will be
addressed and progress on them reported in the months ahead.
III. COORDINATED TRADING HALTS AND REOPENINGS
The Working Group recommends coordinated trading halts and
reopenings for large, rapid market declines that threaten to
create panic conditions. In broad outline the Working Group
recommends that all U.S. markets for equity and equity-related
products — stocks, individual stock options, and stock index
options and futures — halt trading for one hour if the Dow Jones
Industrial Average (DJIA) declines 250 points from its previous
day's closing level. The Working Group also recommends that the
New York Stock Exchange (NYSE) use reopening procedures, similar
to those used on so-called Expiration Fridays, designed to
enhance the information made public about market conditions.
Under the Working Group's recommendations, a second closing, this
time for two hours, and reopening would occur if the DJIA
declines 400 points below its previous day's closing level. The
recommendations are detailed in Appendix A.

- 5 -

In designing these procedures, the Working Group has focused
on market events that are so dramatic as to trigger ad hoc and
destabilizing market closings. This was manifest during the
market break through systems breakdowns, reduced liquidity, and
concerns over trading because of fears of counter-party and even
clearing corporation failure. The Working Group recognizes that
trading disruptions are undesirable. Thus, its proposal is
designed to substitute planned for unplanned, ad hoc trading
halts without increasing the overall frequency of such
disruptions. The Working Group's recommendation also recognizes
the need for reopening procedures designed to limit the duration
of the halt while providing for information dissemination to
permit consideration of buy or sell decisions during periods of
stress.
Members of the Working Group have consulted with the SROs,
as well as with knowledgeable industry participants, about the
design of these procedures. The Working Group believes that its
recommendations can be implemented most effectively and
expeditiously by SRO-initiated rule changes, with appropriate
notice, comment, and agency review.
IV. MARGIN REQUIREMENTS
The Working Group considered the appropriate levels of
"prudential" margins for stocks, stock index futures and options,
defined as the maintenance margin levels needed to protect
broker-dealers, futures commission merchants, and clearing
corporations from investor and trader defaults on their margin
obligations. Based upon the past price movements of stocks and
stock indexes, the Working Group calculated the likelihood that
prices would move to a point where various margin levels would
not satisfy prudential concerns. See Appendix B.
On the basis of these statistical measures, the Working
Group concludes as follows. First, current minimum margin
requirements provide an adequate level of protection to the
financial system, although they do not cover all possible price
movements. Because margin levels sufficient to provide
protection against all possible price movements would impose
unacceptable costs to market participants and the liquidity and
efficiency of markets, the Working Group agreed that means other
than margins to protect against extreme price movements should be
considered. In this connection, the Working Group recognized
that other mechanisms are in place that address the risk of large
price movements relative to margins, such as capital
requirements, clearing-fund guarantee deposits, and intra-day
variation margin payments. Moreover, the Working Group's

- 6 -

recommendations on a circuit-breaker mechanism and credit,
clearing, and settlement improvements should add significant
protections against financial system risks from extreme price
movements.
Second, the prudential maintenance margin percentages
required for carrying an individual stock should be significantly
higher than the percentage margin required for a futures contract
on a stock index. This conclusion follows from the facts that
stock indexes have a smaller percentage price variability than do
individual stocks and the payment period for margins in the
futures market is shorter than the period for stocks. The extent
to which stock margins should exceed those for futures depends
not only on measured volatilities and stated grace periods, but
also on (i) actual margin settlement and position sell-out
practices, (ii) portfolio strategies, such as the
diversification of stock portfolios and the combination of
stock, futures, and options positions, and (iii) the application
of margin exemptions.
These conclusions concerning minimum margins relate only to
minimum levels of margin set by regulatory or self-regulatory
organizations. The Working Group notes that financial
intermediaries typically require an amount in excess of these
minimums for less credit-worthy customers and those with
concentrated positions. Furthermore, capital requirements of
firms and clearinghouse guarantee funds further enhance the
stability of the securities and futures clearance and settlement
systems.
The Working Group was not able to agree on whether or not it
is appropriate or effective to raise margins above prudential
levels in an attempt to reduce leverage or dampen volatility.
Chairman Ruder believes that certain futures-related trading
strategies have resulted in a dramatic increase in the size and
velocity of institutional trading which, in turn, has resulted in
substantially increased price volatility. For this reason,
Chairman Ruder believes that, at least as an interim measure,
margins on futures and options should be increased, in order to
increase investor confidence, decrease derivative market
speculative activity, and reduce the illusion that the derivative
markets provide sufficient liquidity to allow investors and
traders to liquidate quickly large portions of their entire
portfolios. Chairman Gramm, the Treasury, and Chairman
Greenspan, on the other hand, do not believe that the evidence
supports the conclusion that higher margins will reduce
volatility. Moreover, higher margins raise transaction costs and
could have a negative effect on market liquidity and efficiency,
possibly increasing volatility, and risking the movement of
futures trading into off-shore markets.

- 7 -

The members of the Working Group disagreed about the
appropriate scope and form of federal oversight of margins.
Chairman Gramm believes, based on the historical record, the
different function and practices of futures margins, and the
interest of individual firms and clearinghouses in protecting
their capital, that the current approach to futures margins —
set by SROs, with emergency authority at the CFTC — is entirely
appropriate. Chairman Gramm also believes that it may be
reasonable to have different regimes for equities since such cash
market investments can involve purchases on credit and, in many
cases, have lengthy settlement periods.
Chairman Greenspan and the Treasury believe that, while the
primary responsibility for setting margins in all markets should
be with the SROs, which have the superior expertise and economic
stake to perform this role most effectively, there should be
authority for each SRO's regulator to disapprove margin rule
changes. There is sufficient possibility that at some point SROs
might establish margins that were inconsistent enough to present
market problems or set them at levels that might present
potential costs to other parties that regulatory approval should
be established in all markets. Chairman Greenspan and the
Treasury do not feel that there is sufficient justification for
adding any further levels or mechanisms for federal oversight
beyond the primary regulator.
Chairman Ruder agrees with Chairman Greenspan and the
Treasury on the need for regulatory rule disapproval authority,
but feels that it is important to add a mechanism (i) by which
any unresolved disputes that might arise between the SEC and the
CFTC over margin levels established by their respective SROs and
not disapproved by the relevant regulator would be settled by
decision of the Federal Reserve, and (ii) by which the Federal
Reserve would have residual authority to adjust margins taking
into account leverage and investor protection concerns.
V. CLEARING AND SETTT.KMFNT RECOMMENDATIONS
The Working Group reviewed existing audit, clearing, and
payments systems to identify and set priorities for actions that
could be taken to reduce uncertainty, increase coordination,
assure confidence in the integrity of such systems, and
facilitate their smooth operation in volatile markets. In
undertaking its review, the Working Group also interviewed major
market participants, including large commercial and investment
banks, exchanges, and clearing organizations. (The views of
these market participants are summarized in Appendix C.)

- 8 -

Based on these interviews and on its own analysis, the
Working Group endorses the view that the coordinated functioning
of these systems is integral to the proper functioning of the
financial markets as a whole and is pleased to report that
significant progress has been made. In this connection, and as
more fully set forth in Appendix D, the Working Group recommends
the following agenda of additional measures to achieve the goal
of more perfectly coordinated systems.
First, it is necessary that parties to the clearing and
settlement process have a clear, consistent understanding of
their obligations and those of other parties and that all parties
make arrangements to have the financial capacity and the
information necessary to assure timely compliance with those
obligations. To this end, the Working Group recommends a number
of incremental actions, which generally can be undertaken by
federal regulators within the scope of their existing authority.
(See Appendix D, Parts I and II.)
The Working Group believes that the system refinements
based on these actions, a number of which are already underway,
will go a long way toward coordinating the clearing and
settlement process, can be undertaken in the short term without
legislation, and should be undertaken without delay.
Second, the Working Group believes that the securities,
futures, and banking industries should explore and pursue
initiatives to ease potential cash flow stress by reducing the
size of payment obligations. Experience during October 1987
indicates that large intra- and intermarket payments could add
strain to the financial system during periods of volatility. As
a result, the Working Group believes that ways to reduce such
cash flows must be explored. The Working Group believes that
this effort can be accomplished by immediate incremental actions
that would facilitate evaluation of the necessity for, and the
relative costs and benefits of, more profound structural changes
to securities and derivative markets clearing and settlement
systems. One potential method for reducing cash flows is crossmargining. Coupled with futures-style margining for options,
this method may have particular promise and should be tested.
Other approaches to netting obligations also should be pursued,
including netting member settlements at clearing banks. In the
near term, the Working Group recommends efforts to set up pilot
programs. In the longer term, the Working Group believes that
the securities and futures markets should explore the costs and
benefits of a wider range of initiatives, including shortened
settlements in the cash market that, if implemented on a
coordinated basis with expanded linkages with the derivative
markets, could reduce system risks and payments.

- 9 -

In summary, the Working Group recommends specific actions in
the following areas:
(1) clarification of the obligations of participants
in the clearing and settlement process;
(2) facilitation of timely payments;
(3) exploration of methods to reduce cash flows and
simplify settlement systems; and
(4) refinement of relevant legal frameworks.
1. Clarification of the obligations of participants in the
clearing and settlement process. The Presidential Task
Force on Market Mechanisms identified events in October
1987 that apparently caused some market participants to
question previous assumptions concerning the set of
obligations of the various parties to the clearing and
settlement process. The Working Group believes that
uncertainty concerning these rights and obligations may
not only diminish overall confidence in such processes,
but also could lead to unilateral actions that are
inconsistent with such obligations and that could
adversely impact the willingness or ability of other
market participants to satisfy their own obligations.
CONSEQUENTLY, THE WORKING GROUP RECOMMENDS THAT EFFORTS BE
MADE TO CLARIFY AND CONFIRM THE RIGHTS AND DUTIES OF PARTIES
TO THE CLEARING AND SETTLEMENT PROCESS. (See Appendix D,
Part I.)
2. Facilitation of timely payments. Increased clarity of
clearing and settlement obligations should be
accompanied by efforts to ensure the capacity of those
who are obligated to make or finance such payments to
do so on a timely basis. The Working Group has
identified several features of existing clearing and
settlement systems relevant to payment capacity that
can be enhanced to facilitate the timely satisfaction
of payment obligations.
CONSEQUENTLY, THE WORKING GROUP ADVOCATES MEASURES TO
ENHANCE THE CAPACITY OF EXISTING SYSTEMS TO ASSURE TIMELY
FLOWS OF FUNDS INCLUDING:
Reviewing facilities to support payments;

- 10 -

Augmenting the ability of clearing organizations
to satisfy the obligations of defaulting market
participants;
Consider increasing Fedwire availability in highly
volatile markets;
Coordinating settlement processes across markets;
and
Increasing the availability of timely information
to participants in the settlement process
concerning payment obligations and cash flows.
(See Appendix D, Part II.)
3. Exploration of methods to reduce cash flows and
simplify settlement systems. The Working Group
reviewed a number of potential means of modifying
existing clearing and settlement systems to reduce the
necessity for cash payments on an intra-market and
intermarket basis. Such measures may require material
structural changes and may affect legal relationships
that reflect the distinctive functions of and
regulatory protections applicable to the affected
financial markets and thus raise substantial legal,
policy, and administrative issues. The Working Group
believes that these issues have not been explored
sufficiently to warrant a determination as to whether
to recommend full-scale implementation of these
measures at this time. Nonetheless, the Working Group
does recommend a cross-margining pilot program for
non-customer accounts.
THE WORKING GROUP ALSO RECOMMENDS THAT SEVERAL SPECIFIC
INITIATIVES BE EXPLORED TO DETERMINE THE DESIRABILITY AND
FEASIBILITY OF VARIOUS APPROACHES TOWARD MORE EXTENSIVE
MODIFICATIONS OF EXISTING CLEARING AND SETTLEMENT
ARRANGEMENTS TO REDUCE CASH TRANSFERS, SIMPLIFY SETTLEMENT
SYSTEMS, AND UNIFY CLEARING, INCLUDING:
Futures style margining for options;
Netting of cash flows on a contractual basis;
Shortening the five-day settlement process for
securities transactions; and
Integrated clearing. (See Appendix D, Part III.)

- 11 -

Refinement of relevant legal frameworVs. The Working
Group, recognizing the very complex legal and federal
issues involved, is also proposing that consideration
be given to harmonization of transfer, delivery, and
pledge requirements for options and uncertificated
securities at the federal level. Further, the Working
Group recommends that bankruptcy provisions relevant to
securities and commodity brokers be reviewed to assure
appropriate coordinated bankruptcy protection of such
market participants. (See Appendix D, Part IV.)
VI. CONTINGENCY PLANNING
The Working Group believes that the purpose of contingency
planning is to ensure that regulatory agencies and the selfregulatory organizations have in place systems that will allow
them to identify emerging problems quickly and to react
appropriately in the event of a market crisis. In an important
sense, the Working Group recommendations for implementing circuit
breakers, improving information flows, clarifying credit
arrangements, and strengthening the clearing and settlement
process can be viewed as a key part of contingency planning; by
improving the market system's ability to withstand and react to
shocks, these measures will enhance the system's first line of
defense.
Going beyond this, the Working Group has given high priority
to enhancing channels of communication among staffs of the
respective regulatory agencies. The first step in this process
has been to improve each agency's awareness of the existing
information flows available from routine surveillance systems
and to identity more clearly the existing regulatory mechanisms
available to each agency to act in crisis situations. Further
steps include the distribution of a contact list of names and
telephone numbers of key officials at the regulatory agencies
and the securities and futures exchanges. Similar efforts to
improve communications and share information among the exchanges
and their respective clearing organizations are being implemented
by the SRO's. In particular, the securities and futures
exchanges have developed a hot-line capability that allows
simultaneous communication between all relevant markets.
Moreover, the clearing organizations are working on procedures
for sharing information both on a routine basis and during
periods of market stress.
In addition, staffs of the four agencies are working jointly
to improve information sharing across the agencies, with
particular emphasis on a framework for coordinated monitoring of
exposures and developments at major market participants. This is
expected to incorporate a framework for identifying their

- 12 -

activities in each of the various markets, for monitoring intracompany financial interrelationships, and for assessing the
extent of credit and funding interrelationships among such
participants. It also will include coordinated efforts to
encourage further improvements in the scope and quality of
information available to such market participants, and hence to
the regulators, from their internal exposure control systems. It
is expected that this will enhance prospects for coordinated
actions by the authorities and SRO's to protect the integrity of
markets and clearing systems in extreme situations.
As with all of these issues, the Working Group recognizes
that there are international dimensions to policy coordination.
In this regard, steps are being taken by the various agencies to
strengthen existing contacts with their counterpart authorities
in other major market centers to improve further this aspect of
market surveillance.
Beyond such efforts, contingency planning does not lend
itself to pre-determined responses. Our financial markets have
experienced various difficulties in the past, and each has raised
different concerns and required a different response by
regulators and market participants. Recognizing this, the
Working Group believes that contingency planning must provide a
flexible framework for addressing problems in a way which does
not create unreasonable expectations of government intervention
in a crisis. Continuation of the Working Group could enhance
this flexibility by providing a forum for informed discussion and
resolution of problems as they are identified.
VII. SUMMARY OF ACTIONS TAKEN ON CAPITAL ADEQUACY AND SYSTEMS
CAPACITY ENHANCEMENT
Market participants, SROs, and regulatory agencies have
taken or are planning a number of significant actions to enhance
capital and improve automated systems — two of the issues the
Working Group and others have identified as critical to the
financial integrity and smooth functioning of the markets. This
section summarizes developments regarding: (A) specialist
capital; (B) broker-dealer capital; (C) financial integrity in
the futures markets; and (D) systems capacity. A more complete
listing of actions taken is found in Appendix E. The Working
Group will continue to monitor developments in these areas to
ensure that needed improvements are made.
A. Specialist Capital
Because of the unique responsibility of specialists to
maintain fair and orderly markets, it is important that
specialists have sufficient capital during periods of high volume

- 13 -

and market turmoil. A specialist's ability to take the other
side of a transaction when no one else is willing to do so
depends on liquidity. During the October break some specialists
on the NYSE and the American Stock Exchange (Amex) reached the
limits of their buying power or encountered serious solvency
concerns. This contributed to the market's difficulties and to
problems faced by investors seeking to execute orders.
During the October break the NYSE required specialists to
have minimum capital of the greater of $100,000 or a percentage
of the value of shares of the stock assigned to them. The last
time the NYSE changed its specialists' capital requirements was
in 1977. Since then, of course, specialists* exposure has risen
with the bull market and increased volume and volatility.
The President of the NYSE and the Brady Task Force have
suggested that no amount of capital could enable a specialist in
effect to stand in front of a stampeding market. The SEC's
Staff Report, The October 1987 Market Break (February 1988),
concurs, pointing out that it is unlikely that increased levels
of specialist capital could have retarded to any degree the
market decline of October 19 and 20. The SEC also stated that it
is unrealistic to expect any one group of market participants to
have or commit sufficient capital to retard extraordinary selling
pressures. Nevertheless, the SEC Staff Report concluded that
minimum specialist capital requirements imposed by the exchanges
do not reflect the actual capital needed to maintain fair and
orderly markets in securities with different trading
characteristics. Accordingly, the SEC has urged the exchanges to
consider revising the minimum financial requirements imposed on
specialists to reflect more closely the requirements of today's
markets.
The Working Group is concerned that past requirements for
specialist capital may not be sufficient. The SEC and securities
SROs are best suited to resolve these issues because they are
closest to the problem. Indeed, they already have made
substantial progress to bolster the capital of specialists:
o The SEC has recently approved a proposed rule change by
the NYSE to raise the minimum dollar amount for
specialists' capital to $1 million from $100,000 and to
increase the measure based upon the trading unit
position to three times its current level. (For
example, the current 5,000 share position requirement
for common stock has been increased to 15,000 shares.)

- 14 -

The NYSE has increased its monitoring of both
specialists' capital and positions by requiring that
such information be filed with the NYSE by 9:00 a.m.
daily.
o In an effort to attract more capital, the NYSE has
revised its Rule 98 to suspend a prohibition on
securities underwriting firms acquiring specialists.
The proposed rule change was approved by the SEC on a
temporary, emergency basis. A proposed rule change to
make this modification permanent has been filed with
the SEC.
The Amex and regional exchanges also have taken or are
considering actions to enhance specialists' capital and the
exchanges' surveillance of specialists' financial condition (as
described more fully in the appendix).
The Working Group encourages the SEC and its constituent
self-regulatory bodies to continue to review these efforts and to
enhance specialists' ability to continue their function during
volatile market conditions whenever necessary.
B. Broker-Dealer Capital
In addition to specialists' capital, the Working Group
considered the capital adequacy of options firms and firms
conducting a public business and/or trading for their own
accounts.
The SEC's report found that, although the largest upstairs
firms suffered substantial losses as a result of the October
break, none fell below the Commission's net capital early
warning levels. Of the approximately 6700 upstairs firms, about
60 were at some time in violation of the net capital rule. Of
that number, only three carried customer accounts and only one of
those had to be liquidated under the Securities Investor
Protection Act.
The SEC's report also found that some options market makers
experienced substantial losses, which created severe liquidity
problems at some of their clearing firms.
The SEC concluded that, in light of the increased volatility
in the market, it would reexamine the minimum net capital
required of certain types of broker-dealers as well as the level
and structure of haircuts for equity securities and futures. In
addition, the Commission plans to review financial activities
conducted in affiliates of broker-dealers to determine whether
these financial activities create undue risk exposure for the

- 15 -

broker-dealers and the financial markets generally. The
Commission also will examine regulatory requirements regarding
the amount of equity an options market maker should have in its
account and the amount of market maker business a clearing firm
should carry without additional resources.
The securities clearing houses also are making significant
progress in this area:
o The Options Clearing Corporation (OCC) has undertaken a
special study of its systems that will include eight
broad areas for review, including those identified in
the SEC Staff Report. The objective of the OCC study
is to identify any structural weaknesses or areas that
can be improved.
o OCC has been considering increasing its net capital
requirements and will analyze the costs and benefits of
such increases as part of its study.
The Working Group encourages the SEC, SROs, and clearing
houses to continue this process of evaluating the sufficiency of
broker-dealer capital and finding ways to improve existing
practices and requirements.
C. Capital Adequacy in the Futures Markets
The CFTC has taken a number of actions to assess the
operation of CFTC and futures SRO financial regulatory systems
during the market break, to identify measures that could be taken
to reinforce the capacity of existing financial systems, to
respond to extreme market volatility, and to stimulate SROs to
review and enhance their own programs to augment available
financial protection. These recommendations were made,
notwithstanding the fact that there were no defaults of futures
commissions merchants (FCMs) nor significant problems at such
firms. These actions include:
o Establishment of a centralized computer base for
futures commission merchant financial data; and
o Enhancement of market financial surveillance programs.
In response to the CFTC's recommendations, the futures
exchanges have taken a number of actions to enhance the financial
security of the futures markets. These actions include the
following:

- 16 -

The Chicago Mercantile Exchange's (CME) pool of
security deposits, which are liquid funds to be used in
the case of a default, was increased from $4.5 million
to $42 million. This fund is but one source to which
the Exchange would look in the event of a default.
The Exchange also has a common-bond system that
provides for the allocation among its clearing members
of any loss to the Clearing House caused by a default.
The aggregate capital of all Exchange firms is
approximately $17 billion.
o The CME has passed a rule requiring guarantees from the
owners of clearing members. The rule essentially
requires each owner of 5 percent or more of the equity
securities of the clearing member to guarantee all
obligations arising out of the non-customer accounts
(house and proprietary) of the clearing member.
o The CME's Clearing House is in the process of
negotiating a substantial committed line of credit with
major banks. This will provide added liquidity to the
Clearing House to allow it to meet its obligations in
the event of unusual conditions in the financial
markets.
o Over the past year, the CME significantly increased the
number of memberships that each clearing member must
have in order to maintain clearing privileges. (These
memberships may be sold by the Exchange in the event of
a default by the firm.) As of May 6, 1988, all
clearing members must have at least six memberships,
two in each of the three divisions of the Exchange.
Clearing members with a large number of branch offices
or guaranteed introducing brokers have an additional
membership requirement. Based on membership prices at
the end of March 1988, the value of these memberships
is $1.6 million per clearing member.
The foregoing actions are highlighted from a more extensive
list contained in Appendix E. The Working Group encourages the
CFTC and its SROs to continue to evaluate and improve further
their programs.
D. Systems Capacity Enhancements
The GAO, in its "Preliminary Observations on the 1987
Crash," concluded that enhancement of the SROs' automated
operational systems is a critical action that needed to be taken
immediately. The SEC's Report also concluded that the October
break demonstrated a need to expand the capacity of the NYSE to

- 17 -

meet the increased liquidity demands created by today's trading
strategies and market structures. The Brady Report also cited
the need to improve overall computer and communications
performance.
The Working Group notes that substantial progress has been
and is being made, but agrees that further improvements are
needed in this area. Among the enhancements already in process
are the following:
The New York Stock Exchange (NYSE)
o The NYSE is planning to have the capacity to handle a
peak of 600 million shares by June of this year, and it
believes that if it were to experience a 600-millionshare day now, it would be able to process it with
significantly fewer delays than the Exchange
experienced last October.
o On April 30, the NYSE conducted a test of its 11
computer systems to determine whether it already could
handle a 600 million share day. The preliminary
results of the test indicated that core portions of the
NYSE's order handling systems generally operated
effectively.
o Beyond this, the NYSE is planning to have the capacity
by late 1989 to process a billion shares.
o The NYSE is initiating an independent audit of its
trading systems by an outside firm every 12 to 18
months to further ensure their proper operation. As
the audits are conducted, the NYSE is going to share
the findings with the SEC.
o In November 1987, the NYSE increased the Designated
Order Turnaround (DOT) system's memory and separated
several of the system's data files to allow more
efficient processing. Further system enhancements are
scheduled to be completed by July 1988 to improve DOT'S
processing capability even more.
o In January 1988, program changes were completed in the
Limit Order System to reduce system bottlenecks
discovered during the October market break. A major
upgrade of the system with more efficient computers was
completed in March 1988, resulting in a 40 percent
increase in capacity.

- 18 -

The NYSE had begun to replace completely its Automated
Pricing and Reporting System prior to October 1987, but
only a small fraction of the new system was operational
by the week of the 19th. An entirely new system was
completed on February 22, 1988.
o The ability of the NSYE's Universal Floor Device
Controller to store and process data has been
increased. To add additional capacity, major portions
of data normally routed through the Universal Floor
Device Controller are being re-routed to other systems,
a process that will be completed by the end of June
1988.
o On January 19, 1988, the NYSE opened its expanded Blue
Room, adding 30 more high speed printers for an
increase of 20 percent. Seventeen more high speed
printers were added to the trading floor in March 1988.
In addition, the NYSE currently is working to double
the speed of all existing printers.
o The NYSE also has increased the number of electronic
display books on the trading floor by 70 percent,
reducing the overall need for printers. In addition,
it has increased the number of stocks on display books
by over 140 percent since October 19th, so that
currently there are approximately 1,150 stocks on 376
display books.
o The NYSE recently announced the formation of an
Operations Advisory Committee to evaluate problems
encountered during peak processing periods and to
recommend synchronized corrective actions that would
enhance the entire process.
o In March, the NYSE established a Pension Managers
Advisory Committee to help make the NYSE more aware of
the investment needs of fund managers and help keep the
fund managers better informed of the system
capabilities of the Exchange now and in the future.
The American Stock Exchange (Amex)
o The Amex is working with those specialists who have
touchscreen execution (AutoPer) terminals located
behind them to provide space to relocate the terminals
in front to the front of the specialists post.

- 19 -

In addition, the Amex is in the process of redesigning
the AutoPer screen to eliminate the need, in some
instances, to use an additional page to complete
execution of an order. The redesigned screen will
permit specialists to execute orders even more quickly
and reduce the possibility of having orders print and
being executed out of sequence.
Amex has a pilot program underway with respect to the
implementation of an electronic book that will provide
smoother integration of AutoPer and booked limit
orders.
The Amex is developing systems to allow same-day floorderived points of sale comparison for equities and
options. It is well into the design phase of this
system and plans to implement the first stage in the
last quarter of 1988.
The exchanges' examination of ways to upgrade order
delivery systems to improve the capacity of Amex's
systems to execute all orders — including Intermarket
Trading System (ITS) commitments — is ongoing. The
Amex and other exchanges are in the process of
implementing such upgrades, and believe such
developments will permit it, under reasonably
anticipated high volume conditions, to execute incoming
ITS commitments in a timely manner.
An arrangement has been decided upon whereby OPRA will
regularly update the vendor/user committee of the
Information Industry Association on volume and capacity
projections to assist the vendor community in its
efforts to have facilities keep pace with growth and
provide for unexpected spikes in activity.
The Amex has adopted a policy of delisting selected
series of puts and calls within an options class when
no open interest exists.
The Amex and the Chicago Board Options Exchange (CBOE)
have proposals, currently awaiting SEC action, that
will expand the use of their small order execution
systems for options. In addition, the CBOE has filed
with the SEC a number of proposed rule changes to
increase market participation in its system.

- 20 -

National Association of Securities Dealers (NASD)
o The NASD has responded to problems encountered during
the market break by proposing a number of initiatives:
raising the penalty of unexcused withdrawals by
market makers from National Association of
Securities Dealers Automated Quotation System
(NASDAQ);
requiring all NASDAQ market makers to participate
in its Small Order Execution System (SOES);
providing that SOES executions will continue in an
Over-the-Counter (OTC)/National Market System
security when quotes are locked or crossed;
eliminating preferencing of market makers when a
locked or crossed market exists; and
establishing the Order Confirmation Transaction
service that will permit firms to access market
makers over the computer without voice contact.
o During and after the week of October 19, the NASD
expanded the hours of operation of its Trade Acceptance
and Reconciliation Service, which allows firms quickly
to reduce the number of uncompared transactions.
o The NASD agrees with the SEC's suggestion that the SROs
accelerate their efforts to generate same-day compared
trades, thereby enabling members to know their
positions and market exposure before trading commences
the next day. The NASD plans an Automatic Confirmation
Transaction System that, together with the Small Order
Execution System, Order Confirmation Transaction
Service, and the Trade Acceptance and Reconciliation
Services, would provide an almost total same-day
comparison capability for the NASDAQ market.
o The regional stock exchanges also have taken or are
planning a number of actions to enhance their systems
(as described more fully in the appendix).
Amex, NYSE. NSCC Committee
o A committee composed of representatives of the Amex,
NYSE and National Securities Clearing Corporation
(NSCC) has been formed to explore the possibility of
shortening the comparison cycle with the intent of

- 21 -

increasing the amount of time available to process
"don't knows" (DKs) and "questionable trades" (QTs) by
one full day.
Option Price Reporting Authority
o The Options Price Reporting Authority (OPRA) Technical
Committee immediately began to design system
modifications that will allow the announcement of new
series through computer formatted messages. Such
modifications will in turn enable vendors to implement
computer automatically programs to add these new series
to their systems, eliminating the time-consuming and
error-prone process of transcribing the administrative
messages that is currently used. The Committee reached
agreement on the message type at a meeting on December
9th, and implementation of the system modifications is
expected to be completed this summer.
The Working Group encourages the securities SROs and
clearing agencies to continue to make progress to help the market
function smoothly and to provide prompt, quality executions for
all market participants.

APPENDIX A
COORDINATED TRADING HALTS AND REOPENINGS
I. 250 Point Dow Jones Industrial Average (DJIA) Decline
A. Price Limits
1. Stock Index Futures Price Limits: Stock index
futures markets will set downward price limits at
levels comparable to a 250 point Dow Jones
Industrial Average (DJIA) decline below its
previous day's closing value. When the limit is
reached, the markets will trade only within the
limit, unless there is a trading halt as described
in Section B or a reopening following a trading
halt as described in Section C.
2. Broad-based Stock Index Options: Broad-based
stock index options markets (OEX, NYA, XMI, FNCI,
XVL) will establish either comparable price limits
or procedures under which all trading in the index
options will cease at levels comparable to a 250
DJIA decline.
B. Trading Halt
If the DJIA falls 250 points below its previous day's
closing value, all broker-dealer intermediated equity
security 1/ trading in the United States, including all
standardized individual stock and stock index options
trading, and all stock index futures trading in the
United States, will halt.
C. Reopenings
1. Halts initiated prior to 3:00 p.m. EST or EDT
a. The New York Stock Exchange (NYSE): If the
halt occurs prior to 3:00 p.m. EST or EDT,
procedures similar to those used to open
stocks on the NYSE on Expiration Fridays will
be used in order to reopen trading on the
NYSE 60 minutes after the initiation of the
halt. Thus:

"Equity security" is defined in Section 3(a)(11) of the
Securities Exchange Act of 1934 and Rule 3all-l thereunder.

- 2 (i)

30 minutes after the halt occurs, market
order imbalances for major stocks will
be publicly disseminated (at present it
is not feasible to include limit
orders).
As a logistical matter, it may be
necessary to have some size
threshold for order imbalance
dissemination (e.g., 50,000 shares)
to facilitate prompt dissemination
of key order imbalances. In
addition, some limitation on the
total number of stocks for which
imbalances are disseminated may be
necessary.
(ii) 45 minutes after the halt, quote
indications will be provided indicating
the expected range in which each stock
would reopen.
(iii) 60 minutes after the halt, each stock
will either:
AA. reopen, or
BB. if new orders substantially change
the order imbalance, new quotations
will be disseminated
this presumes that orders can
be cancelled at any time prior
to the reopening
CC. subsequent quote indications will
be disseminated on an as needed
basis in 10 minute intervals (or 5
minutes if the subsequent quote
indication overlaps the prior quote
indication).
b. Other Markets:
(i) Other markets will use any appropriate
reopening procedures designed to permit
them to recommence trading one hour
after the initiation of the stock
trading halt, except that trading in

- 3 standardized options on individual
stocks will not recommence until trading
in the underlying stock has recommenced
in the stock•s primary market.
(ii) After a one hour halt, trading in stock
index futures and options could occur
(at the option of each futures or
options exchange) below the 250 limits
(see Section I.A.), unless the markets
decline to levels equivalent to 400 DJIA
points below their previous day's
closing levels (see Section II).
2. Halts initiated between 3:00 - 3:30 p.m. EST or
EDT:
If the 250 level is reached between 3:00 - 3:30
p.m. EST or EDT, abbreviated reopening procedures
will be used in order to permit markets either to
reopen or to establish closing prices by the
markets' normal closing times.
3. Halts Initiated After 3:30 p.m. EST or EDT:
If the 250 level is reached after 3:30 p.m. EST or
EDT, the market will close for the rest of the
trading day.
400 Point DJIA Decline
A. Similar price limit, halt, and reopening procedures
will be used for DJIA declines of 400 points, except
that the halt will last two hours instead of one.
Thus, if the 400 level is reached after 2:00 p.m. EST
or EDT, the markets will close for the rest of the
trading day.
Trigger Readjustments
A. Based upon current index levels, 250 and 400 point DJIA
declines are approximately equivalent to 12% and 20%
declines. The 250 and 400 point triggers and the
comparable triggers for the stock index futures and
options markets will be reviewed at least quarterly to
determine if changes in index levels necessitate
changes to these triggers in order to maintain
percentages approximately equivalent to 12% and 20%.

APPENDIX B
ADEQUACY OF PRUDENTIAL MARGIN

REQUIREMENTS

While margins requirements may be thought to serve a variety
of purposes, the crucial one analyzed in this appendix is the
setting of margin requirements to yield a reasonable level of
protection against default, i.e., prudential maintenance
margins. The purpose of prudential margins is maintaining the
financial integrity of the obligation, i.e. , assuring that market
participants who take positions in securities, futures, or
options can fulfill their obligations to brokers and other
intermediaries so that brokers and clearinghouses can fulfill
their obligations as well. Default can occur only if an adverse
price change, after the margin call but before the position is
sold out, is larger than the remaining margin and the customer
avoids paying the resulting liability. Whether a particular
margin level is considered adequate to protect brokers and
futures commission merchants (FCMs) depends, among other things,
on the level of default risk exposure that will be tolerated.
Margins of 100 percent would fully assure the solvency of the
brokers or FCMs, but would also tend to reduce the benefits
experienced by investors from trading on margin or hedging with
stock-index futures and options. Generally, much lower margin
levels are adequate to provide protection against 90, 95, or even
99 percent of expected price movements. Very low margin levels,
however, could leave the broker or FCM open to an unacceptable
risk of failure. The margin level ultimately chosen will reflect
the risk exposure tolerance of the exchange or clearinghouse.
Another important factor relevant to the adequacy of margin
requirements is the period of time the broker or the FCM is
exposed to default risk on a customer's open positions—the
amount of time expected to lapse between the margin call and the
customer's response. This grace period depends on the liquidity
of the relevant investor group and the efficiency of the clearing
and settlement system. In the futures markets, where investors
are primarily institutions and settlement occurs at least daily,
margins that will cover the vast majority of one-day price
movements would be considered adequate. In the cash markets,
however, where individual investors are relatively more important
and settlement takes as long as five days, margins should be
adequate to cover price movements over three or five-day
periods. A broker is allowed to give an investor up to 15
business days to meet a margin call. In practice, however, most
brokers demand payment over a shorter period.
Experimental Design
This analysis of margin adequacy takes two different, but
related, approaches. The first is a non-parametric approach in
which actual frequency distributions in price movements are
calculated over various sample periods. These distributions are
then
employed
213-632
0 - 8 8 - 2 to determine the margin required to cover price
changes given various levels of exposure.

- 2 -

The second is a parametric approach following Figlewski
(Stephen Figlewski, "Margins and Market Integrity: Margin
Setting for Stock Index Futures and Options," The Journal of
Futures Markets, 1984, pp. 385-416). Assuming that stock prices
follow a logarithmic diffusion process with a constant drift
parameter (r) and volatility (v) per unit of time, one can
calculate the probability that a security price will change
enough, following a maintenance margin call, such that the
remaining margin is insufficient (i.e., the margin is
violated). While this probability obviously depends on r and v,
it also depends on the level of the maintenance margin and the
length of the grace period. In particular, the higher the
maintenance margin, the lower the probability of a margin
violation; the higher r (which can be thought of as an annualized
rate of return due to price movements during the grace period),
the lower the probability of a margin violation; the higher v
(the standard deviation of price movements), the higher the
probability of a margin violation; and, the longer the length of
the grace period, the higher the probability of a margin
violation.
Non-Parametric Results
Frequency distributions were calculated (a) only for price
declines and (b) for all price changes over six sample periods:
(1) January 1986 - April 1988,
(2) January 1986 - September 1987,
(3) October 1987 - April 1988,
(4) November 1987 - April 1988,
(5) June 1984 - April 1988,
(6) June 1984 - September 1987.
Tables 1-6 indicate the minimum levels of maintenance
margins necessary to protect brokers and futures clearinghouses
against losses that might be incurred should stock prices decline
and investors fail to meet margin calls. In particular, the
tables show margins required to cover most of the recent price
declines in the Standard and Poor's 500 stock index and price
declines in the 75 individual stocks that compose the
Institutional index, that is, stocks of large companies favored
by institutional investors.
Block 2 in tables 1-6 indicates the
margins necessary to protect against price declines on 50 percent
of the 75 individual stocks composing the Institutional Index
that demonstrated the least variability during this sample period
for varying grace periods and levels of exposure. Blocks 3-5
indicate similar margins for larger percentages of the stocks in

- 3 -

this index. Tables 7-12 contain comparable information for all
price changes in the nearest to expire S&P 500 and MMI maxi
futures contracts.
The two key factors relevant to judging the adequacy of
margin reguirements—the acceptable level of exposure and the
length of the grace period—are highlighted in the tables. For
example, the first three lines of each of the first twelve tables
indicate the margins necessary to protect FCMs and broker/dealers
against possible price movements of the S&P 500 index over
periods of one, three and five days. (Price declines for the
cash index in tables 1-6; price declines and increases for the
futures index in tables 7-12). The three columns indicate the
90, 95, and 99 percent confidence intervals or levels of exposure
associated with the indicated margins. For example, the first
line in the S&P 500 index block in table 1 indicates that, during
the January 2, 1986 to April 29, 1988 period, a one-day price
decline greater than 4.40 percent or a five-day price decline
greater than 10.09 percent occurred in only one percent of the
observations. In other words, if the distribution of price
declines were assumed to remain the same in the future as it was
during this period, a margin of 4.4 percent when margin calls
must be met on the next day, or of just over 10 percent when
margin calls do not have to meet until 5 days have passed, would
be expected to provide adequate protection against 99 percent of
all price declines of the S&P 500 index. From table 7,
comparable, though slightly larger, margins would be required to
provide adequate protection against 99 percent of all price
declines or 98 percent of all price changes (i.e., increases and
decreases) for the S&P 500 futures index. Furthermore, as
exhibited in blocks 2-5 of tables 1-6, since individual stocks
typically exhibit larger variability than either cash or futures
indexes, margin requirements are accordingly higher for
individual stocks given the same grace period and level of
exposure.
To summarize, for each sample period, tables 1-12
demonstrate three important characteristics concerning the
adequacy of prudential maintenance margins:
(1) The lower the level of exposure (i.e., the higher the
desired level of protection against price changes), the
higher the level of margins.
(2) The longer the grace period, the higher the necessary
margin level for a given level of exposure.
(3) Indexes (cash or futures) exhibit less price volatility
than do individual stocks, implying that lower margins
on index products than on individual stocks are adequate
to achieve the same protection against price changes.

- 4 -

Given the sample specificity of the calculated frequency
distributions, a comparison of the margins required over
different samples sheds light on the robustness of "adequacy of
margins" calculations over time. Various permutations of time
periods were chosen--short and very recent periods, long periods,
and periods including and excluding the October 1987 stock market
crash and the recent period of price volatility. Because of
differences in price volatility over time, the actual levels of
margins required to cover price movements are very sensitive to
the time period of analysis. In particular, inclusion of the
October 1987 market break uniformly and markedly increases the
"adequate" margin level. For example, table 3, which contains
only observations from the market break and the recent period,
indicates much higher margin levels than table 2, which contains
only pre-crash observations. For each of the periods, however,
the level of prudential margins still depends on the level of
exposure, the length of the grace period, and the volatility of
indexes versus individual stocks, as discussed above.
Parametric Results
Determining an "adequate" margin requirement using the
parametric approach outlined above requires knowledge of r and v
in addition to the length of the grace period and the acceptable
level of exposure. Reasonable ranges of values for r and v can
be obtained by calculating these two variables over various
sample periods. Table 13 contains these calculations annually
for the S&P 500 and the NYSE Composite indexes for the period
1975-87, for the first 63 business days of 1988, and for four of
the six sample periods examined in tables 1-12.
The tables
reveal that the annual values of r range from -0.126 (i.e., -12.6
percent) to 0.281 for the S&P 500 index and range between -0.100
and 0.284 for the NYSE Composite index. Annual values of v range
between 0-092 and 0.342 for the S&P 500 index and between 0.087
and 0.318 for the NYSE Composite index. Note that the annual
values of v for 1987 are by far the largest during the more than
thirteen years examined. Furthermore, the value of v for the
first 63 business days of 1988 has remained somewhat above pre1987 levels. Consequently, higher than historically normal
values of v may now be appropriate for setting prudential
margins.
Also, since an objective of this analysis is the examination
of margin adequacy for individual stocks as well as for cash and
futures indexes, it is necessary to obtain values of v for
individual stocks. Chicago Research and Trading Ltd. (CRT) has
provided estimates of v for three categories of stocks: (a) low
volatility stocks (e.g., utilities), (b) medium volatility stocks
(e.g., conglomerates), and (c) high volatility stocks (e.g.,
computer software companies). During approximately the last two
years (including October 19, 1987), CRT's highest calculated
value of v is 1.10. This value is used as the upper extreme in
the margin calculations that follow.

- 5 -

The parametric approach enables the analysis of margin
adequacy from two angles. First, given a required margin level,
values for r and v, and a particular grace period, the
probability of a margin violation can be calculated.
Alternatively, given values of r and v, a particular grace
period, and a desired probability of margin violation (i.e. one
minus the level of exposure in decimals), the necessary margin
requirement can be calculated. To conform to the format of the
non-parametric exercise the latter approach was chosen.
Tables 14-17 contain the margin requirements necessary to
achieve a desired probability of a margin violation 0.01 (one
percent) in tables 14 and 15, 0.05 (5 percent) in tables 16 and
17) for two values of r (0.00 in tables 14 and 16, 0.10 in tables
15 and 17) and for a wide range of grace periods and values of
v. (The margin calculation was found to be relatively
insensitive to r. Hence, results using two representative values
are the only ones reported.) Grace periods of less than one day
were included to examine the impact of intra-day margin calls, a
common phenomenon in futures markets.
The calculated margins from the Figlewski model conform
quite closely with those calculated in the non-parametric
exercise. For example, from table 14, for daily settlement and
v=0.35 (just above the calculated value of v for 1987 for the two
indexes), a margin requirement of 5.4 percent would be expected
to provide adequate protection against 99 percent of all price
declines. This is essentially the same as the 4.4 percent
contained in table 1 for the S&P 500 index. Furthermore, as the
volatility increases, so does the margin requirement given the
same level of exposure. Also, as before, if the grace period is
5 days (and v=0.35), the required margin rises to 11.8 percent in
table 14, again comparable to the 10.09 percent in table 1.
Finally, for a higher level of exposure (table 15 compared with
table 17), a lower margin requirement will suffice.
Thus, the parametric exercise yields the same general
conclusions as did the non-parametric approach: adequate
prudential margins vary inversely with the level of exposure,
directly with the length of the grace period, and directly with
price volatility.
Conclusion
The existing structure of maintenance margins appears to be
adequate for prudential purposes even if one were to assume that
protection against 95 or 99 percent of all price declines was
required. This conclusion is supported by both the nonparametric exercise conducted across a variety of sample periods
and the parametric exercise using historically reasonable values
for return and volatility parameters.
An important additional conclusion is that "harmonious" or
"consistent" margins across cash and futures markets do not imply

- 6 -

equal margins across cash and futures markets. The analysis here
indicates clearly that margin adequacy depends critically on
price volatility and the length of the grace period following the
margin call. These relationships are clearly evident in the
attached tables (e.g., tables 1 and 14), but are visually
apparent in figure 1. Figure 1 plots the maintenance margin
necessary to achieve protection against 99 percent of all price
declines assuming r=0.00 for various grace periods and
volatilities. To the extent that the volatility of indexes (cash
or futures) is lower than those of individual stocks and that
grace periods are longer in the cash market than in the futures
market, maintenance margins in the futures market (e.g., point A
in figure 1 where v=0.25 and the grace period is one day) are
consistent with much higher margins in the cash market (e.g.,
point B or C where v=0.5 and 1.0, respectively, and the grace
period in five days).

Table 1
MAINTENANCE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 1/2/86 - 4/29/88

Exposure tolerance
90%
95%
99%
1. S&P 500
Index
One-Day
Three-Day
Five-Day

1.,33
2.,53
3.,30

2.,03
3.,73
4.,82

4.40
7.09
10.,09

One-Day
Three-Day
Five-Day
Fifteen-Day

2..06
3..89
4..85
7,.28

2.,94
5.,19
6.,60
10..41

5.,44
9.,27
11.,75
24.,66

One-Day
Three-Day
Five-Day
Fifteen-Day

2,.36
4,.20
5..38
8..55

3.,26
5..78
7..30
12..41

6.,52
11.,66
17.,22
30.,62

One-Day
Three-Day
Five-Day
Fifteen-Day

2 .53
4 .47
5 .61
9..05

3,.48
6,.20
7,.62
13,.60

7,.29
13,.19
19,.12
33,.45

One-Day
Three-Day
Five-Day
Fifteen-Day

3..55
5 .82
7 .61
11 .96

5 .29
8 .04
10 .24
17 .39

8 .87
19 .16
29 .21
42 .80

2. 50% of
Institutional
Index Stocks*

3. 80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5. 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 2
MAINTENANCE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 1/2/86 - 10/2/87

Exposure Tolerance
90% 95% 99%

1. S&P 500
Index
One-Day
Three-Day
Five-Day

1.07
1.94
2.35

1.65
2.80
3.69

2.56
4.85
6.35

One-Day
Three-Day
Five-Day
Fifteen-Day

1.84
3.29
4.12
5.98

2.47
4.46
5.54
8.26

3.95
6.85
8.25
12.41

One-Day
Three-Day
Five-Day
Fifteen-Day

2.09
3.66
4.61
6.92

2.77
4.98
5.94
9.27

4.45
7.90
9.52
14.66

One-Day
Three-Day
Five-Day
Fifteen-Day

2.23
3.85
4.78
7.26

2.96
5.12
6.29
10.44

5.00
8.23
10.88
16.78

One-Day
Three-Day
Five-Day
Fifteen-Day

3.21
5.22
6.26
10.50

4.47
6.96
8.31
13-80

6.54
11.78
13.49
22.12

2. 50% of
Institutional
Index Stocks*

3. 80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5. 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 3
MAINTENACE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 10/5/87 - 4/29/88

Exposure Tolerance
90% 95% 99%

1. S&P 500
Index
2.,29
4..36
5-.12

3.,82
6.,08
9.,05

14.,98
23. 85
26.,25

One-Day
Three-Day
Five-Day
Fifteen-Day

3,.19
5..69
7,.38
10,.68

4.,79
7.,68
10..37
17..35

16.,77
24.,53
26.,65
30.,53

One-Day
Three-Day
Five-Day
Fifteen-Day

3,.65
6,.66
8,.52
13,.77

5,.51
9..87
13,.71
26,.65

19..80
28..47
31,.37
37..26

One-Day
Three-Day
Five-Day
Fifteen-Day

4,.02
7,.37
9,.59
16,.24

6,.25
10,.72
16,.09
28,.50

21,.83
31,.38
34,.61
44,.21

One-Day
Three-Day
Five-Day
Fifteen-Day

5,.63
10,.25
13,.24
23,.17

7 .87
17 .02
27 .47
35 .46

26 .80
37 .00
41 .64
56 .03

One-Day
Three-Day
Five-Day
2. 50% of
Institutional
Index Stocks*

3. 80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5- 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 4
MAINTENANCE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 11/2/87 - 4/29/88

Exposure Tolerance
90% 95% 99%
1. S&P 500
Index
One-Day
Three-Day
Five-Day

1..93
3,.66
4,.64

2,.65
4,.53
5,.10

6,.16
6,.43
7,.55

One-Day
Three-Day
Five-Day
Fifteen-Day

2,.57
4,.63
5,.72
7,.09

3,.74
5,.83
7..03
8,.77

7,.08
8..67
9..31
12..40

One-Day
Three-Day
Five-Day
Fifteen-Day

3..02
5..50
6,.80
9..48

4..28
6..86
8,.37
12..10

8..63
10,.62
12..00
15..17

One-Day
Three-Day
Five-Day
Fifteen-Day

3..26
5..91
7,.23
11,.46

4..76
7,.76
8,.99
14,.07

9,.74
12,.04
13,.21
19,.12

One-Day
Three-Day
Five-Day
Fifteen-Day

5,.08
7,.92
11,.05
14,.52

7,.01
10,.99
13 .60
20 .12

11 .42
20 .87
17 .38
25 .97

2. 50% of
Institutional
Index Stocks*

3. 80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5. 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 5
MAINTENANCE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 6/1/84 - 4/29/88

Exposure Tolerance
90% 95% 99%
S&P 500
Index
One-Day
Three-Day
Five-Day

0.96
1.87
2.27

1.53
2.84
3.83

3.12
6.07
7.41

One-Day
Three-Day
Five-Day
Fifteen-Day

1.89
3.37
4.12
6.08

2.66
4.65
5.80
8.59

4.72
7.74
9.66
19.53

One-Day
Three-Day
Five-Day
Fifteen-Day

2.10
3.78
4.68
7.12

2.92
5.15
6.46
10.21

5.46
9.07
11.35
27.28

One-Day
Three-Day
Five-Day
Fifteen-Day

2.27
4.07
5-08
8.18

3.12
5.47
6.89
11.45

6.34
10.59
13.76
28.76

One-Day
Three-Day
Five-Day
Fifteen-Day

3.38
5.76
7.35
11.28

4.79
7.80
9.73
15.04

7.88
14-04
17.28
36.29

2. 50% of
Institutional
Index Stocks*

80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5. 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 6
MAINTENANCE MARGIN REQUIRED TO COVER POTENTIAL PRICE DECLINES
Period: 6/1/84 - 10/2/87

Exposure Tolerance
90% 95% 99%

1. S&P 500
Index
One-Day
Three-Day
Five-Day

0,.84
1..60
1..93

1..21
2..18
2..83

2..32
3..89
5..19

One-Day
Three-Day
Five-Day
Fifteen-Day

1..73
3,.02
3..74
5,.33

2.,36
4.,07
5.,03
7.,30

3.,82
6.,20
7.,88
11.,70

One-Day
Three-Day
Five-Day
Fifteen-Day

1,.96
3,.37
4,.14
6,.17

2..69
4,.60
5,.55
8,.54

4.,37
7..27
8..91
14..23

One-Day
Three-Day
Five-Day
Fifteen-Day

2,.10
3,.61
4,.59
7,.39

2,.76
4,.86
6,.33
10,.00

4,.60
8,.23
10,.12
16,.29

One-Day
Three-Day
Five-Day
Fifteen-Day

3,.15
5,.41
6,.77
10..62

4 .44
7 .32
8 .86
13 .05

6 .61
11 .15
12 .86
27 .78

2. 50% of
Institutional
Index Stocks*

3. 80% of
Institutional
Index Stocks*

4. 90% of
Institutional
Index Stocks*

5. 100% of
Institutional
Index Stocks*

* 75 Individual Stocks Composing the Institutional Index

Table 7
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

1/1/86 - 4/22/88
Exposure Tolerance
Price Declines
Price Increases
99%
90%
95%
99%
90%
95%

S&P 500 Futures
One-day
Three-day
Five-day

-1.57
-2.74
-3.74

-2.39 -5.33
-4.08 -7.88
-5.03 -11.08

1.57
2.73
3.36

1.96
3.47
4.45

3.87
7.03
6.51

-1.57
-2.64
-3.50

-2.34 -4.85
-3.88 -7.03
-5.11 -10.40

1.58
2.75
3.65

2.21
3.70
4.59

3.87
5.96
6.62

MMI maxi Futures
One-day
Three-day
Five-day

Table 8
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

1/1/86 - 10/1/87
Exposure Tolerance
Price Declines
Price Increases
99!
90'
95%
90%
95%
99%

S&P 500 Futures
One-day
Three-day
Five-day

-1.19
-2.24
-2.76

-1.92
-2.99
-4.04

-2.98
-5.25
-7.15

1.36
2.50
3.25

1.77
3.17
4.08

2.76
4.12
5.27

-1.16
-2.07
-2.62

-1.85
-2.96
-3.89

-2.81
-4.94
-5.97

1.42
2.56
3.50

1.99
3.28
4.21

2.78
4.35
5.91

MMI maxi Futures
One-day
Three-day
Five-day

Table 9
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

10/1/87 - 4/22/88
Exposure Tolerance
Price Declines
Price Increases
99%
90%
95%
99%
90%
95%

S&P 500 Futures
One-day
Three-day
Five-day

-2.52 -3.95
-4.72 -6.47
-5.34 -9.43

-20.01
-31.17
-33.68

2.06
3.83
4.85

3.54
5.10
5.69

14.22
17.95
13.76

-2.84 -4.53
-4.90 -6.93
-6.12 -9.72

-17.39
-26.19
-29.39

2.29
3.97
4.37

3.81
4.80
6.28

11.32
15.19
14.02

MMI maxi Futures
One-day
Three-day
Five-day

Table 10
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

11/1/87 - 4/22/88
Exposure Tolerance
Price Increases
Price Declines
90%
95%
99%
95%
99%
90%

S&P 500 Futures
One-day
Three-day
Five-day

-2.35 -2.95
-3.77 -5.03
-4.84 -5.22

-7.70
-7.11
-7.92

1.79
3.41
4.77

2.24
4.50
5.47

4.17
10.37
15.43

-2.45 -2.92
-4.10 -5.18
-5.14 -5.93

-7.16
-6.92
-9.18

2.06
3.72
4.49

2.47
4.67
6.32

3.90
9.02
15.41

MMI maxi Futures
One-day
Three-day
Five-day

Table 11
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

6/1/84 - 4/22/88
Exposure Tolerance
Price Declines
Price Increases
99%
90%
95%
90%
95%
99%

S&P 500 Futures
One-day
Three-day
Five-day

-1.07 -1.84
-2.07 -3.06
-2.56 -4.10

-3.41
-6.31
-8.12

1.33
2.42
3.08

1.79
3.08
3.99

3.37
4.97
6.27

-1.13 -1.82
-2.01 -3.03
-2.60 -4.15

-3.93
-6.52
-6.92

1.36
2.48
3.12

1.99
3.35
4.13

3.81
4.91
6.52

MMI maxi Futures
One-day
Three-day
Five-day

Table 12
MAINTENANCE MARGINS REQUIRED TO COVER
POTENTIAL PRICE MOVEMENTS
Period:

6/1/84 - 10/1/87
Exposure Tolerance
Price Declines
Price Increases
99<
90%
95%
90'
95'
99!

S&P 500 Futures
One-day
Three-day
Five-day

-1.00 -1.43
-1.82 -2.37
-2.15 -3.12

-2.58
-4.64
-5.24

1.25
2.30
2.93

1.68
2.90
3.37

2.64
4.16
5.41

-0.94 -1.46
-1.64 -2.41
-2.00 -2.94

-2.57
-3.88
-4.71

1.23
2.33
2.94

1.65
2.92
3.84

2.70
4.15
5.88

MMI maxi Futures
One-day
Three-day
Five-day

Table 13
MEAN RETURN AND VOLATILITY CALCULATIONS
FOR STOCK INDEXES

Period
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
6/1/84-10/2/87
1/2/87-10/2/87
10/2/87-3/31/88
11/2/87-3/31/88

N*
253
253
252
252
253
253
253
253
253
250
252
253
253
63

S&P 500
r
0.281
0.180
-0.126
0.010
0.119
0.235
-0.105
0.141
0.163
0.014
0.241
0.140
0.020
0.192

0.156
0.112
0.092
0.127
0.110
0.166
0.136
0.184
0.140
0.128
0.102
0.153
0.342
0.233

844
191
126
105

0.239
0.413
-0.484
0.068

0.137
0.158
0.472
0.258

Number of business days.

Index
V

NYSE Comp osite Index
r
V
0.284
0.153
0.109
0.200
0.087
-0.100
0.021
0.125
0.148
0.110
0.234
0.164
-0.093
0.133
0.134
0,173
0.165
0.12G
0.119
0.013
0.239
0.095
0.134
0.141
-0.002
0.318
0.242
0.209
0.230
0.381
-0.457
0.099

0.127
0.146
0.439
0.234

Table 14
MAINTENANCE MARGIN REQUIREMENTS NECESSARY TO SET PROBABILITY
OF MARGIN VIOLATION BELOW ONE PERCENT
(r = 0.00)
Period
(days)

Values of V
0.35
0.50

0.10

0.15

0.20

0.25

0.75

1.00

1.10

0.2

0.7

1.1

1.4

1.8

2.5

3.5

5.2

6.9

7.6

0.5

1.1

1.7

2.2

2.8

3.9

5.5

8.1

10.7

11.7

1.6

2.4

3.1

3.9

5.4

7.7

11.3

14.8

16.1

2.2

3.3

4.4

5.5

7.6

10.7

15.6

20.2

22.0

2.7

4.1

5.4

6.7

9.2

12.9

18.7

24.2

26.2

3.5

5.2

6.9

8.5

11.8

16.4

23.5

30.0

32.5

4.9

7.3

9.6

11.9

16.2

22.3

31.5

39.7

42.6

6.9

10.2

13.3

16.4

22.1

30.0

41.5

51.1

54.4

Table 15
MARGIN REQUIREMENTS NECESSARY TO SET PROBABILITY
OF MARGIN VIOLATION BELOW ONE PERCENT
(r = 0.10)
Grace
Period
(days)

0.10

0.15

0.20

0.25

0.2

0.7

1.1

1.4

1.8

2.5

0.5

1.1

1.7

2.2

2.8

1.6

2.3

3.1

2.2

3.3

2.6

Values of
i V
0.35 0.50

0.75

1.00

1.10

3.5

5.2

6.9

7.6

3.9

5.5

8.1

10.7

11.7

3.9

5.4

7.6

11.3

14.7

16.1

4.4

5.4

7.5

10.6

15.5

20.2

22.0

4.0

5.3

6.6

9.1

12.8

18.7

24.1

26.2

3.3

5.1

6.7

8.4

11.6

16.2

23.4

29.9

32.4

4.6

7.0

9.3

11.6

15.9

22.1

31.3

39.5

42.4

6.3

9.6

12.7

15.8

21.6

29.6

41.1

50.7

54.1

Table 16
MARGIN REQUIREMENTS NECESSARY TO SET PROBABILITY
OF MARGIN VIOLATION BELOW FIVE PERCENT
(r = 0.00)
Grace
Period
(days)

0.10

0.15

0.20

0.25

0.2

0.5

0.8

1.1

1.3

1.9

0.5

0.9

1.3

1.7

2.1

1.2

1.8

2.4

1.7

2.5

2.1

Values of v
0.35 0.50

0.75

1.00

1.11

2.7

4.0

5.3

5.8

3.0

4.2

6.2

8.2

9.0

3.0

4.2

5.9

8.7

11.4

12.5

3.4

4.2

5.8

8.2

12.1

15.8

17.2

3.1

4.1

5.1

7.1

10.0

14.6

19.0

20.7

2.7

4.0

5.3

6.6

9.1

12.7

18.4

23.8

25.8

3.8

5.6

7.4

9.2

12.6

17.5

25.0

31.9

34.5

5.3

7.8

10.3

12.7

17.3

23.8

33.5

41.9

45.0

Table 17
MARGIN REQUIREMENTS NECESSARY TO SET PROBABILITY
OF MARGIN VIOLATION BELOW FIVE PERCENT
(r = 0.10)
Grace
Period
(days)

0.10

0.15

0.20

0.25

0.2

0.5

0.8

1.1

1.3

1.9

0.5

0.8

1.3

1.7

2.1

1.2

1.8

2.4

1.6

2.5

2.0

Values of v
0.35 0.50

0.75

1.00

1.10

2.7

4.0

5.3

5.8

2.9

4.2

6.2

8.2

9.0

3.0

4.1

5.9

8.7

11.4

12.5

3.3

4.1

5.8

8.2

12.0

15.7

17.2

3.0

4.0

5.0

7.0

9.9

14.5

18.9

20.6

2.5

3.8

5.1

6.4

8.9

12.6

18.3

23.7

25.7

3.5

5.3

7.1

8.9

12.3

17.2

24.8

31.7

34.3

4.7

7.2

9.7

12.1

16.8

23.3

33.1

41.6

44.7

Figure 1
Relationship between Maintenance Margin
and Grace Period for Probability
of Violation of 0.01
(r=0.00)

Maintenance
margin (%)

v=1.00.

—

—>

grace period
(days)

APPENDIX C
REPORT OF STAFF SUBGROUP ON CREDIT
PAYMENT AND SETTLEMENT SYSTEM ISSUES
I.

INTRODUCTION AND SUMMARY OF KEY ISSUES

The staff subgroup working on credit and payment system
issues has completed interviews with market participantsincluding SROs, banks, and investment firms—in New York and
Chicago. The primary purpose of the visits was to ask
senior management of these institutions about weaknesses in
the current system that may have impeded the smooth flow of
credit and payments in October and to elicit their views on
possible steps to strengthen the system. A complete summary
of these interviews is contained in Section II below.
The views expressed by the market participants did not
imply a need for major reform of the structure of systems
for clearing and settling securities and their derivative
instruments. Given the magnitude of the payments flows and
stresses imposed on the clearing systems in October, most
felt that the market mechanisms had held up quite well.
Nonetheless, there are areas where it was felt that
improvements could be made. In broad terms, these areas
include better coordination of payment timing and linkages
among the exchanges to ease cash flow problems,
clarification of responsibilities of clearing organizations
and their members, the application of the Uniform Commercial
Code to pledges of securities as collateral for loans, and
procedures to ensure adequate information flows on which to
base decisions.
Improvements have been made in some of these areas
already, and ongoing discussions among the exchanges,
regulators, and financial institutions are seeking solutions
to others. The following summarizes issues viewed as
TO IMPROVE THE COORDINATION AND TIMING OF CASH FLOWS AMONG
important in the payment and settlement process and notes
EXCHANGES:
those issues viewed as less important.
1. Timing of variation margin pays and collects should
be coordinated to ease liquidity problems. Steps
already have been taken by the exchanges: intraday

-2margin pays and collects now are done concurrently
on the Chicago Mercantile Exchange (CME), and the
CME and Board of Trade Clearing Corporation (BOTCC)
have coordinated the timing of daily and intraday
settlements. There may be other steps that can be
taken, but the private sector appears to be
addressing this issue.
Efforts to reduce the volume of cash flow by
netting payment obligations arising from securities
and futures positions across different markets with
different settlement procedures and time frames is
attractive in concept. Nevertheless, there are
difficult practical problems involved in
implementing such arrangements. Netting, in
effect, would link clearinghouses in risk sharing
pools. Of particular concern are legal and
economic questions of who bears what risk in the
event of a default of one or more parties.
Formal netting arrangements may be viewed as
steps toward longer-run unification of the clearing
process under a single clearing structure. Market
participants generally were skeptical of the
utility and feasibility of creating a single
clearing structure in the near future.
Cross-margining of futures and options positions
would lower initial margin requirements for a given
position and consequently would reduce cash or
securities behind a given volume of gross
positions. The implications of cross-margining for
risk exposures is uncertain.
The availability of Fedwire during periods of
crisis, which may fall outside normal operating
hours, is very important. But Fedwire is useful
only to the extent that knowledgeable lending
officers at banks are available to make credit
decisions when funds transfers are needed.
Procedures should be established in advance for
early opening of Fedwire, if needed, in unusual
situations. Such procedures should provide for
good communication among the clearing organizations
and their members as well as the settlement banks
and the Federal Reserve Banks, with informed
personnel at banks available to make credit
decisions.

-3TO REMOVE UNCERTAINTY CONCERNING LENDER RESPONSIBILITIES IN
CREDIT ARRANGEMENTS:
5. "Finality" of the settlement process prior to the
opening of trading is important to market
participants. Contractual arrangements between
settlement banks and clearing organizations should
clarify the responsibilities of each party when
clearing member funds are insufficient and
determine when payments to the clearing
organization are final and irrevocable.
To this
end, discussions between banks and clearing
organizations are underway.
6. Futures commission merchants'(FCMs)
responsibilities to their customers in the event of
non-payment by a clearing organization should be
clarified.
7. Legal means of establishing a "perfected security
interest" in an option instrument should be
investigated. Existing ambiguities in the Uniform
Commercial Code and bankruptcy laws concerning the
status of options as collateral inhibit the
willingness of some banks to finance options
positions. More broadly, efforts to strengthen the
legal rights of banks lending against options under
federal bankruptcy laws and differing versions of
the Uniform Commercial Code would ease lending and
collateral processes.
8. The desirability of developing collateral
arrangements other than those currently provided by
"agreements-to-pledge" (APs) should be
investigated to see if greater security can be
achieved at reasonable costs. Most market
participants, however, suggested that flexibility,
competitive pressures, and cost considerations
necessitated reliance on APs and expressed concern
that requiring delivery of collateral could be
destabilizing during times of stress.
9. On the issue of "committed" versus "uncommitted"
lines of credit, there appears to be little
advantage to recommending greater reliance on
"committed" lines. "Material adverse change"
clauses may permit creditors to escape such
commitments during periods of stress. The cost of
a paid line that assured access to credit during
crisis periods likely would be prohibitive for
borrowers that need it the most.

-4TO IMPROVE INFORMATION FLOWS AMONG FINANCIAL MARKET
PARTICIPANTS:
10. Sharing of information on variation margin pays and
collects is important to the exchanges, and systems
are in progress to provide this service.
11. Commercial banks do not feel a need to have
information on margin pays and collects for their
lending decisions. The major banks also do not see
a need for margin surplus and deficit data or
aggregate position data from the exchanges on a
routine basis. Typically, they can get this
information quickly from their customers, as
needed. Formal arrangements for sharing
information with market participants raised
concerns about confidentiality problems among those
interviewed.
II. SUMMARY OF INTERVIEWS WITH MARKET PARTICIPANTS
On April 11 and 12 staff from the four agencies
conducted interviews with senior management at a number of
major commercial banks, investment banks, and clearing
organizations for equity-related products. The purpose of
these interviews was to solicit views of senior market
participants at these institutions about what actions, if
any, should be taken to strengthen market mechanisms and to
ensure the adequacy of information necessary to support
credit decisions for financing market positions and funding
settlement obligations. To provide a framework for these
discussions, a list of questions was sent to the
participating institutions prior to the interviews focusing
on three broad areas: information to support credit
decisions; clearing and settlement system characteristics;
and credit facility characteristics.
The questions on "Information to Support Credit
Decisions" were intended to evaluate the adequacy of current
information flows to creditors; the ability of financial
institutions to monitor on a current basis their aggregate
credit exposures to customers in different markets as well
as their own positions; and the need for greater sharing of
position data and other information collected by the futures
and options exchanges. "Clearing and Settlement System
Characteristics" questions dealt specifically with the
operation of margining and clearing arrangements and steps
that might be taken to ease or speed the flow of cash across
exchanges and among institutions and to remove potential
ambiguities in credit transactions among clearinghouses,
clearing members, and banks concerning who must pay and
when. And finally, a number of questions on "Credit

-5Facility Characteristics" addressed concerns about specific
lending arrangements, including collateral control
procedures, financing of options, lines of credit, and the
overall effect of the stock market crash on terms of
lending. The results of these interviews are summarized
below.
Information to Support Credit Decisions
The New York bankers interviewed stated that they are
selective in their customer base. Their securities
customers comprise a limited number of large, wellestablished institutions, as well as some major regional
firms and specialists. The Chicago banks generally had a
somewhat broader customer base. All the banks, however,
asserted that maintaining close knowledge of, and
relationships with, their customers is the keystone for
their lending and credit policies. In this regard, all the
bankers interviewed believe that they have ample information
to support their credit decisions, that is, they "know their
customers." They obtain this knowledge through the process
of screening prospective clients, monitoring financial
reports, reviewing capital and management structure,
routinely reviewing data on items such as online deposit
records, credit records, and balance sheets from their
customers. When additional or more current information is
needed, they call the customer directly. In a crisis, the
ability to contact key personnel in the borrowing
institution is deemed vital.
Because of customer-bank relationships, the lending
institutions do not attach much value to additional
information, such as daily variation margin pays and
collects data, that might be supplied by futures exchanges.
Pay and collect data already are available to the Chicago
settlement banks but are not viewed as terribly useful in
credit decisions involving large customers. No banks
routinely get margin surplus and deficit data or aggregate
position data from the exchanges, but they may seek it
selectively from customers. While, in some circumstances,
the ability to confirm positions through access to a third
party source might be useful, it was not deemed necessary.
Although the banks feel that they have adequate
information on their customers to make credit decisions,
this information did not include full knowledge of
individual customers' aggregate exposures across markets.
Most of the banks either have, or are seeking to install,
procedures for monitoring the bank's aggregate exposure to
any one customer, but such systems typically do not track
intra-day
Intra-day
risk
the
ability
toexposures.
track positions
during
themonitoring
day, whichrequires
is now done

-6in only a few markets. Integration of global credit
exposures also is done on a less regular basis; several
banks noted that information on international position
exposures could be obtained through foreign office contacts
with a delay of a few hours or a day. The banks are
becoming more vigilant in this direction; New York banks, in
particular, emphasized concerns about increasing global
involvements and efforts to monitor such exposures. For
some, global exposures and exposures in non-regulated
markets outweigh concerns about domestic futures, options,
and securities activity.
The investment banking firms that were interviewed also
confirmed the importance of customer relationships in
determining credit decisions. These firms may attach
somewhat more importance than banks to margin pays and
collects and other information that might be provided by the
exchanges. Nonetheless, they indicated it would be
difficult to implement formal cross-market sharing systems
that provide information on a timely basis. Banks,
securities firms, and clearinghouses expressed concerns
about confidentiality of a formal arrangement; they think
that, for competitive reasons, customers and financial
institutions might not like to have information shared. A
concern was also expressed that current intraday information
might be interpreted inappropriately if recipients lacked
the expertise
and historical
background
for analysis. Some
Clearing
and Settlement
System
Characteristics
indicated they would have difficulty handling large volumes
The
heavydata.
volume of transactions in October highlighted
of daily
problems that occur when flows of cash through the system
are imperfectly coordinated. Institutions were asked about
possible steps to alleviate discrepancies in timing or to
reduce the need for funds transfers. Specifically, views
were solicited on the substitutability of capital for
margins, the timing of variation margin pays and collects,
benefits and costs of cross-margining proposals, and systems
of netting cash flows. Respondents also commented on the
clarity and possible ambiguities in contractual
relationships between clearing organizations and clearing
banks and between clearing firms and their customers. The
importance to creditors and other market participants of
knowing that daily margin settlements of the clearing houses
are final before the markets open and the adequacy of
Fedwire operations for this purpose were discussed.
Substitutability of Capital and Margins. Capital is
not viewed by market participants as a substitute for margin
deposits or collateral. Both capital ana margin play an

-7important role. Banks and investment houses emphasized that
while capital is the ultimate buffer against losses and a
major factor affecting credit decisions, it is used to
support a variety of activities. Margin deposits or
collateral, on the other hand, apply to specific
transactions and are a first line of defense against
counterparty risk. Margin is not subject to competing
claims, and is typically more liquid than capital.
Some of the New York institutions expressed the view
that margin on futures and options should be higher. Some
said that they set customer futures margins consistently
higher than the minimum set by the exchanges; nonetheless,
they did not see a need for federal regulation of futures
margins.
Timing of Variation Margin Pays and Collects. All the
organizations agree that coordinated timing of daily and
intra-day margin collections would be helpful. Release of
margin collects as well as demands for pays intra-day also
is favored. Several changes introduced by the exchanges
since October move in these directions. Currently, the CME
clearinghouse and the BOTCC make regular daily and intra-day
settlements that are coordinated in time. The CME has
altered its intra-day practices so that gains are paid out
at the time losses are collected. BOTCC already had such a
policy. At least one investment bank believed that intraday distributions by the clearinghouses should be based on
the most up-to-date information available to avoid affecting
the security of the clearing system. The Options Clearing
Corporation's (OCC) daily settlements do not occur until
9:00 a.m., two hours after those of the CME and BOTCC. This
discrepancy, however, was not viewed as a significant
problem by banks.
Cross-margining and netting proposals. There was less
uniformity in views on the benefits and costs of crossmargining, and methods of implementing such proposals. The
prospect of lower original margin requirements for a
combined futures/options position through cross-margining is
viewed as a potential benefit by some clearing organizations
and banks. Chicago institutions noted that, in the
aggregate, positions might increase in response to reduced
margin costs. Possible increases in clearing risk are a
concern in cross-margin arrangements.
Some advocate cross-margining as a method of increasing
the ability of lenders to finance margin payments; the OCC,
for example, suggests that the current cross-margining
proposals, which apply to posting of original margins, would
create a position that banks can use as collateral. Others
noted, however, that cross-margined positions stand as
security to the clearing organization. The positions would

-8be double-pledged if banks relied on them as security for
lending.
The futures clearinghouses that were interviewed
believe that proposals for cross-margining do not address
the problem of funding options positions and the issue of
the differential cash flows generated by basic differences
in margining systems of futures and options. Crossmargining, as currently described, would reduce only
original margin requirements. Even in a unified
options/futures clearinghouse, there would be a need for
daily margin flows where a trader had a long option coupled
with a short futures position, for example. The futures
clearinghouses would like to see options markets shift to a
margining system similar to that for futures in terms of
providing daily cash flow to cover changes in market values.
The OCC feels option market participants would oppose such a
change. Investment banks also noted that cross-margining
does not relieve the cash flow differences between
derivative and cash stock positions.
None of the respondents provided concrete suggestions
for implementing other netting arrangements to reduce cash
flows. While the concept of netting is appealing, it
requires coping not only with differences in settlement time
frames and different procedures applicable in futures,
options, and securities markets, but also with a host of
legal questions associated with bankruptcy treatment of
netting agreements.
On the issue of unified clearing in general, most of
the organizations questioned the utility and feasibility of
establishing a single clearing organization. Existing
clearing organizations embody considerable expertise geared
to the specific needs of the various stock, futures, and
options markets. In addition, a single clearing
organization would lead to a concentration of risk which
currently is diversified across multiple clearinghouses.
Some offered the opinion that many of the benefits of
unified clearing could be obtained by operating within the
existing structures to improve information sharing and to
coordinate funds flows and other operating procedures.
Clarifying Ambiguities in Contractual and Lending
Relationships. The clearinghouses are working on legal
documents that more clearly delineate their responsibilities
and those of the settlement banks. For example, the OCC
already has an arrangement that, unless the bank notifies
the clearinghouse otherwise, the bank is committed to
providing funds to cover margin settlements. Bankers view
this as a question that can be resolved by agreement between
the banks and the clearing organizations.

-9Two investment banks identified as an important issue
the ambiguity surrounding a futures clearing member's
obligations to its customers for the payment of margin funds
in the absence of the receipt of funds from the
clearinghouse. One firm questions whether it is responsible
for the clearinghouse to its customers and is reviewing its
contracts with its customers as it relates to this point.
Finality of Margin Settlements Prior to Market Opening.
There was strong agreement among most of those interviewed
that "finality" of the settlement process before the opening
of trading was critical to the integrity of the system.
(The OCC, which settles after the opening of trading, did
not feel pre-opening to be critical, but did want "finality"
early in the day.) Otherwise, clearinghouses could face
potentially large financial exposures.
Market participants in Chicago stressed the importance
of access to Fedwire in this process, with several
advocating earlier opening of the wire. Clearinghouses tend
to favor routine earlier opening, while banks viewed
occasional (as needed) early openings acceptable, perhaps
contingent upon exceeding pre-determined price or volume
parameters. The Chicago institutions suggested a need to
better educate the New York bankers about the futures
clearing process and the importance of having knowledgeable
persons available to make credit decisions early in the day.
Several pointed to the inaccessibility of New York bankers
on October 20 prior to the opening of the futures markets.
New York banks had little to say about the question of
"finality," while the investment banks viewed "finality" as
very important. The issue of altering Fedwire hours
Credit
Facility
Characteristics
generally
was not
viewed as critical by New York
respondents.
The commercial banks reported that their own credit
policies and terms of lending have not changed significantly
as a result of the stock market turbulence, and the
investment banks confirmed that their borrowing arrangements
with large banks were largely unaffected. But several
institutions remarked that foreign banks and small regional
banks have cut back lending to securities firms since
October. Some of the interviewed banks discussed changes in
their internal procedures for assessing credit exposures,
including more formal global communications structures and
developing comprehensive measures of risk exposure to
individual customers.

213-632 0 - 8 8

-10None of the respondents saw any benefit of increasing
reliance on "committed" versus "uncommitted" lines of
credit. Committed lines generally have "material adverse
change" clauses which may permit the creditor to escape its
commitment during periods of stress. The availability of
credit will ultimately depend on the lender/customer
relationship.
Two credit areas where some of the banks expressed
dissatisfaction with current systems are collateral pledging
arrangements and financing of options positions. Each of
these is discussed briefly below.
Collateral Control Procedures. Collateral for secured
loans may be held in a number of ways. It may be delivered
to the bank lender or a third party custodian. It may be
held at the Depository Trust Company (DTC) on a book entry
basis and transferred from one member's account to another
upon instruction. Or, it can be maintained in a segregated
account at the borrower's office under an agreement-topledge arrangement (AP). With AP arrangements, creditors
usually conduct periodic audits of the securities firms'
procedures to ensure the adequacy and safety of the pledged
collateral.
Agreement-to-pledge arrangements are quite common.
From the borrower's perspective, AP is preferable because it
costs less than pledging collateral through DTC. Also, when
stocks or securities are put into a pledge account at DTC,
they cannot be released without the permission of the
lender. A firm that finances equity holdings (its own
inventories or customer debits) through DTC pledging worries
that the lender will not release the stocks in time for the
securities firm to get them to the next party.
Most banks indicated that competitive pressures and
cost considerations necessitated reliance on APs and
recognized that a change to require delivery of collateral
would be destabilizing during a crisis. If one bank
suddenly demands delivery of collateral, others would do the
same and the result would be a "disaster." Some of those
interviewed suggested that the Depository Trust Company may
not have the capacity currently to handle all collateral
should lenders require it.
While banks recognized the needs served by AP
arrangements, several indicated dissatisfaction with these
arrangements. Auditing the status of collateral is
difficult and, thus far, no court has ruled on the validity
of the creditor's lien on collateral under APs. Several
banks indicated that if they have a concern about the
counter-party, they will not use this system. One bank

-11reported that, because of these legal ambiguities, it has
over time reduced the volume of its AP lending.
One investment banking firm identified problems
surrounding the original margin deposits of registered
investment companies as an important issue. Currently, such
an investment company is required to post original margin in
a bank or other third party custodial account, and the FCM
must provide funds from its own account to meet the
customer's margin obligations with the clearinghouse. These
third party custodial requirements reportedly create
liquidity problems in volatile situations, and it is not
clear how such accounts would be treated should the FCM go
bankrupt. This investment banking firm suggested review of
SEC regulations prohibiting investment companies engaged in
futures trading from depositing original margin with their
FCMs.
Financing Options Positions. Bankers, other than two
Chicago banks, are reluctant to extend credit for options
positions because of the volatility of these instruments and
ambiguities in the Uniform Commercial Code and bankruptcy
laws about their status as collateral. Most of the banks
stated they generally do not finance options positions for
these reasons and one bank indicated, in addition, that it
did not have the expertise to dispose of the collateral in
the event of defaults. The question of obtaining additional
financing for options was not seen as a regulatory issue,
but as a legal question of how to establish a "perfected
security interest" in an option instrument.

APPENDIX D
CLEARING AND SETTLEMENT RECOMMENDATION
I.

Clarification of Clearing and Settlement Obligations

The Working Group believes that the reduction of uncertainty
concerning the obligations of participants in the clearing and
settlement process and concerning the ability of such
participants to discharge their obligations is an important
improvement that can be made to address the impact of the stock
market decline of October 1987 upon clearing and settlement
mechanisms. Both the Securities and Exchange Commission (SEC)
and Commodity Futures Trading Commission (CFTC) reports on the
October 1987 market events identify instances in which margins
owed or payable on options and futures positions were not paid
within normal time frames. These delays have led some market
participants to question previous assumptions concerning the
obligations of various parties in the settlement chain. While
the issues they raise are, in many instances, at odds with
settled law and practice, the Working Group believes that efforts
should be made to establish a clear, uniformly held understanding
of the obligations of each party in the settlement process. The
Working Group therefore recommends that steps be taken to confirm
existing law and to dispel ambiguities in the following areas:
A. Clearing banks1 obligations to honor their
confirmations of variation payments. The SEC and CFTC
have recommended that contracts between clearing
organizations and their clearing banks be clarified to
assure certainty that bank confirmations of payments to
the clearing organization are irrevocable. A further
point that may require clarification is the extent to
which clearing banks that confirm variation margin
payments for defaulting customers may claim rights to
original margin deposits held by the clearing
organization on behalf of such customers. The Board of
Trade Clearing Corporation, Chicago Mercantile
Exchange Clearing House and the Options Clearing
Corporation are currently reviewing draft agreements
designed to afford greater clarity as to the
relationships between clearing banks and clearing
organizations.
Action items:
The CFTC and SEC should monitor the options and
futures self-regulatory organizations' (SROs)
progress toward finalizing revised settlement
agreements with their clearing banks.

- 2 The Working Group supports conclusion of
agreements which specify that payment obligations
are final once confirmed.
B. Clearing organization guarantees and timely payment.
Generally, clearing organizations are required to make
variation margin payments without regard to whether
they have "received" variation payments from clearing
firms. It is important to confirm that clearing
organizations guarantee payment of profits and losses
accrued as of each day's settlement. Such payments
should ordinarily be backed by final confirmations
received by futures clearing organizations prior to the
opening of trading or, in the case of the Options
Clearing Corporation, prior to 9:00 a.m. Central Time.
In any event, such payments are guaranteed by the
clearing organization and therefore do not depend upon
the clearing organization's receipt of funds from the
clearing firms from which such funds are owed.
Further, clearing organizations should release such
payments promptly in accordance with their rules and
by-laws.
Action items:
The SEC and CFTC should confirm that futures and
options clearing organization guarantees assure
payments owed collecting firms in accordance with
their rules and that such payments should be
released timely in accordance with such rules and
by-laws.
Clearing organizations should review their by-laws
and rules in this regard and consider whether
further specificity concerning payment guarantees
and timing of those payments would be desirable.
II. Facilitate Timely Payments
The SEC and CFTC Reports on the October Market Break
describe the crucial role of payment systems in securities and
futures markets. Those markets depend on payment systems to move
funds and provide financing to meet clearing member and clearing
organization payment obligations within established time-frames.
Experience during the market break indicates that enhancements to
existing payment systems to assure coordinated intermarket
payments should be pursued.

- 3 The Working Group believes that assurance of the full and
timely satisfaction of clearing and settlement obligations can be
fostered by increasing the coordination of settlement processes,
the information available to market participants concerning their
payment obligations and other payment-related data, the
accessibility of wire transfer systems, and the financial
resources available to clearing organizations to fulfill their
guarantee obligations in the event of a clearing firm default.
The Working Group therefore recommends that actions be taken in
the following areas to increase the ability of market
participants to fulfill their payment obligations on a timely
basis.
A. Review of arrangements to support: payments by clearing
members to settlement banks. Clarifying the obligation
of settlement banks to honor commitments to clearing
organizations is just one step in the process and must
be supported by a review of the arrangements in place
to support the making of such commitments. During
times of stress, settlement banks may be called upon
early in the morning to "confirm" to clearing
organizations large payments by clearing members. In
the absence of good funds from those firms on hand at
the bank, the settlement bank may determine that the
payment called for exceeds its prudential limit for
unsecured transfers and therefore refuse to "confirm"
the payment before the market opens. In this event,
consequences which could ensue include unwarranted
liquidation of a firm's positions or continued trading
by a firm which may later be found to be insolvent.
Mechanisms should be established that allow clearing
firms to be assured that their payments to clearing
organizations will be "confirmed" and that provide
comfort for banks to make the desired confirmations.
Action item:
Federal regulators should review current
facilities and consider what further prudential
measures are necessary, including requiring that
the relevant market participants have secure
facilities in place that will support large
payments to clearing organizations.
B. Increase the liquidity and security of clearing
organizations.
1. Review the adequacy of clearing organization
guarantee funds, and where appropriate, increase
member contribution requirements. Futures and
securities clearing organizations collect from and

- 4 pay to clearing members significant dollar amounts
each day (routinely ranging from $50 million to
$500 million in the aggregate and, on particularly
volatile days, exceeding $1 billion). Futures and
securities clearing organizations, generally, are
obligated to make those payments regardless of
member defaults. An important back-up source of
funds (in addition to individual member margin
deposits) in the event of default is the clearing
organization's guarantee fund (also known as
clearing or participants' fund), to which clearing
members are required to contribute.
Action item:
Clearing organizations should review the adequacy
of clearing member guarantee fund contributions,
in light of other financial protections and system
safeguards. Federal regulators should assess the
results of these reviews.
2. Enhance the liquidity of guarantee funds. Futures
and securities clearing organizations currently
maintain high proportions of their guarantee funds
in letters of credit and other non-cash interests.
Because of the potential urgency of demands for
cash flows generated in volatile markets, the
immediate availability of sufficient clearing
funds in cash and cash-equivalents in conjunction
with credit lines to redress the expected
counterparty risk assumed by the clearing
organization under the traditional clearing
organization guarantee is desirable.
Action item:
The SEC and the CFTC should encourage securities
and futures SROs to explore the desirability of
converting portions of existing securities and
futures clearing organizations' guarantee funds to
cash or cash equivalents on an incremental basis.
C. Increase the availability of payment-related
information. The Working Group believes that in
addition to assuring that market participants have a
clear understanding of their payment obligations,
measures should be taken to assure that market
participants have access on a timely basis to
information concerning the specific size and nature of
those obligations so that they can make appropriate
arrangements to fulfill them. Critical to reducing

- 5 risks and increasing confidence in the stock futures
and options markets are efforts to monitor clearing
firm risk more effectively on a coordinated basis.
During the market break, clearing corporations
effectively communicated on an ad hoc basis regarding
firms suspected of being in financial difficulty.
Nevertheless, the Working Group strongly supports the
development of regularized systems which allow all
clearing corporations to identify the system-wide
payment obligations and position exposures of all
clearing firms. The Working Group recommends that
information systems be enhanced in three key respects
to increase the timeliness and availability of margin
and position data.
1. Maximize cross-market input into the existing
futures pay, collect, and margin surplus data
system. The Board of Trade Clearing Corporation
(BOTCC) has in place a system for the routine,
electronic exchange of pay and collect data which
will include all futures clearing organizations
and, when formatting issues are resolved, will
also include Options Clearing Corporation (OCC)
data pursuant to agreements already in place.
The addition of National Securities Clearing
Corporation (NSCC) data also is under discussion.
Inclusion of margin surplus and deficit data in
the pay and collect system is being explored as
well. Appropriate securities data should be
integrated into this system to maximize its
usefulness as a tool for monitoring inter-market
exposures.
Action items:
Procedures should be implemented fully for
centralized collection and availability of pay and
collect information.
Subject to appropriate control, cost,
confidentiality and oversight procedures, NSCC and
OCC
should
besystem
encouraged
toconsider,
provide data
to the
Users
of the
should
collectively,
BOTCC
pay
and collect
system.
BOTCC
be
how
the
system
should be
operated
andshould
paid for.
encouraged to develop appropriate software to
accommodate such data.

- 6 2.

Enhance trade matching capacity to supply
increased data concerning intra-dav exposures and
foster development of on-line trade matching
systems. The Working Group believes that the
capacity of market participants to satisfy the
large cash demands generated in volatile markets
such as occurred in October 1987 may be materially
affected by their ability to monitor their
exposures on a daily and intra-day basis and
consequently to ascertain their payment
obligations on a timely basis. In addition, such
data should enhance the security of clearing
organizations by permitting them to respond to
intra-day position changes that increase financial
risk and could assist lenders in making earlier
credit assessments, potentially reducing the
credit judgments required to be made at the time
of daily margin settlements. Futures contract
markets and options exchanges currently complete
initial trade comparisons on a same-day basis.
Securities and over-the-counter ("OTC") trades
are compared on a same-day and a next-day basis.
The BOTCC currently has intra-day trade matching
systems that match trades at 11:30 a.m. and 1:30
p.m. Central Time, as well as at the close of
trading each day; the Chicago Mercantile Exchange
(CME) also has developed intra-day trade matching
capacity. The SEC has recommended that the New
York Stock Exchange, American Stock Exchange, and
the National Association of Securities Dealers
accelerate the development of systems to compare
all trades on the trade date. That process has
already begun.
Action items:
Near Term: The SEC, should continue to encourage
affected national securities exchanges and the
National Association of Securities Dealers, to
establish systems and procedures necessary for
same-day trade comparison of inter-dealer
corporate equity transactions.
Far Term: The SEC and CFTC should foster progress
toward on-line trade matching systems at
securities, futures and option exchanges.
3. Increase availability of securities position data.
The CFTC currently receives on a daily basis for
each futures market data detailing the aggregate
positions of each clearing firm and the positions

- 7 of individual traders that exceed specified
reporting levels (large traders). Similarly, the
securities SROs have access to data for
broker-dealer proprietary positions. In
addition, the SEC has recommended to Congress
establishment of a comparable large-trader
reporting system for the securities markets to
identify customers engaging in large securities
transactions. OCC position data, for which
reporting systems are currently being developed,
could be used in the initial phase of such a
system. Such data and other available securities
data on cash market positions eventually could be
incorporated in the position data base currently
under development by the CFTC to produce aggregate
position data for clearing firms and large
traders in securities as well as futures markets.
Such data would be useful in analyzing the
combined risk positions of firms across markets on
an "as needed" basis in periods when augmented
surveillance is desirable. Consideration must be
given to the specific data to be collected;
controls surrounding that data to address, among
other things, confidentiality concerns
(particularly with respect to foreign investors);
and allocation of costs associated with collecting
and maintaining position data.
Action items:
Near Term: Immediate development of a trial
reporting system of large-trader data for OCC
positions, perhaps through incorporation in the
existing CFTC database with direct SEC access;
Far term: Consider legislative changes to the
securities laws necessary to obtain large-trader
data.
D. Arrangements to support payments
1. Increase coordination of margin calls and
settlements. The Working Group believes that the
effectiveness of clearing and settlement systems
is enhanced by the use of settlement procedures
that occur at consistent times and that use daily
intra-day margin calls to reduce the volume of
funds required to be transferred at settlement.
Since October 1987, Chicago futures clearing
organizations and OCC have increased their use of
intra-day margins calls. Currently, BOTCC and CME

- 8 daily and intra-day settlements occur on the same
schedule. Daily morning settlements occur at 7:00
a.m. Central Time and intra-day calls are made on
a routine basis by both clearing organizations at
2:00 p.m. Central Time. OCC's daily settlement,
however, occurs at 10:00 a.m. Central Time. The
CFTC's Financial Follow-up Report recommended
increased use of routine intra-day margin calls to
reduce the burdens of effecting large daily margin
settlements in volatile markets. Particularly in
volatile markets, predictable intra-day margin
flows, coordinated across markets, and consequent
reduction in the size of daily settlements, would
be facilitated by the use of an intra-day call on
a consistent basis in options and futures markets.
The SEC Division of Market Regulation's Report on
the October market break urged OCC to review its
pay/collect system, including the adequacy of its
variation margin collection system. The Working
Group recommends that the timing of settlements on
the BOTCC, CME and OCC be harmonized to facilitate
orderly cash flows and credit decisions.
Action items:
The SEC and CFTC should encourage OCC and
commodity clearing organizations to complete their
system reviews with a view to harmonized
settlement time frames.
In particular, OCC should ensure that its revised
procedures for intra-day margin calls to the
extent used are coordinated with intra-day margin
calls of futures clearing organizations.
2. Increase Fedwire availability, at least in
extremely volatile markets, and coordinate
operations during banking or market center
holidays. The Fedwire currently opens at 7:30
a.m. Central Time, a half hour after daily
settlement confirmations are due on the BOTCC and
CME. Although clearing banks generally confirm
margin payments without reliance upon Fedwire
funds transfers prior to the market's opening, a
number of market participants have expressed the
view that earlier availability of Fedwire
transfers could help assure the availability of
funds in circumstances in which credit extensions

- 9 of unusual magnitude are required and could reduce
daily settlement pressures. In addition, bank
holiday schedules vary among market centers and
may not coincide with trading market holiday
schedules.
Action items:
The Federal Reserve Board should explore earlier
opening of the Fedwire as needed during volatile
markets. Earlier opening of the Fedwire would be
useful only to the extent that knowledgeable
officers at banks are available to make credit
decisions and approve funds transfers. Futures
and securities SROs should establish arrangements
with member firms to ensure that early opening
procedures for Fedwire can be effectively used.
SROs, regulators and market participants should
review and augment existing mechanisms to assure
smooth market operations when banks in one market
center are closed but are open in other market
centers and when markets are open but banks are
not.
3. Establish framework for periodic meetings of
clearing organizations, clearing banks, federal
regulators and SROs. A round-table discussion
forum, which includes representatives of the
BOTCC, CME, OCC, NSCC and the Depository Trust
Company, clearing banks, securities SROs and
federal regulators, has been established to
address means of enhancing coordination of
settlement processes. The monitoring
coordination group, which is composed of all
securities clearing organizations, also met
recently in Washington concerning measures to
enhance clearing agency oversight of members and
coordination with marketplace SROs. Periodic
meetings, including additional securities SRO
participants, to discuss coordination of and
assure appropriate contingency planning with
respect to settlement processes, should be
encouraged.
Action item:
The Working Group should encourage establishment
of a regular schedule of meetings among
participants in futures and securities clearing
and settlement processes and federal regulators.

- 10 III. Explore Methods to Reduce Cash Flows and Simplify Settlement
Systems
The Working Group believes that the above measures to
increase the certainty and reliability of clearing and settlement
payment systems should be taken on a priority basis. These
measures are designed to ensure that existing systems operate
effectively even in volatile markets. The Working Group has also
reviewed proposed measures to reduce the size of cash transfers
required to be made in volatile markets and to further coordinate
clearing and settlement systems. The Working Group believes that
efforts to explore measures that could reduce the size of net
cash flow obligations should be a priority. Although an
important goal, the Working Group is cognizant of the many
difficulties in increasing coordinated clearing of related stock,
futures and options products. These difficulties range from
differences in margining procedures and settlement time-frames to
inconsistent treatment of securities and futures for bankruptcy
purposes. Consequently, the Working Group recommends that
measures which address possible structural modifications in
existing systems and that could potentially reduce the cash
flows through settlement systems and simplify clearing and
settlement processes be explored to provide a basis for
determining whether more profound systems changes are
appropriate. The Working Group recommends that the following
actions be taken to address the potential costs and benefits of
structural modifications of existing clearing and settlement
systems:
A. Explore the utility of cross-margining, through a pilot
program limited to non-customer funds. Current
cross-margining proposals are designed to reduce
initial margin requirements but do not reduce the
necessity for variation margin transfers. However, as
discussed below, modification of option margin systems
to resemble futures-style margin systems could permit
cross-margining systems to further reduce cash flows.
Alternatively, mechanisms for facilitating lending
against the excess value of long options positions
could also generate cash for such purposes. A trial
cross-margining program is appropriate to permit
evaluation of the capacity of cross-margining systems
to simplify payment structures and reduce cash flows in
a controlled environment.
Action items:
Near Term: CFTC and SEC should expedite
consideration of current rule proposals before
them which would establish a pilot program for
cross-margining of house positions cleared by the

- 11 Intermarket Clearing Corporation for the
Philadelphia Board of Trade, and the New York
Futures Exchange.
Other clearing organizations should be encouraged
to consider, and the SEC and CFTC should
facilitate, cross-margining proprietary position
pilot programs for products such as stock index
options and futures.
The CFTC should evaluate whether there are
mechanisms to permit floor traders and market
makers to participate in cross-margining pilot
programs consistent with its segregation rules
and, if not, the desirability of changing those
rules.
Far Term: The SEC and CFTC should work with the
Securities Investor Protection Corporation (SIPC)
and other federal agencies, as necessary, to
resolve relevant legal issues, and to determine
what legislative changes are necessary and
desirable to facilitate a broader cross-margining
program.
B. Explore use of futures-style margin settlements for
options. A number of market participants interviewed
by the Working Group staff stated that cross-margining
systems would have limited utility in reducing cash
flows because futures gains and losses are paid on a
daily basis but securities and option gains and losses
are not. For example, although the changes in clearing
margins need not necessarily be passed on to
customers, buyers of options could be permitted to
margin the premium. If futures-style margining were
adopted, all option positions would be marked to the
market, and gains and losses on those positions would
be transferred at least on a daily basis. Any options
margin system which transfers cash daily would
significantly change current contractual obligations
and may pose new risks. Currently, the purchaser of an
option who does not use the value of the option for
collateral does not pose any financial risks to
clearing organizations or clearing members because the
entire premium due with respect to that position is
paid in full the morning after acquiring the option.
Until the option holder exercises the option (to buy or
sell), the holder has no obligation with respect to

- 12 that position. Although a futures style system would
change this and also would alter the pricing of
options, such a system could make cash flows between
options and futures symmetrical and thus could have
benefits.
Action item:
The practical impediments to and risk implications
of modifications of option margin systems should
be studied in light of potential liquidity gains
that might be achieved. This study should focus
on the desirability of experimenting with
futures-style margining of options as part of the
development of pilot programs for coordinated
clearing of professional positions in stock index
options and futures products.
Explore means of netting cash flows on a contractual
basis. To a limited extent, netting occurs on the
basis of clearing firms' use of a single bank as the
settlement bank for more than one market in which such
firm maintains offsetting positions.
Netting of settlements among clearing organizations may
raise questions in the event of member defaults. Among
other things, clearing organizations, clearing members
and their bankers would need certainty concerning
security interests to protect against financial losses
due to member defaults and other questions with
respect to the various rights of the parties to the
netting arrangements. Nevertheless, the risks and
benefits of netting cash flows on a contractual basis
should be studied.
Action item:
The Working Group should encourage the SROs, in
conjunction with clearing banks, to explore
approaches to netting of payment obligations.
Shortening the five-day settlement time frame for
routine transactions in corporate eguitv securities.
Transactions in equity securities generally entail
three distinct contracts: two contracts between
broker-dealers and their customers — the buyer, the
seller and their broker-dealers — and another
contract between the buying and selling broker-dealers.
Settlement between institutional customers and their
broker-dealers generally occurs at securities
depositories; settlement of contracts between

- 13 broker-dealers generally occurs through netting at
clearing corporations (excess delivery or receipt
obligations are settled through book-entry movements at
securities depositories with payments at the clearing
corporation).
Currently, transactions in corporate securities settle
five business days after the trades are executed. This
time-frame allows completion of tasks associated with
settling those trades: inter-dealer trade comparison
and, through stock clearing corporations, inter-dealer
netting of delivery and payment obligations; dealer
confirmation of trade terms to investors (particularly
money managers acting on behalf of institutional
investors); money manager acknowledgement of the trade
and issuance of instructions to the institution's
custodian bank concerning the delivery of securities
and payment of funds; and settlement of the transaction
between the dealer and the custodian bank through
securities depositories. The vast majority of
institutional trades in corporate securities
(exceeding 90%) now settle within the five-day time
frame, primarily because parties to these trades
routinely use securities depository facilities for
confirmation, affirmation and book-entry settlement of
dealer-institutional transactions.
Establishing an earlier settlement time frame depends,
among other things, on the ability of dealers, money
managers and custodian banks to communicate trade terms
and settlement instructions and respond to those
communications quickly. Because many custodian banks
and money managers access securities depositories
through other institutions, communicating
confirmation, affirmation and settlement data often
requires two to three days. Accordingly, any
significant reduction in settlement time frames would
entail costs and changes to operational procedures but
these costs and changes should be evaluated relative to
the potential benefits of reduced settlement
time-frames.
Action item:
The New York Stock Exchange, National Association
of Securities Dealers, the American Stock
Exchange, clearing organizations and market
participants should identify costs and benefits of

- 14 an earlier settlement time-frame and identify how
a shorter time-frame can be implemented consistent
with reducing clearing system exposure and
facilitating coordinated clearing of equities,
options and futures.
E. Integrated clearing of stock and related options and
futures products. Currently, options contracts are
cleared and settled at OCC, futures contracts and
futures options con-tracts are cleared and settled at
clearing organizations affiliated with or designated
by contract markets trading specific futures products;
and securities transactions are cleared and settled at
interfaced clearing corporations and securities
depositories. Existing clearing organizations serve
the needs of the stock, options, and futures markets
and allocate default and credit risks differently to
meet the requirements of those markets.
Consolidation of clearing systems would raise
substantial questions regarding CFTC/SEC customer
segregation requirements and bankruptcy law treatment
of commodities and securities positions. For example,
SEC segregation requirements may have to be augmented
or CFTC requirements diminished in order to integrate
the two systems.
However, consolidation of stock and derivative market
clearing organizations may offer potential for reduced
cash flows and simplified payment and operational
procedures. Whether consolidation would reduce risk
through central control of positions or increase risk
because of concentration of positions is unclear.
Asynchronous settlement time-frames, different margin
procedures and distinct clearing organization
responsibilities with respect to issuer-based as
opposed to exchange-based instruments, as well as
concerns for competition among clearing organizations,
raise questions as to the cost-effectiveness of
consolidation of stock and derivative clearing
facilities. Consolidated clearing of related futures
and options positions may raise somewhat different
questions.
Action item:
Futures and securities clearing organizations
should identify costs and benefits of integrated
clearing and determine how integrated clearing
could be achieved. This analysis may be
facilitated by data generated by any

- 15 cross-margining or netting pilot programs
established by futures and option clearing
organizations. The SEC and CFTC should monitor
the progress of these studies and address public
interest and competitive issues that any proposals
for integrated clearing may raise.
IV. Refine Relevant Legal Frameworks
The Working Group also identified several aspects of
existing legal frameworks that should be reviewed to assure that
a lack of uniform or coordinated legal standards does not
increase market uncertainty or reduce the security of clearing
and settlement systems.
A. Develop bankruptcy framework for FCM/broker-dealers.
Currently, different bankruptcy frameworks apply to
insolvencies of FCMs and those of securities
broker-dealers. In view of the substantial intermarket
trading activities of certain dual registrants, a
uniform or integrated bankruptcy framework for such
entities may be desirable. Development of such a
bankruptcy framework for dual registrants could be
accomplished through coordinated rule-making by the SEC
and the CFTC if the SEC were granted rule-making
authority comparable to that of the CFTC to define
customer property and to determine other matters
relevant to broker-dealer bankruptcy distributions.
Action item:
The CFTC and SEC should review existing bankruptcy
laws and regulations to formulate a coordinated
approach toward FCM/broker-dealer bankruptcies and
identify areas requiring legislative action.
B. Consider harmonizing state commercial laws to establish
uniform transfer, delivery and pledge reguirements for
options and uncertificated securities. The laws of the
various states do not have uniform requirements for
transfers and pledges of options, and transfers and
pledges of certificated and uncertificated stocks.
State requirements are set forth in commercial statutes
(adapted from Articles 8 and 9 of the Uniform
Commercial Code) that vary significantly from
jurisdiction to jurisdiction. Approximately 25 states
do not have statutory standards recognizing
uncertificated securities. Judicial interpretation of
those laws also varies among states, and determining
which law to apply in multi-state transactions can
often be difficult. If the substantial legal obstacles

- 16 can be overcome, investors, market professionals and
their lenders should have a single, clear set of rules
for the transfer and pledge of securities, similar to
those being developed by the ™ ^
J ^ ^ * 1 1 *
Department for trans-actions in United States
Government Securities.
Antion Item:
Consideration should be given to whether
legislation authorizing the appropriate
regulators to establish federal rules for the
transfer and pledge of stock and securities
options would be desirable.

APPENDIX E

Market Reform Actions Taken (or Planned)
by Federal Agencies. Self-Regulatory Organizations,
Clearing Agencies, and Market Participants as of May 16. 1988

Federal Agencies

A. Securities and Exchange Commission (SEC)
Actions by the SEC—Extensive Study of the Market Break and
Recommendations for Market Reform
o On February 2, 1988, the SEC published a staff study
prepared by its Division of Market Regulation entitled The
October 1987 Market Break. This study detailed, among other
things, the role of program trading in the market break; the
capacity of the self-regulatory organizations (SROs) to meet
the volume and other demands placed on their trading systems
by the heightened volatility; and an analysis of market
break related investor complaints. This study also
contained recommendations for market reform on both an
individual exchange basis and across all markets.
o Thereafter, pursuant to recommendations made by the
Commission and staff, the Commission engaged in a continuing
dialogue with the SROs to encourage SRO action in the
following areas:
increased operational capacity through order handling
system enhancements;
increased market liquidity through new specialist
capital requirements and the development of new trading
techniques;
increased financial integrity of market participants
through, for example, increases in derivative market
margins and reassessment of the manner and timing of
variation margin calls;
improvements in post-execution trade processing; and
enhanced clearing agency safeguards against member
default.

2
Actions bv the SEC—Coordination Efforts
o Coordination of inter-market issues with the Commodity
Futures Trading Commission, Federal Reserve Board, and the
Department of the Treasury.
o Contingency planning with the other regulators and the SROs.
o Coordination of international issues with foreign
regulators; meetings with officials of the Japanese Ministry
of Finance, the Tokyo Stock Exchange (February 1988), the
Department of Trade and Industry, Securities Investment
Board, and the International Stock Exchange of the United
Kingdom and the Republic of Ireland Ltd. (March 1988) to
discuss the global impact of market volatility.
Actions by the SEC—Surveillance Data
o The Commission believes that the collection and
dissemination of market, information related to program
trading is necessary for the detection of frontrunning (both
intra- and inter-market) and is of vital importance in
maintaining market integrity. Toward this end,
consideration is being given to proposals that would require
securities traders to report large transactions to the
Commission.
o The SEC has also suggested to the New York Stock Exchange
(NYSE) that it give consideration to augmenting its audit
trail procedure to obtain by electronic means the identity
of member firms' customers. Currently, the NYSE audit trail
tracks the time of stock executions and the brokers involved
in the trade, but requests for customer names must be made
separately to member firms.
Actions bv the SEC—Systems Enhancements
o The SEC has reviewed plans by the securities SROs to
increase the capacity of their order routing and execution
systems to handle the volume of message traffic experienced
on October 19 and 20.
o The Commission is reviewing stress tests of SRO order
routing and execution systems.
B. Commodity Futures Trading Commission (CFTC)
Actions bv the CFTC—Financial Integrity of Futures Markets
o Since the October market break, the CFTC has completed four
studies of futures activity during October, 1987; made
recommendations to futures SROs concerning program

3
enhancements to strengthen protections in volatile markets;
monitored SRO progress in responding to the CFTC
recommendations; initiated improvements in its own data
collection processes and data bases; coordinated and
consulted with other federal regulatory agencies in
addressing contingency planning and other post-market break
responses; and communicated with foreign regulators to
promote information-sharing and cross-border financial
surveillance.
>ost-Market Break Studies
> Following October 19, the CFTC thoroughly assessed the
operation of regulatory and self-regulatory financial
protection systems during the market break. The staff's
preliminary conclusions were summarized in the Interim
Report on Stock Index Futures and Cash Market Activity
During October 1987. which was prepared on an expedited
basis and presented to the Commission on November 9, 1987.
D Subsequently, the CFTC developed additional data concerning
the financial impact of the October market break upon
futures firms and futures customers. The staff's findings
based upon this data were summarized in its Follow-up Report
on Financial Oversight of Stock Index Futures and Cash
Market Activity During October 1987. Although the CFTC
staff concluded that the financial safeguards of the futures
markets operated effectively during the market break,
aspects of financial systems that could be strengthened to
provide added protection against extreme volatility were
identified.
D Separately, the CFTC staff reviewed October 20, 1987 trading
in the Major Market Index futures contract on the Chicago
Board of Trade and found no reasonable basis for concluding
that manipulative activity had occurred.
D The CFTC staff's Final Report on October 1987 futures
market events was issued in January 1988. In addition to
providing a detailed analysis of futures trading activity
during the relevant period, the Final Report set forth
recommendations for additional system enhancements to
facilitate more effective financial and market surveillance.
Post-Market Break Recommendations
3 While the CFTC's staff reports reflect that existing
regulatory and self-regulatory protections functioned
effectively during October 1987, the CFTC has carefully
reviewed SRO programs as well as its own systems, to
identify areas in which each can be strengthened to assure
that it remains effective even in highly volatile markets.

4
The CFTC staff initiated this process directly following the
market break, writing to all futures exchanges and clearing
organizations on November 12, 1987, to request that they
review existing programs and consider potential enhancements
to provide added protection against future periods of
volatility. The staff preliminarily identified seven
program areas for SRO consideration. Subsequently, the CFTC
staff reviewed these recommendations with the Joint Audit
Committee, a coordinating group on which all futures
exchanges and clearing organizations are represented and
formulated additional recommendations for SRO program
improvements, which are more fully set forth in the CFTC's
post-market staff reports. In brief, the CFTC staff has
recommended:
Expedited implementation of the pay and collect datasharing system. Culminating efforts that were
commenced well before the market break, the futures
SROs entered into an agreement on October 21, 1987,
for the routine, electronic exchange of pay and collect
data with respect to dual and multiple clearing
members. The CFTC staff recommended implementing this
system on a priority basis.
Clarification of legal relationships between clearing
organizations and banks. To assure the unimpeded flow
of variation margin payments between clearing
organizations and clearing firms, the CFTC staff
recommended that the legal relationships between
clearing organizations and clearing banks be clarified
to establish the irrevocability of clearing bank
confirmations of variation margin payments in the daily
settlement process.
Intra-day margin calls. The CFTC staff recommended
increased use of intra-day margin calls on a routine
basis to enhance the capacity of the settlement system
to function smoothly in times of extreme volatility.
Integration of market and financial surveillance data.
the CFTC staff recommended that the SROs, all of which
now have large-trader systems, give priority
consideration to enhancement of their computer systems
to integrate large-trader data into their financial
surveillance systems on an automated basis.
Intra-month capital compliance systems. The CFTC staff
recommended that the SROs review the feasibility of
enhancing their audit programs to ensure that their
member firms have the capability to monitor and
maintain continuous capital compliance.

5
Lines of Credit. The CFTC staff recommended that firms
be required to provide confirmation to their SROs of
the availability of and any conditions to their
existing lines of credit and that all firms be required
to have adequate local banking relationships.
Internal controls by member firms over guaranteed floor
traders. The CFTC staff encouraged the SROs to review
the capacity of their member firms to control their
exposure as guarantors of floor traders.
Review and consider enhancement of margin security
against risks of extreme volatility. The CFTC staff
recommended that the SROs review the adequacy of margin
levels to assure that there is an appropriate cushion
against aberrant price spikes and extreme volatility.
o The CFTC has actively monitored the activities of the
futures SROs in response to these recommendations and
encouraged enhanced coordination among futures exchanges,
securities exchanges, and clearing banks involved in the
futures and securities settlement processes. As Part II of
this summary reflects, the futures SROs have effected many
system improvements since the market break which respond to
recommendations by the CFTC and have taken steps toward more
formal inter-market coordination.
Enhancement of CFTC Data and Surveillance Systems
o Following the market break, the Commission initiated efforts
to improve its own data systems to provide more complete and
timely data for analysis in the event of continued
volatility in the stock market and to enhance its financial
surveillance data base.
o Trade identification. Each futures exchange currently
maintains a daily record of each trade (trade register)
which contains certain identifying information. This
information includes the name of the firm clearing the trade
and a customer-type indicator (CTI) that shows the type of
account for which the trade was executed. The CFTC staff
is exploring ways to use this daily record of trades to
identify more rapidly and accurately specific types of
transactions involving both futures and stock trades, such
as index arbitrage.
In the short run, consideration is being given to
requiring additional CTI codes for stock index futures
transactions to identify various types of
transactions.

6
For the longer term, the Commission is exploring with
the exchanges and futures commission merchants (FCMs)
changes and additions to account-number information.
o With respect to the CFTC's large-trader reporting system,
the Commission staff has implemented a special
identification system for trading institutional accounts.
The staff is also reviewing the levels at which the
positions of large traders in stock index futures are
currently reported to the Commission in terms of the
proportion of open interest represented by reporting traders
and the number of traders being reported.
o Financial surveillance data systems. The Commission staff
is also exploring ways in which data currently collected
and used by the CFTC and the futures exchanges for market
and financial surveillance can be refined to enhance
financial surveillance. Specifically, the CFTC staff is
developing refinements of the Commission's existing largetrader and clearing member data base to produce aggregate
position data for all futures markets. Aggregate position
data could be made available to exchanges and other
regulators during periods of volatile markets, and, once
established, such a system could provide a model for data
systems that would reflect all market exposures, including
domestic and foreign securities positions.
The CFTC is also exploring development of a centralized
computer data base for financial information relating to
FCMs. The Commission currently maintains financial
information filed by the FCMs in hard copy and computerizes
a limited amount of such data. The Commission contemplates
development of a computer data base that would be accessible
to the SRO financial surveillance staffs as well as to the
Commission.
Coordination With Other Regulators
o The CFTC has consulted extensively with the SEC, the Federal
Reserve Board, and the Department of the Treasury to address
inter-market coordination and contingency planning issues
raised by the market break.
International Coordination
o The CFTC is coordinating with foreign regulators in a number
of areas, including financial surveillance and information
sharing:
The Securities and Investments Board has proposed that
a lead regulator be designated for firms operating in
the United States and the United Kingdom. The CFTC has

7
responded in writing to this proposal following
discussions between the CFTC and SRO officials and
discussion of the issue by the Joint Audit Committee.
The CFTC is also coordinating with the SEC on this
matter.
Information sharing meetings have been held with
officials in England, Japan, France, Singapore, Canada,
Australia, and Switzerland.
Frontrunning
o At the direction of the CFTC staff, all exchanges that
trade stock index futures are reviewing rules relevant to
frontrunning. Each exchange has indicated that it would
interpret frontrunning as a violation of existing rules
relating to just and equitable principles of trade. The
CFTC and the futures exchanges are participating in a
subgroup of the Intermarket Surveillance Group formed to
discuss intermarket frontrunning and other intermarket
offenses. The exchanges and the CFTC are also working
toward unified standards and interpretations of frontrunning
with the securities exchanges and appropriate informationsharing to facilitate surveillance, as well as considering
the possibility of a regulation establishing a more specific
futures industry standard for the prohibition of intermarket
frontrunning activity involving transactions on futures
exchanges.
Customer Complaints
o The Commission investigated the number and kinds of customer
complaints filed with respect to stock index futures
activity during the October market break. The futures
exchanges which trade stock index products, the National
Futures Association (NFA) and the CFTC's reparation forum,
reported a total of only 35 customer complaints relating to
stock index trading on futures exchanges during the period
October 16-23, 1987.
C. Federal Reserve Board
o In conjunction with the other federal bank regulatory
agencies, the FRB conducted interviews with the major
banking organizations to determine their lending policies
and practices during the market crisis.
o The FRB reviewed the functioning of Fedwire and daylight
overdraft caps and is continuing to evaluate the hours of
operation of Fedwire, and to assess the costs and benefits
of potential changes.

8
o

The FRB has continued contingency planning for market
emergencies, including co-ordination with the other
regulators.
D. Treasury Department
o Closely monitor financial market developments, promote
better communication and coordination among the agencies,
and work through the Working Group to correct market
weaknesses.
II. Self-Regulatory Organizations and Clearing Agencies
SEC Oversight:
A. New York Stock Exchange (NYSE) Specialist System
o The NYSE has reallocated the stocks of J.P. Morgan and Co.,
Gould, Inc., Neiman-Marcus Group, Carter-Wallace, Inc., and
Pansophic Systems, Inc., away from six specialist units.
o There may be additional disciplinary actions resulting from
the week of October 19th, and, when appropriate, additional
stocks will be taken away from other specialists that fail
to meet Exchange standards.
o The SEC has approved revisions to NYSE Rule 103A concerning
evaluation of specialist performance. The revised rule
establishes, among other things, specific objective
standards for measuring specialist performance in the areas
of specialists' Designated Order Turnaround (DOT) system
order handling and reporting, timely opening of securities,
handling of administrative message traffic and market share.
See Securities Exchange Act Release No. 25681, May 9, 1988.
The development of additional specialist performance
standards utilizing objective measures is currently being
considered.
o The NYSE Board of Directors on April 7 approved a proposal
to enhance their procedures for allocating stocks to
specialist units. The NYSE expects to submit the proposal
to the Commission shortly.
o The SEC has approved an NYSE proposal to increase specialist
capital requirements, as an interim measure, to the greater
of $1 million from $100,000 or 25% of the trading unit
position requirements, which would be increased to three
times their current levels. (For example, the current 5,000
share position requirement for common stock has been
increased to 15,000 shares.) See Securities Exchange Act
Release No. 25677, May 6, 1988.

9
The NYSE has increased its monitoring of both specialists'
capital and positions by requiring that such information be
filed with the NYSE by 9:00 a.m. daily.
The NYSE is exploring the need for specialists to maintain
additional lines of credit and other lending arrangements.
Over the next several weeks, the NYSE staff will meet with a
number of its largest member firms to discuss their credit
and banking arrangements, including the number and types of
banking relationships and efforts to obtain other financing.
i In an effort to attract more capital, the NYSE has revised
its Rule 98 to suspend temporarily a prohibition on
securities underwriting firms acquiring specialists. The
proposed rule change has been filed with the SEC for
approval.
initiatives To Increase Trading Capacity
> In November 1987, the DOT's system's memory was increased
and several of the system's data files were separated to
allow more efficient processing. Further system
enhancements are scheduled to be completed by July 1988 to
improve DOT's processing capability even more.
> In January 1988, program changes were completed in the Limit
Order System to reduce system bottlenecks discovered during
the October market break. A major upgrade of the system
with more efficient computers was completed in March 1988,
resulting in a 40 percent increase in capacity.
> The NYSE had begun to completely replace its Automated
Pricing and Reporting System prior to October 1987, but only
a small fraction of the new system was operational by the
week of the 19th. An entirely new system was completed on
February 22, 1988.
) The ability of the NYSE's Universal Floor Device Controller
to store and process data has been increased. To add
additional capacity, major portions of data normally routed
through the Universal Floor Device Controller are being rerouted to other systems, a process that will be completed by
the end of June 1988.
A problem associated with the Universal Floor Device
Controller during the week of October 19th was a backlog of
orders directed to printers on the trading floor. On
January 18, 1988, the NYSE opened its expanded Blue Room,
adding 30 more high speed printers for an increase of 20
percent. Seventeen more high speed printers were added to
the trading floor in March 1988. In addition, the NYSE
213-632 0 - 88 - A

10
currently is working to double the speed of all existing
printers.
At the same time, the NYSE also has increased the number of
electronic display books on the trading floor by over 85
percent, reducing the overall need for printers. In
addition, it has tripled the number of stocks on display
books, an increase of over 140 percent since October 19th,
so that currently there are approximately 1,251 stocks on
373 display books.
o The capacity of the NYSE's Post Support System to store and
process orders has been increased through the use of
additional computer power for the system.
o Enhancements in the NYSE's Universal Floor Device Controller
and its printers currently underway will reduce the
potential for delays in the Exchange's link with the
Intermarket Trading System (ITS).
o As of November 1987, the computers running the Consolidated
Tape System have been replaced. As a result, the
Consolidated Tape System now has the capacity to process
efficiently a peak volume in excess of 600 million shares.
o Computer enhancements were made to the As-Of-Status-System
on October 24th and 25th, 1987.
o On a broader scale, the NYSE is planning to have the
capacity to handle a peak of 600 million shares by June of
this year, and it believes that if it were to experience a
600-million-share day now, it would be able to process it
with significantly fewer delays than the Exchange
experienced last October.
o On Saturday, April 30, 1988, the NYSE conducted a test of
its 11 computer systems to determine whether the systems
could process adequately 600 million shares in one day.
Preliminarily, the NYSE was very satisfied with the test
results; the NYSE is currently analyzing the data generated
by the test.
o Beyond this, the NYSE is planning to have the capacity by late 1989 to process a billion shares.
o The NYSE recently announced the formation of an Operations
Advisory Committee, headed by NYSE President Robert Birnbaum
and made up of experts in trading operations from member
firms of various sizes. The purpose of the Committee is to
evaluate problems encountered during peak processing periods
and to recommend synchronized corrective actions that would
enhance the entire process.

11
In March the NYSE established a Pension Managers Advisory
Committee in order to help make the NYSE more aware of the
investment needs of fund managers and help keep the fund
managers better informed of the system capabilities of the
Exchange now and in the future.
Last January, the NYSE formed an Individual Investor
Advisory Committee to serve as a liaison between individual
shareholders and the NYSE Board to enhance communications
between individual investors and the Exchange. Its charter
is to advise the Board on policies and programs that affect
individual investors in equities, options, futures and fixed
income securities.
• The NYSE is initiating an independent audit of its trading
systems by an outside firm every 12 to 18 months to enhance
the system's proper operation. As the audits are conducted,
the NYSE is going to share the findings with the SEC.
>rogram Trading
> The NYSE required, as of May 15, the daily submission of
information relevant to all program trading activity
engaged in by its members or member organizations either on
a proprietary or agency basis.
> A new procedure is being implemented by the NYSE to enable
it to identify accurately all types of trading, including
program trading.
circuit Breakers
) In early February, the NYSE adopted a procedure and proposed
a rule to the SEC to take index arbitrage out of its
automated order routing system whenever the Dow Jones
Industrial Average moves 50 points up or down from the
previous day's close. The NYSE's proposal was approved by
the SEC on a six-month pilot basis on April 19, 1988, See
Securities Exchange Act Release No. 26699, 53 FR 13371.
The NYSE is working toward a proposal that could provide for
a coordinated all-market circuit breaker in the event of a
precipitous market decline. The Exchange is hopeful that
agreement on this issue can be reached in the near future.
frontrunning
) The NYSE has sent a letter to its members stating that
inter-market frontrunning — or trading futures contracts
to profit on knowledge of impending orders in the stock
market — may violate just and equitable principles of

12
trade, and could be a violation of the Exchange's trading
rules. See NYSE Information Memo No. 88-9, April 13, 1988.
In addition, the NYSE plans to provide the futures exchanges
with audit-trail information on stock trading that would
enable the Chicago futures markets to conduct ongoing
surveillance for front-running. See NYSE Information Memo,
April 21, 1988.
Environmental Impact Statement
o The NYSE Chairman Phelan has proposed development of a
financial version of an environmental impact statement that
can provide guidance, or even an early warning, regarding
the potential consequences of new financial instruments, new
trading technologies and new forms of risk management.
Communications
o On January 11th, the heads of several SROs met at the NYSE
to discuss a variety of methods to improve communications.
Similar meetings involving all equities futures and options
exchanges were also held on February 24th, March 24th and
May 3rd.
o The NYSE also is supporting a proposal to include the stock
index futures as associate members of the Intermarket
Surveillance Group (ISG), which provides access to an
integrated database of inter-market surveillance
instruments.
The NYSE is also heading up a sub-group of the ISG to better
identify inter-market trading violations and promote
information sharing.
On April 5th, there was a meeting of all the members of
the ISG. The stock index futures contract markets
attended that meeting, and the CFTC participated as an
observer.
Compared Trades
o The NYSE is working on (1) a shortened comparison cycle, and
(2) an on-line automated Questioned Trade process. The
exchange is developing an electronic Floor Derived
Comparison (FDC) system to accomplish these objectives.
The NYSE plans to implement FDC in three phases during
1988. The NYSE and the American Stock Exchange report that
they have been working closely on these projects with the
National Securities Clearing Corporation (NSCC), the
Securities Industry Automation Committee (SIAC), and others.

13
The NYSE intends to amend its rules by May 1989 to require
its members to resolve all trades by the evening of the day
after trade-date.
B. American Stock Exchange (Amex)
lurveillance Technology
> In 1986, the Amex began in 1986 a broad effort to upgrade
surveillance technology. These efforts run the spectrum
from on-line, intraday market monitoring to post-trade tools
for investigations. In the last year, the Amex has
implemented:
A new StockWatch system to monitor trade-by-trade
activity for comparison versus historic trading
patterns.
An Amex Trade Information Center (ATIC) for more
efficient data gathering for ad hoc investigations.
A NewsAlert system that uses voice synthesis to notify
market operations personnel of listed company
announcements that may require trading halts.
A DowScan system that reads all the Dow stories and
captures those that are related to Amex listed equity
options for later reference by surveillance analysts.
A new capability to monitor electronically trading for
Rule 193 ("Chinese Wall") violations by firms engaging
in specialist activities.
Systems to monitor automatically option trading for
front running, mini-manipulation, pegging and capping.
) In 1988 and 1989, the development program will expand to
include:
An expert system that uses artificial intelligence
software to analyze potential insider trading market
and manipulation cases and estimate the likelihood that
a case will eventually result in charges. This will
allow surveillance analysts to handle case loads more
accurately and productively.
An upgrade of ATIC software and hardware to include a
relational database and network access to Intermarket
Surveillance Group files. This will reduce the amount
of time required to build up case information during
investigations.

14
An OptionWatch system to duplicate for options the
services provided by StockWatch for equities.
Specialist Performance
o The Commission is currently considering an Amex proposal
that would require that non-regulatory trading halts, or a
reopening following a non-regulatory halt, be approved by a
Floor Governor or Exchange Official. Currently, only the
approval of a Floor Official or, in some instances, a Floor
Governor, is required in such situations. The Amex is also
considering making the same change for approval of gap
openings beyond specified limits.
o In addition, the Exchange is currently considering a
mandatory requirement that all specialists prepare a form
indicating the pre-halt condition of the specialist's book
and any orders represented in the trading crowd prior to and
subsequent to any halt in trading. This form would be
submitted for the Floor Official•s review prior to any
stoppage, resumption of trading for gap openings beyond
specified limits so that a speedy analysis could be made of
specialist pricing, timing and proprietary trading
activity. It could be subsequently used by Exchange staff
for surveillance purposes. Currently, the use of such forms
by specialists is optional.
o The Amex has examined trading in every security traded on
the exchange during the market break period. To date, the
Amex's review of specialist performance has resulted in the
reallocation of two stocks from two specialist units.
Capital Requirements
o The Amex has thoroughly reviewed the current capital
requirements for specialists under Amex Rule 171, and
is in the process of detailed analytical work on a proposal
to its board to increase specialist capital requirements.
o Based on a review of its system of specialist capital
surveillance, the Amex concludes that several changes should
be made in routine surveillance procedures as well as in
monitoring during periods of market turbulence.
The Amex is intensifying surveillance through the following
action:
requiring firms' clearing specialist accounts to
provide, on a daily basis, standardized account
information for specialists and traders. For dual
members this would include account statements, or a
summary thereof, for trading activity on other

15
exchanges where they are members. Standardizing the
information received and obtaining it for positions
other than the Amex will eliminate reporting gaps that
currently impede overall evaluation of specialist
financial condition;
requiring daily information from self-clearing
specialists who now are subject to monthly reporting.
Because most of these specialists are designated to the
NYSE for financial oversight, the Amex will develop a
plan for obtaining and sharing information on dual
members; and
closely monitoring the effects of increased capital
requirements following their implementation to
determine whether higher standards create a need for
additional capital to maintain a comfortable cushion
over early warning levels;
o During times when closer monitoring becomes necessary, the
Amex is considering requiring specialists identified as
most susceptible to damage to provide daily position and
profit and loss estimates shortly after the close of
business. The Amex is also prepared to dispatch examiners
to review specialists' books and records, on a daily basis
if needed, to obtain information not otherwise available.
Market Operations
o The Amex is working with those specialists who have touch
screen execution (AutoPer) terminals located behind them to
provide space to relocate the terminals in front.
o In addition, the Amex is in the process of redesigning the
AutoPer screen to eliminate the need, in some instances, to
use an additional page to complete execution of an order.
The redesigned screen will permit specialists to execute
orders even more quickly and reduce the possibility of
having orders printed and being executed out of sequence.
o Finally, a pilot program is underway with respect to the
implementation of an electronic book that will provide
smoother integration of AutoPer and booked limit orders.
o A committee composed of representatives of the Amex, NYSE
and NSCC has been formed to explore the possibility of
shortening the comparison cycle with the intent of
increasing the amount of time available to process "don't
knows" (DKs) and "questionable trades" (QTs) by one full
day. The Amex is also developing systems to allow same-day
floor-derived points of sale comparison for equities and
options. It is well into the design phase of this system

16
and plans to implement the first stage in the last quarter
of 1988.
o As a result of an extensive review of the events of the week
of October 19 from an equity comparison standpoint, several
proposed enhancements to the NSCC Equity Comparison System
are being considered.
Inter-market Trading System
o The Exchange is examining ways to upgrade order delivery
systems to improve the capacity of the Amex's systems to
execute all orders, including ITS commitments. The Amex,
and other exchanges, are in the process of implementing such
upgrades, and believe such developments will permit
execution, under reasonably anticipated high volume
conditions, incoming ITS commitments in a timely manner.
o The Amex specialists generally have used ITS Plan preopening application procedures following both regulatory and
imbalance trading halts. The Amex would support an
initiative by ITS participants to apply uniform pre-opening
procedures following both these trading halt situations.
o The Amex supports defining procedures for communication
among the exchanges and identifying an ITS contact person
in each market who will be available during market
emergencies.
Options
o The Exchange has adopted a policy of delisting selected
series of puts and calls within an options class when no
open interest exists.
o The Amex is considering the possibility of using its
authority in the event of another dramatic market break to
introduce new strike prices only at levels immediately
surrounding the market price of the underlying stock or
index. In such situations, as the market in the particular
underlying instrument turns around, new strikes could be
introduced to fill in the gaps between those added earlier
and current levels. The Amex is carefully examining the
possibility of modifying its policy in this manner, and
plans to discuss it with the appropriate Exchange committees
when its analysis is complete.
o The Exchange has a number of proposals currently awaiting
SEC approval which will expand the use of the Amex's
automated execution system (AutoEx). These proposals
include the use of AutoEx in select equity options on a
full-time basis. See File Nos. SR-Amex-88-6 and Amex-88-9.

17
It is the Exchange's intention, upon approval of these
proposals, to broaden Registered Options Trade (ROT)
participation in a variety of ways, including allowing ROTs
to 1) sign on the AutoEx system at any time during the day;
2) choose whether they will participate in either calls,
puts or both; and 3) participate on the AutoEx system for
more than one option (provided the ROT is able to be
considered in the trading crowd for each option).
The Amex is seeking ways in which to improve both the speed
and quality of opening rotations.
The Amex is examining the feasibility of introducing an
opening rotation in the Major Market Index that would allow
for the opening and free trading of the more actively traded
options series in a more timely fashion than afforded by the
current system. The more actively traded series are
generally the near term months with strikes at or near the
money. The proposed rotation would allow for first opening
those options which qualify for AutoEx. Immediately upon
completing the opening rotation in these strike prices, they
would become available for free trading.
Additionally, the AutoEx system would be turned on
simultaneously with free trading. This would allow for all
AutoEx qualified orders (currently market orders or
executable limit orders of 10 contracts or less) entered via
the Amex automated system to receive instantaneous
execution.
The benefits are that more actively traded options would be
opened and free traded on a more timely basis. Because of
the time reduction, disproportionate changes in opening sale
prices and next sale prices should be reduced, and AutoEx
would be available sooner than currently possible. If this
proposal proves to be more efficient than current methods,
the feasibility of using this system floor-wide can be
examined.
The Amex proposes to monitor closely and review option
specialists' participation each month, with an increased
emphasis on specialists' performance in maintaining tight,
liquid markets.
Despite the difficulties of using traditional performance
measures for derivative markets, the Exchange's review of
the market break has caused the Amex staff to begin
consideration of more formal standards. The Amex believes
that such guidelines should be based primarily on quote
spread differentials, and that a determination of
unsatisfactory performance on this basis should lead quickly

18
to the imposition of appropriate sanctions, up to and
including reallocation.
o The Amex is also considering the feasibility of imposing a
modified firm quote policy in options. Under such a policy,
option specialists would be expected to disseminate timely
quotations markets that reflect actual market conditions
with consideration given to supply and demand in the trading
crowd. Both of these initiatives must be fully reviewed and
adopted by committees and the Exchange Board prior to
implementation.
o A special study of the Major Market Index (XMI) specialist
and ROT performance for trade date October 20 was undertaken
by the Exchange and has been completed.
o The Exchange reviewed and compiled customer complaints and
all materials associated with XMI trading, including options
journals, cash index values, MMI Futures trading time and
sales, component stock data and other relevant
documentation. This review involved a number of meetings
and a special study regarding volatility in XMI and the
Major Market Index generally.
The Performance Committee determined that a number of put
executions — specifically, those that occurred at a
volatility factor exceeding 325 — were improperly priced,
and that, with respect to these executions, the Unit's
performance was unsatisfactory. The Committee severely
admonished the specialist unit for substandard performance
and advised it that any recurrence of inadequate performance
in XMI would leave the Committee with no alternative other
than to consider strongly reallocation. The Committee
instructed the specialist to develop a plan to ensure
adequate performance in the future.
o Consistent with the Performance Committee's action, the XMI
specialist and member firms representing customer executions
that exceeded the volatility factor have been negotiating
adjustments. These negotiations are continuing.
o As a result of the October market break, margin
requirements for broad-based index options were increased
effective November 2, 1987. See Securities Exchange Act
Release No. 25081, 52 FR 42751. The Exchange subsequently
filed a proposal to increase further the margin on broadbased index options and equity options. See File No. SRAmex-88-12, noticed in Securities Exchange Act Release No.
25646, May 3, 1988.
o The Exchange believes that margin action dealing with
changes in price volatility levels of stocks and indexes

19
underlying options could be better dealt with if Exchanges
were given authority to adjust margin levels above an SECapproved floor without the necessity of filing for rule
changes as is the current practice.
C. National Association of Securities Dealers (NASD)
) The NASD has responded to problems encountered during the
market break by proposing a number of initiatives:
raising the penalty for unexcused withdrawals by market
makers from the National Association of Securities
Dealers Automated Quotation (NASDAQ) system;
requiring all NASDAQ/NMS market makers to participate
in Small Order Execution System (SOES);
providing that SOES executions will continue in an
Over the Counter (OTC)/National Market system security
when quotes are locked or crossed;
eliminating preferencing of market makers in the SOES
when a locked or crossed market exists;
establishing the Order Confirmation Transaction (OCT)
service that will permit firms to access market makers
through NASDAQ without voice contact. See Securities
Exchange Act Release No. 25263 January 11, 1988, 53 FR
1430 (granting accelerated approval for 90 days.)
o The NASD states that its hotline, which at present can be
used to contact 50 of the largest market makers, remains in
place and continues to be part of its routine operational
procedures, including apprising market makers whose quotes
are locked or crossed that they must take remedial action.
o The NASD agrees with the Commission's suggestion that the
NASD review with broker-dealers the desirability of
establishing diverse lending relationships with a number of
banks, as well as the feasibility of obtaining more
committed lines of credit than currently exist. The NASD
will discuss these suggestions with its members.
o During and after the week of October 19, the NASD expanded
the hours of operation of its Trade Acceptance and
Reconciliation Service (TARS) which allowed firms quickly to
reduce the number of uncompared transactions. See
Securities Exchange Act Release No. 25088, November 3, 1987,
52 FR 43141.
o The NASD closely monitored the adequacy of capital of its

20
member firms during the period of the market crisis to
assure their continuing liquidity.
o The NASD has in place a substantial customer complaint
investigation program and will investigate and take
disciplinary action where appropriate in response to these
complaints.
o The NASD agrees with the SEC's suggestion that the SROs
accelerate their efforts to generate same-day compared
trades, thereby enabling members to know their positions and
market exposure before trading commences the next day. The
NASD plans an Automatic Confirmation Transaction System
that, together with the SOES, Order Confirmation Transaction
service, and the on-line TARS, would provide an almost
total same-day comparison capability for the NASDAQ market.
The NASD also filed, and the SEC approved, a rule change
that requires all NASD members to use TARS. See Securities
Exchange Act Release No. 25595, April 18, 1988, 53 FR 93370.
o The SEC has granted the NASD the authority to halt OTC
trading of NYSE-listed and Amex-listed securities when an
important news announcement is made, thus matching the
authority of the NYSE and the Amex. Current rules permit
the NASD to halt only the dissemination of stock quotations
pending a news announcement.
D. Regional Exchanges
Contingency Planning and Information Sharing
o The Pacific Stock Exchange ("PSE") has established a
Contingency Planning Task force. The Task Force's primary
objective is to improve both internal and external
communications when a market disruption occurs. This
includes formalizing internal procedures to communicate
effectively within the staff and with other markets, the
SEC, members and public customers, the news media and the
general public. The PSE also sponsored a meeting with the
other .regional markets on March 28 to discuss, among other
things, specialist capital requirements, inter-market
trading systems performance, communication linkages and
contingency planning for market emergencies.
Specialist Performance
o Four regional stock exchanges, the Cincinnati Stock
Exchange ("CSE"), Midwest Stock Exchange ("MSE"),
Philadelphia Stock Exchange ("Phlx"), and PSE, have examined
individual specialist performance during the market break
and have not identified any questionable actions that would
require disciplinary actions or reallocation proceedings.

21
These exchanges note that they have not received any formal
complaints regarding specialist performance during the
market break.
> The Boston Stock Exchange ("BSE") is currently investigating
one matter that relates indirectly to the market break.
) Individually, the MSE supports the development of objective,
relative standards to evaluate specialists and will be
filing with the Commission, in the near future, a new set of
criteria for specialist evaluation based on a relative
standard of performance.
3 The PSE is currently examining the market making obligations
of regional specialists and has agreed to explore this issue
with each of the other regional markets.
improved Systems
D The BSE does not currently have an automated routing and
execution system. The BSE, however, is in the process of
developing the BEACON system — Boston Exchange Automated
Communications and Order-Routing Network. The BSE expects
that when BEACON is in place it will be able to process at
least 10 million shares per day, which is approximately
three times the BSE's current average daily volume. The BSE
expects the BEACON to be fully operational by year end.
o The CSE has been in the process of implementing major
hardware and software improvements to its trading system to
accommodate volume surges and higher volume levels. The CSE
states that the implementation of these enhancements is
progressing expeditiously at this time and should increase
capacity by approximately 50%. The CSE believes these
enhancements will enable it to process volume such as
occurred during the week of October 19 without any problem
or delay.
o The MSE has increased the capacity of its automated order
execution system (MAX) system from 36,000 trades per day to
54,000 trades, a 50% increase, since the market break.
According to the MSE, this increase means that, assuming a
normal mix of orders, its system could process, with no
delays or problems, the volume of orders experienced during
the market break. Additional changes are being implemented
through June 30, 1988, that will increase capacity further
to 60,000 trades. The MSE also has developed a "performance
management measurement methodology" to improve MSE capacity
forecasting and obtain increased capacity with their

22
current systems on an as needed basis. Both staff and
software tools have been added to implement this program
throughout 1988.
The Phlx estimates the capacity of its automated order
execution system (PACE) has been increased from
approximately 12,500 orders per day to 17,000-17,500 orders
per day since the market break. The Phlx states that
further enhancements that are expected to be in place by
June 1988 should increase system capacity to over 20,000
orders per day without queuing. The Phlx also has
accelerated its plans to replace its current computer
system for PACE by year end. The Phlx estimates this change
will increase capacity to 40,000 orders per day and will
allow the Phlx to handle its anticipated share of volume on
an 800 million to 1 billion share day. Further, when its
new computer system is in place the Phlx believes it will be
able to increase capacity to accommodate volume surges with
less than 24 hour turnaround time. The Phlx conducted a
series of tests on PACE'S capacity after these improvements
were made.
The Phlx has also made modifications that permit automatic
reporting to continue when the automatic execution feature
of the system is disengaged. This will allow the Phlx to
switch to manual execution of orders, which was done on
October 20-22, without encountering the reporting delays
that occurred at that time.
The Phlx has also increased the capacity of its CENTRAMART
System, which processes incoming quotation and transaction
information, by approximately 20% since the market break.
By year-end, computer enhancements should increase
CENTRAMART capacity to the 800 million to 1 billion share
level and allow additional capacity to be added quickly when
needed.
The PSE states that it has doubled the capacity of its
automated execution system (SCOREX) since the market break
to 50,000 messages per day. "Messages" would include
incoming orders, order status report requests, and order
cancellations. On October 19 and 20 SCOREX received 47,000
messages per day. The PSE achieved this increased capacity
primarily by adding two additional data communications lines
between the San Francisco and Los Angeles trading floors,
which expanded capacity of this component of the system by
50%. The PSE believes that with this increased capacity it
would now be able to handle the volume levels experienced
during the October market break without problems. The PSE
notes that further enhancements still underway, such as the
elimination of unnecessary trade and quote data received
from SIAC and the possible addition of two communication

23
processors, should provide reserve capacity to accommodate
even higher volume levels. Finally, the PSE expects that
its on-going computer replacement project, to be completed
within the next two years, will increase capacity to 100,000
messages per day. On March 5, 1988, the PSE conducted a
test of SCOREX capacity. The PSE has hired an independent
consultant to examine and verify the test results.
lontingency Plans for Dealing with Unusual Volume
i The BSE has stated that once it has implemented the BEACON
system, it also will create a back-up system. As to
training, floor operations personnel currently trained to
supplement floor brokerage functions will also be trained in
the BEACON system. The BSE non-floor personnel also are
trained in a variety of clerical floor functions.
> The CSE has upgraded its staff with more qualified employees
to improve overall competence. The CSE also notes it is
continually reviewing and upgrading the quality of its backup systems.
> In 1988, the MSE intends to improve back-up capabilities
including a communications link between the MSE and large
member firms and service vendors. Further back-up
capabilities are being planned for future years. The MSE is
also developing a contingency capacity fall back plan for
1988 that will identify any non-essential MAX activity that
could be eliminated during unusual volume surges to
accommodate more volume.
) The MSE also has developed a program to train upstairs
personnel to supplement floor staff in "volume breakout
situations." The staff will be trained in Trade Input and
MAX customer interface functions. The MSE procedures
provide for the additional staff to be on the trading floor
within 15 minutes when needed.
) The Phlx believes that it currently has adequate back-up
personnel at all levels including data processing,
operations and marketing/customer communications. In
addition, the Phlx notes that the PACE system will have two
important back-up systems when the computer changes noted
above are implemented by year end. First, all computer
functions will be performed in duplicate and cross-checked
so that any system breakdown will be detected immediately.
Second, because the new computers are modular, additional
temporary capacity can be added within a day.
> The PSE is refining its contingency plans to re-route orders
manually to floor booths if its other enhancements prove

24
insufficient at a particular time. The PSE also has formed
a working group to plan the training of staff to meet the
requirements of market disaster, such as providing relief
for regular staff. A list of former options staff who have
assumed other responsibilities at the exchange is regularly
updated and these employees will be receiving refresher
courses. Other staff will be trained in equities floor
operations and receive regular training updates to
supplement the equity floors when needed.
Improved Communications with Retail Firms
o The BSE intends to notify the BEACON users of delays and
other system problems through administrative messages,
supplemented by direct contact with member firms. In
addition, the BSE has recently appointed a new officer who,
among other things, will be responsible for improving
communications with member firms.
o The CSE has made certain improvements, including a direct
line to retail firms, to expedite communication concerning
system problems and delays.
o The MSE recently has implemented procedures to shorten the
amount of time it takes to notify retial firms of problems
or changes to MAX by both administrative message and
telephone. Under the procedures, the MSE will first notify
firms of problems, delays or changes to MAX through
administrative message and will follow-up with phone calls
to the firms.
o The Phlx has developed procedures to ensure there is
adequate notice to PACE users and Phlx marketing personnel
of any changes to system execution parameters.
o The PSE currently is upgrading and formulating its current
procedures for contacting retail firms when system
operational problems or delays occur. The PSE will also be
notifying SCOREX users that during periods of extremely
heavy volume the automatic execution feature may be
disengaged to enable additional "throughput". Both firms
and the SEC would be notified prior to any actual
disengagement of the automatic execution features.
Improved Coordination between Exchanges Concerning Problems with
Small Order Systems
o The CSE states it is committed to timely communication, by
both telephone and administrative message, with other
markets on problems with CSE systems.

25
o

The MSE has implemented the procedures necessary to use the
ITS broadcast administrative message capability at the SIAC
to notify other Exchanges of problems or shut-down of small
order systems, as agreed upon with the other exchanges.
o The PSE is contacting other exchanges to explore the
development of better communications among the markets
during a market break. The PSE believes better SRO
communications and coordination of activities for the
benefit of the market as a whole would be particularly
beneficial concerning the exchanges' automatic execution
systems.
Intermarket Trading System Improvements
o The exchanges unanimously agreed that developing pre-opening
procedures that would apply after order imbalance halts was
of great importance to the efficient operation of ITS.
Several exchanges noted that they would initiate the
proposal at the next meeting of ITS representatives.
o At the last ITS Operating Committee meeting in early
February, the communication issue was discussed and all
exchanges agreed to designate the operating committee member
as the contact person for each exchange. The contact person
in turn was to designate a back-up person and communicate
the information to the other participants. Furthermore,
each participant is to provide current names and phone
numbers for key members familiar with ITS operation and
policy.
o The CSE further recommended that the ITS Operating Committee
identify certain situations that adversely impact the
effective operation of ITS and develop procedures for
decision-making in such situations.
Specialist Capital
o The Phlx, MSE and PSE are currently reviewing the adequacy
of their respective specialists' capital.
o The BSE, effective December 31, 1987, increased specialists'
equity capital requirements from $80,000 to $100,000 and
effective June 30, 1988, will increase the requirements to
$125,000.
o The MSE is studying requiring specialists to file financial
reports on a more timely basis (from quarterly to monthly
for self-clearing specialists and from annually to quarterly
for introducing specialists). The MSE is developing a
mechanism to review specialists' inventory positions on an
intra-day basis, rather than on an overnight basis only.

26
o

The PSE believes that its existing procedures worked
effectively during the market break. The PSE is reviewing
specialist capital surveillance systems to determine if they
capture in a timely manner all the desired information for
adequate monitoring. Based on the current status of the
review, it appears that some modifications to the current
daily reports and monitoring process will be implemented.
o The MSE and the Midwest Clearing Corporation (MCC) are
reviewing the possibility of imposing higher capital
requirements on self-clearing specialists firms.
o The PSE will consider whether to require higher capital for
specialists that do not have bank credit lines.
o The CSE states that requiring lines of credit or higher
capital requirements for dealers without such accommodations
is an issue that needs further review. The CSE will soon
file a proposed rule change that will establish an optional
minimum net liquidating equity requirement for those dealers
who do no customer business and maintain letters of
guarantee with CSE clearing members.
Options
o The Phlx and other OPRA participants have worked and will
continue to work with vendors to address current capacity
problems, plan for future capacity expansion, increase
message capacity, and devise contingency plans for potential
future problems.
o The Phlx received SEC approval to implement its options
order routing system, the Automatic Options Market System,
as a 90-day pilot program, on March 31, 1988. See
Securities Exchange Act Release No. 25540, 53 FR 11390.
o The PSE indicated that present margin levels, for index and
equity options, may not be adequate as permanent standards
and expressed its willingness to join other exchanges and
the SEC in further reviewing margin levels. The PSE
submitted a proposal to increase index and equity option
margin requirements that was noticed in Securities Exchange
Act Release No. 25666 May 5, 1988.
o The Phlx notes that it currently is working with the other
options exchanges to value the adequacy of stock and index
option margin levels. The Phlx concludes from a preliminary
review of trading data that current margin levels are
adequate to ensure credit worthiness and performance of
obligations even during periods of increased market

27
volatility on the scale of last October. According to the
Phlx, serious consideration should be given, however, to
whether current margin levels are adequate to avoid excess
speculation or curb excess market volatility. The PSE
submitted a proposal to increase index and equity option
margin requirements that was noticed in Securities Exchange
Act Release No. 25679 May 9, 1988.
E. Chicago Board Options Exchange (CBOE)
Circuit Breakers
o The CBOE is considering policies to limit the addition of
new strike prices for both stock and index options during
periods of extreme volatility. In particular, the CBOE
would limit new series to those necessary to bracket the
prevailing index value or underlying stock price and to a
limited number of new series farther in- or out-of-themoney. The CBOE believes that further study is required to
define the scale of market volatility that would trigger
implementation of this policy and to determine appropriate
emergency strike price increments.
Systems
o The CBOE is evaluating methods to ensure high levels of
market maker participation in its automated execution system
(RAES) during volatile periods. Efforts are focused on
reducing disincentives to continued participation in RAES
and establishing sanctions for leaving the system. To that
end, the CBOE has submitted a proposed rule change that will
give the CBOE authority to require market maker
participation in RAES in designated equity options classes
and in the Standard & Poor's 500 index option (SPX) through
the next following expiration. See Securities Exchange Act
Release Nos. 25620 April 27, 1988 and 25621 April 27, 1988.
o The CBOE has recently submitted a proposed rule change to
clarify that market maker performance includes participation
in and support for Exchange-sponsored automated programs,
including RAES and Auto Quote. See Securities Exchange Act
Release No. 25570 April 11, 1988.
o The CBOE has communicated with vendors that experienced
capacity problems during the market break and has advised
them to delete less active option series as necessary.
o The CBOE has been reviewing its opening rotation procedures
since last October. Since December, the Standard and Poor's
100 index options (OEX) opening has been informally modified
by dividing OEX series into three groups that are opened
separately and simultaneously. See Securities Exchange Act

28
Release No. 25627 April 29, 1988. According to the CBOE,
these procedures, combined with recent low volume and
volatility levels, have resulted in opening rotations of not
longer than 10 to 15 minutes. In February, the CBOE Board
of Directors approved in principle a plan to divide OEX into
seven zones, six of which would be opened simultaneously
with one or more lead market makers charged with
establishing opening prices and facilitating imbalances.
The CBOE is working with Commission staff to develop an
exchange rule filing that would implement this measure.
The CBOE also received approval from the SEC of a
proposed rule change providing that trading may be
halted and the opening rotation in index options
delayed when unusual market conditions exist. See
Securities Exchange Act Release No. 25600 April 19,
1988, 53 FR 13458.
The CBOE also has plans to test hand-held radio
communication terminals that would enable trade data
input and comparison to be accomplished at the time of
the trade. The current system compares trades in the
evening after trading closes.
Market Maker Performance
o The CBOE's Market Performance Committee is examining the
adequacy of the CBOE's rules relating to market obligations.
In particular, the CBOE is examining its policies respecting
modification of these rules during unusual market
conditions. The CBOE is focusing on determining which rules
should be waived during unusual market conditions and
whether back-up rules should be imposed to ensure that
orders are handled fairly and efficiently during market
stress periods.
o A special panel of CBOE members and persons associated with
CBOE members firms has reviewed October 20, 1987 OEX
pricing. The panel report characterized options pricing on
the morning of the 20th as "extreme but understandable in
light of the chaos and extreme volatility then prevailing in
all markets." The CBOE notes that as a "goodwill gesture"
it will make refunds to member firms based on the difference
between the premiums actually paid by public customers for
certain November OEX options during the market break and the
prices they would have paid if premiums had been based on an
implied volatility of 300. The total amount to be paid
(approximately $1.2 million) will be recovered by assessing
a voluntary fee of $.01 per contract on market makers'
future OEX transactions. As a result of a number of
customer and member firm complaints, the CBOE regulatory
staff also is reviewing market maker performance during the

29
market break, with special emphasis on October 30. The CBOE
expects to complete this review in the near future.
Margin Levels
o The CBOE has been reviewing the adequacy of index and equity
option margin levels and suitability standards in
consultation with major retail firms, other options markets,
and the Commission. At its February meeting, the CBOE Board
of Directors decided to retain the current "Premium plus"
margin methodology and to increase the "add-on" component of
such margin calculation from 10 to 15 percent for index
options and from 15 to 20 percent for equity options. The
minimum margin for out-of-the-money options (both index and
equity) would be increased to 10 percent. The CBOE proposes
to conduct more frequent monitoring of the adequacy of these
margin levels. The CBOE is also considering imposing a
minimum equity requirement for accounts approved to write
naked short options, straddles, and combinations. These
minimums could be established as part of additional
suitability guidelines, which currently are under review by
the CBOE and other options exchanges. The CBOE filed
proposals to increase margin requirements for index and
equity options that were noticed in Securities Exchange Act
Release Nos. 25552 April 7, 1988, and 25600 April 21, 1988.
F. Options Price Reporting Authority
o Within two or three days of the market break most vendors
had expanded their files sufficiently to make their systems
current with each exchange as to all existing options
series.
o Representatives of the Options Price Reporting Authority
(OPRA) Technical Committee immediately began to design
system modifications that will allow the announcement of new
series through computer formatted messages. Such
modifications will in turn enable vendors to implement
computer programs to automatically add these new series to
their systems, eliminating the time-consuming and errorprone process of transcribing the administrative messages
that is currently used. The Committee reached agreement on
the message type at a meeting on December 9th, and
implementation of the system modifications is expected to be
completed this summer.
o An arrangement has been decided upon whereby OPRA will
regularly update the vendor/user committee of the

30
Information Industry Association on volume and capacity
projections to assist the vendor community in its efforts to
have facilities keep pace with growth and provide for
unexpected spikes in activity.
G. Clearing Agencies
The National Securities Clearing Corporation (NSCC),
Depository Trust Company (DTC) and the Options Clearing
Corporation (OCC) support the reconvening of the Monitoring
Coordination Group (MCG) for purposes recommended in the
SEC Report. The NSCC further has suggested, among other
things, that: (1) each participant provide to the
Commission in advance of the first meeting a list of areas
where the events of October 1987 might have shown
improvement as a result of better inter-clearing agency and
Designated Examining Authority (DEA) cooperation; (2) each
participant provide the SEC with an emergency call list that
it will update; and (3) the MCG be chartered, provided an
administrator, required to meet at least quarterly and
provide annual reports to the SEC. The MCG met at the SEC
on April 26, 1988, and agreed to meet again in Chicago on
May 25, 1988.
The NSCC has analyzed daily marks-to-the-market of
guaranteed trades prior to settlement in connection with its
earlier trade guarantee. The NSCC believes that daily marks
would pose financial difficulties for NSCC members, because
NSCC members would be required to fund those marks
themselves for customers that customarily are not required
to pay for securities until delivery under "delivery versus
payment" arrangements. The NSCC is enhancing its ability to
monitor and collect marks by establishing daily computerized
reporting of parameter breaks that will be available within
two to three months. If a parameter is crossed the NSCC
will collect an immediate mark from the member through an
increased clearing fund deposit.
The NSCC and DTC indicate that the idea of cross-liens on
joint assets of clearing agencies is worth exploring
further. The NSCC suggested bringing the matter before the
MCG, and the DTC advised consultations with bankruptcy
experts on possible legal ramifications. The OCC intends to
study the concept of cross-liens as part of its Special
Study of the OCC's systems.
As a general matter, the OCC has undertaken a special study
of its systems, which will include eight broad areas for
review, including those identified in the SEC Staff's
Report. The objective of the OCC's study is to identify any
structural weaknesses or areas that can be improved. The
OCC's margin committee has commissioned a sub-committee,

including margin committee members and industry
representatives, which will complete the study over the next
three months.
As part of the special study noted above, the OCC will
address, among other things, the failure of H. B. Shaine and
Company. While the OCC believes its margin and
concentration monitoring systems worked well during the
October market break, it also believes further examination
is warranted, particularly where concentrations exist in the
form of uncovered short positions and directly affect the
financial strength of a member.
The OCC has been considering increasing its net capital
requirements and will analyze the costs and benefits of such
increases as part of its study. Although the OCC believes
that strengthening its capital requirements could provide
significant risk reduction benefits, the OCC notes that
currently its monitoring system recognizes an OCC member's
net capital as a limiting factor in the amount of risk a
member can pose to the OCC.
The OCC has improved the process by which intra-day
variation margin calls are issued. System enhancements have
shortened the time needed to issue calls from an original
30-45 minutes to a maximum of 15 minutes. The OCC has also
shortened the time for delivery of debit instructions to
clearing banks. The OCC also is investigating the
possibility of automating the transmittal of call
instructions to clearing banks, which, if effected, would
further reduce the time needed to issue calls.
The OCC believes that its monitoring system worked extremely
well during the market break. The OCC, however, intends to
review its monitoring system as part of its study. The OCC
also believes that improvements should be made in the
sharing of information among the OCC and commodities
clearing organizations. Currently, the OCC is negotiating
an agreement whereby the OCC would join commodities clearing
organizations in a centralized system that would collect and
disseminate pay and collect information concerning firms
that belong to multiple clearing organizations.
The OCC agrees that improvements should be made in the
options money settlement process and recently has discussed
this subject with several OCC clearing banks. The OCC,
among other things, has: (1) begun investigating whether
banks can be given earlier notice of settlement
instructions; (2) completed startup of providing facsimile
notification of settlement instructions with one clearing
bank; and (3) undertaken an examination of banking and legal
issues concerning the OCC's ability to make timely payment

32
to members in the event of default or delay by other
members, including examination of the OCC's use of its
clearing funds and bank lines of credit.
o The OCC supports expanded use of its pledge program and
believes greater use of that program could improve
liquidity. The OCC notes, however, that it is in the
process of requesting the Federal Reserve Board to consider
expansion of current regulations concerning loan values of
options positions. The OCC also states that it would be
willing to explore with the DTC whether combined reports
covering options and securities positions could be provided
to banking institutions.
CFTC Oversight:
Chicago Mercantile Exchange (CME)
Chicago Board of Trade (CBT)
New York Futures Exchange (NYFE)
Kansas City Board of Trade (KCBT)
Clearing Agencies
Actions by Exchanges and Clearing Agencies—Financial Integrity
of Futures Markets
o Since October 19, 1987, the CFTC has monitored the actions
of futures exchanges in response to its post market break
recommendations. The actions summarized below, which
include actions responsive to the CFTC's recommendations as
well as independent actions of the SROs, should enhance the
financial security of the futures markets, particularly in
periods of high volatility, and advance related objectives,
such as increasing the efficiency of and coordination among
clearing and settlement facilities.
o Margin pay and collect data-sharing system. In accordance
with previous CFTC staff recommendations, as of October 21,
1987, all futures exchanges and clearing organizations had
entered into a formal agreement for the routine, electronic
exchange of margin pay and collect data with respect to dual
and multiple clearing members. The system is now
operational for 90 percent of futures market volume.
Planned enhancements include securities options premium data
from the OCC, securities data from the NSCC, and surplus
margin data.
o Clarification of contractual relationships between clearing
organizations and clearing banks. Meetings have been held

33
among the interested parties and regulators. The Chicago
Mercantile Exchange (CME) Clearing House, the Chicago Board
of Trade Clearing Corporation (BOTCC) and the OCC are
currently reviewing draft agreements designed to afford
additional clarity and standardization in this area.
Measures to increase, as appropriate, the security afforded
by the margin system against aberrant price spikes and
extreme volatility. In accordance with the CFTC
recommendations to review margins, CME margins on the
Standard & Poor's 500 futures contract have been increased
to $19,000 speculative initial margin ($10,000 maintenance
margin and initial hedge margin). The CME also has
established a policy of resetting its initial speculative
margins for stock index futures to approximately 15 percent
of the value of the contract on a quarterly basis. Chicago
Board of Trade (CBT) margins on the Major Market Index (MMI)
futures contract have also been increased, to $15,000
initial speculative margin ($10,000 for maintenance margin
and for hedge positions).
The CME Clearing House has taken a number of measures
to enhance its security and liquidity. The Clearing
House is in the process of acquiring a $250 million
line of credit to be used in the event of a clearing
firm default. The CME has also adopted a rule change
to increase clearing members' security deposits (which
are standing security in addition to margin deposits).
The rule is designed to increase the available pool of
security deposits from $4.5 million to $42 million.
The CME also has a common-bond system that provides for
the allocation among its clearing members of any loss
to the Clearing House caused by a default. The
aggregate capital of all Exchange firms is
approximately $17 billion.
The CME has also adopted rules requiring the parent
company of a CME clearing member to guarantee losses on
non-customer positions carried by such clearing member.
The CME has proposed a rule change to impose additional
financial requirements on clearing member firms
maintaining 16 or more branch offices or a combination
of 32 or more branch offices and guaranteed
introducing brokers. As of May 6, 1988, each CME
member firm is required to have at least two
memberships in each CME division, or a total of at
least six memberships.
The CME has submitted a rule proposal designed to
establish a margin system for option positions that
more effectively identifies positions that carry

34
greater risk and should, therefore, incur higher
margins. This new option margin system, which was
submitted to the Commission in early February, is
currently, under review. The BOTCC has also taken
action with regard to option margins, increasing the
amount of margin collected for deep out-of-the-money
options.
o Standardized margin deposits. In January 1988 the CME
conformed instruments considered acceptable as margin with
other major U.S. clearing organizations by accepting U.S.
Treasury notes and bonds in addition to Treasury bills for
margin deposits. This should reduce the possibility of
financial gridlock by expanding what is acceptable as
margin.
o Increased use of intra-day margin calls. The CME has
adopted a rule amendment to facilitate implementation of a
new policy of its Board of Governors to make intra-day
margin calls on a daily basis when a specified dollar
threshold is crossed and to pay out gains as well as
collect payments for losses on an intra-day basis. In March
1988, the CME began making routine intra-day calls for
settlement variation. The CME procedures for intra-day
collection and payment of variation margin now provide for
issuance of intra-day calls for settlement variation to any
clearing member owing more than $500,000 and for intra-day
payments of up to 80 percent of gains when $1 million or
more is owed a clearing member.
The CME and BOTCC have now coordinated intra-day pay
and collect procedures. The CME is holding discussions
with the OCC in order to further standardize
procedures.
The BOTCC, which had a pre-existing policy of making
routine intra-day margin calls based on the open
interest at the previous day's close, adopted
additional margin collection procedures following the
October market events to enhance its margin collection
process. Under these new procedures, the previous
evening's trades and all trades submitted to the BOTCC
by approximately 1:30 p.m. each day are matched, and
appropriate variation margins are collected by 2:30
p.m. each day on all open positions as of 2:00 p.m.
In addition, the BOTCC established procedures to ensure
that afternoon variation margin payments are paid to a
clearing member only if the clearing member's required
margins, based on intra-day positions, are sufficient
to cover the newly calculated risk of those positions.
These rules have helped to make it easier to handle

35
high volumes of margin flows on volatile days since
October.
Enhanced clearing and settlement bank financial data. The
CME has organized a roundtable discussion forum to
facilitate better coordination, information-sharing, and
contingency planning among participants in clearing
settlement processes. Members include representatives of
the BOTCC, OCC, Federal Reserve Bank of Chicago, CFTC, SEC,
the four clearing banks used by the BOTCC and the CME
Clearing House, NSCC, the DTC and New York settlement
banks. Two meetings have been held thus far, and additional
meetings are planned.
The CME also hosted a meeting on Friday, March 25, 1988, for
financial surveillance staff representing the CBT, BOTCC,
the NASD, NFA, NSCC, the International Securities Clearing
Corp., the CBOE, Amex, OCC, KCBT, and the NYSE.
Among other things, participants reviewed what additional
information should be shared routinely and during
emergencies and discussed the CME's existing audit plan for
emergency situations. The NYSE hosted the next meeting of
this group.
Integration of market and financial surveillance data. The
CFTC staff recommended that futures SROs, all of which now
have large-trader reporting systems, give priority
consideration to enhancing their computer systems to
integrate large-trader data into their financial
surveillance systems on an automated basis. In response to
these recommendations, a number of SROs stated that they
either had such systems or would consider program
enhancements to do so. For example, the BOTCC reported that
it currently has such a system and the CME Clearing House
has since augmented its risk management procedures to refine
it surveillance data.
Clearing member capital. The CME has stated that it intends
to enhance the security of its Clearing House by
establishing additional minimum capital prerequisites for
membership in the CME Clearing House.
Trading capacity. Most futures markets appear to be capable
of clearing twice the number of transactions that they
currently clear. For example, as a result of recent
enhancements to their computer capability to meet the
Commission's audit trail requirements, the Chicago exchanges
(CME and CBT) have clearance systems capable of handling as
much as two and one-half times the current number of
transactions. The exchanges monitor the volume of
transactions throughout the day, and if there are

36
indications of heavier-than-usual volume, emergency
procedures can be put into effect. These procedures are
generally designed to ensure that clearing firms submit
trade data to the clearing organization more quickly
throughout the day to process the increased volume on a
timely basis. Longer processing hours by the exchanges and
the clearing firms may also be required in such
circumstances.
Most New York futures exchanges also have the capacity to
handle above-average volume.
The largest New York exchange, in terms of volume, the New
York Mercantile Exchange (NYMEX), has experienced
significant growth over the last few years, almost doubling
its volume on a year-to-year basis. The NYMEX average
volume is approximately 130,000 contracts per day so far
this year. The exchange has previously handled 300,000
contracts in a single day and is working towards being able
to accommodate as many as 1 million contracts per day.
NYMEX also plans to implement an on-line system later this
year which will allow brokers to verify and correct the
details of trades during the day.
The Commodity Exchange, Inc. (COMEX) is in the process of
implementing a new clearing system which, when implemented,
should increase its ability to handle high volume.
In a continuing effort to further improve the processing of
orders at the exchange level, the CBT has funded and is
actively working to implement an automated order entry
system that would permit orders to be entered electronically
from terminals at member firms and quotation vendors. The
CBT expects to introduce the system next year.
o Circuit Breakers. On October 19, 1987, there were no price
limits in effect for any actively traded stock index futures
contract. By October 23, however, the CME, NYFE, and KCBT,
by emergency actions, had put into effect price fluctuation
limits for their actively traded stock index contracts. The
fourth exchange with stock index futures trading activity,
the CBT, did not implement limits on an emergency basis.
Subsequently, the CFTC approved permanent limits for the
CBT's, CME's, and KCBT's actively traded stock index
contracts. More recently, both the CME and CBT proposed
further rule amendments that were approved by the
Commission in February 1988. (The emergency action taken by
NYFE in mid-October regarding price limits expired in
January, and no permanent rules have been implemented to
replace those limits for the NYSE Composite futures
contract.)

37
On March 29, 1988, the CFTC approved CME rules establishing
opening range price limits in the Standard & Poor's futures
contract. Specifically, the rule provides that there shall
be no trading during the opening range of 10 minutes at a
price more than 5.00 index points above or below the
previous day's settlement price. In addition, the rules
provide for a two-minute trading halt under certain
circumstances.
The CFTC also approved the CME rules to provide for a
trading halt in options on the Standard & Poor's 500 futures
contract when the Standard & Poor's 500 futures contract is
limit bid or offer at the opening range price limit; or
trading in the futures contract has been halted as set
forth above.
o Trade Practice Review. The CME has participated in various
ISG matters over the last three years. Recently, there have
been three special meetings at which the focus has been on
inter-market abuses, including frontrunning, between the
futures and security exchanges. These discussions are
ongoing to enhance inter-market surveillance efforts.
The CME recently indicated expressly that its existing
rules would prohibit a member from frontrunning a
customer's securities or options order in futures or
option equity index contracts. On May 4, 1988, the CME
Board reviewed a draft of this interpretation in
written form, and intends to solicit comment thereon
from its members shortly.
Inter-market meetings also have been held to improve
coordination and communications among the various
related exchanges in the area of trading and market
information. The first such meeting occurred on
Wednesday, February 24, 1988, at the NYSE; the second
one took place at the CBOE on Thursday, March 25, 1988;
and the third occurred on Tuesday, May 3, 1988, at the
Pacific Stock Exchange. The purpose of these meetings
is to:
Enhance the type of information that the NYSE
disseminates regarding the percentage of stocks
open, those in which trading has been halted or
delayed, bid/ask indications, etc.
Establish an inter-exchange hotline linking the
various trading floors and board rooms for the
exchange of non-standard information;
Identify what other types of information should be
exchanged among the various parties; and

38
Improve and standardize the manner in which
financial data is displayed.
The entities represented at these meetings include the
Amex, CBOE, CBT, MSE, PSE, Phlx, NASD, KCBT, NYSE and
the CME.

APPENDIX F
Working Group on Financial Markets
Participants
U.S. Department of the Treasury
George D. Gould
Charles 0. Sethness
Michael R. Darby
Robert B. Zoellick
Gregory P. Wilson
Dallas S. Batten
Gordon Eastburn
Mark G. Bender
Gerald B. Hughes
Angelo Mascaro
Juhan Jaakson
Brian
S.Reserve
Tishuk System
Federal
Alan Greenspan
Patrick M. Parkinson
E. Gerald Corrigan
Mark Warshawsky
Donald Kohn
Patricia White
Michael Prell
Steven G- Thieke
Thomas Simpson
Christopher McCurdy
Martha Scanlon
Betsy White
Securities and Exchange Commission
David S. Ruder
Alden Adkins
Richard G. Ketchum
Brandon Becker

Mark D. Fitterman
Jonathan Kallman
Kenneth Lehn
Jeff Davis
Sandra A. Sciole
Commodity Futures Trading Commission

Wendy Gramm
Andrea Corcoran
Paula Tosini
Robert Mackay
Susan Ervin
Eugene Moriarity
Support Staff Provided by the U.S. Treasury Department
Linda Johnson
Betty Hunt
Annabella Mejia

LaSean Hudgens
Nancy Hawkins

U.S. GOVERNMENT PRINTING OFFICE : 1988 0 - 213-632

TREASURY NEWS
•apartment of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED
Remarks by
The Secretary of the Treasury
James A. Baker, III
on The Role of Economic Policies
in Improving the Prospects for Global Growth
at the OECD Ministerial
Paris, France
May 18, 1988
Chairman Feldt, Secretary-General Paye, and Distinguished
Colleagues:
This morning's agenda topic — the pursuit of economic
policies to improve global growth and employment — is basically a
job description for Finance Ministers around the world. It poses
the fundamental question we should ask ourselves: What policies
should we pursue in order to strengthen our economies and improve
the well-being of our citizens?
As the world economy becomes more integrated, our success as
Finance Ministers in fulfilling our job descriptions increasingly
requires a cooperative approach. Major changes in the global
economy have intensified the need for economic policy coordination
among the leading industrial countries. In particular:
o The globalization of financial markets has reduced the
independence of domestic policymakers.
o The liberalization of international trade and investment
has increased the importance of the external sector in all
countries.
o Finally, the greater balance in economic size among the
major countries requires that effective external
adjustment be a shared responsibility.
Clearly we need an ongoing process to promote a convergence
of policies and performance that can benefit all. The
coordination process developed since the Plaza Agreement —
endorsed and reinforced at the Tokyo and Venice Summits — is
designed to meet this need. It seeks to promote a sound world
economy and stable international financial system. It seeks the
adoption of compatible, consistent, and mutually supporting
policies by seven of the major industrial countries.
B-1415

-2The process has been developed on a step-by-step basis over
the last 2-1/2 years. And we are about to take another step
forward — with the agreement to use a commodity price indicator
as an additional analytical instrument in our coordination effort.
The agreements of the G-7, I believe, have provided the
framework for important efforts and positive results:
o The United States reduced its federal budget deficit by
$71 billion in the last fiscal year. That drop is
equivalent to almost 2 percent of GNP. The general
government deficit — including state and local
governments — fell to only 2-1/4 percent of GNP in 1987,
a figure below the OECD average.
o Furthermore, the unique Budget Summit Agreement between
the President and the Congress guarantees a $76 billion,
two-year package of budget savings in FY 1988 and 1989.
We expect further deficit reductions in future years, with
the federal deficit down to less than 2 percent of GNP by
FY 1990. We have also avoided protectionism, despite
strong political pressures.
o Japan has pursued a set of monetary and fiscal policies
including last year's important six trillion yen stimulus
package, resulting in the sharpest domestic demand growth
of the industrial countries. This growth, coupled with
efforts to open its markets more fully to imported goods,
is helping to reduce external imbalances.
o The United Kingdom has put into place a major tax reform
which includes a big reduction in marginal income tax
rates.
o Germany has adopted special supports for investment and
has formulated an important medium-term tax reform
program.
I believe that these and other coordinated efforts will help
reduce external imbalances and promote low-inflation growth.
Indeed, since our meeting last May we have been given solid
grounds for optimism. To illustrate:
o The financial turmoil last October, of course, was a
source of concern to us all. But in fact real GNP in
industrial countries grew faster in the second half of
1987 than in the first half. Clearly, the strength of our
expansion was underestimated. Now we are seeing a new
optimism about 1988 growth prospects.
o Moreover, the volume of world trade grew by over
5 percent in 1987, the highest rate since 1984. Exports
of non-oil producing developing countries rose 10 percent
in volume terms — and that helped their real GNP grow by
4-1/2 percent.

-3o

In addition, reductions of external imbalances have
begun in the largest industrial countries. In the
United States, real exports rose 18 percent in 1987, while
imports were up only 7 percent. And, we expect that U.S.
nominal dollar trade and current account deficits will
decline this year, as reflected by the results for the
month of March which were announced yesterday.
o Progress continues to be made in other countries as well.
Japan's trade surplus, as a share of GNP, peaked in 1986
and has come down steadily since; Germany's stabilized
last year and is expected to decline in 1988.
Remaining Challenges
Lest I be charged with having rose-colored glasses, I want
to emphasize that we still have important work to do. While
the near-term economic situation looks encouraging, we need to
maintain this momentum in the medium-term. We must act to sustain
growth, reduce external imbalances, and provide a good environment
for economic development and amelioration of international debt
problems.
The OECD has recognized the need for structural reforms to
complement sound macroeconomic policies. In February 1984 it
sponsored a Mini-Ministerial focused on how structural adjustment
can reduce barriers to growth. Such rigidities prevent market
signals from being translated into economic responses by labor,
business, and consumers. They prevent or slow the rate of
adaptation to new economic conditions and.business environments.
We must all commit our governments to policies that unshackle our
economies.
Many of us have already significantly reduced barriers
that inhibit the flexibility of our economies. Tax reform for
individuals and businesses has become a widely accepted policy in
OECD countries. Marginal income tax rates have been significantly
reduced in many countries and modestly cut in others. Incentives
to work, save, and invest are being created through positive
governmental actions.
Financial deregulation is also spreading. The United Kingdom
and Canada, with their "big" and "little" bangs have led the way.
Others are following suit. In the United States, we are seeking
to expand on the significant deregulation that took place several
years ago. The Congress is now rethinking the law that separates
our banking and securities businesses. The Senate has passed a
bill which would substantially revise the Glass-Steagall Act. Our
Administration strongly supports this long overdue move to
modernize our financial system.

-4We also recognize the need to strengthen savings in the
United States. Therefore, we were encouraged by the rise in the
household savings rate to 4-3/4 percent in the fourth quarter of
last year. The rate remained above 4-1/2 percent in the first
quarter. That is an increase from 3-1/2 percent earlier in 1987
and 4-1/4 percent in 1986.
European countries have made some progress in freeing up
labor and capital markets and in reducing the burden of regulation
on business. But much more needs to be done to reduce high
unemployment and generate higher growth without inflation.
Japan's progress in creating more competitive and efficient
capital markets has been notable. But more action is needed to
reduce remaining rigidities and ensure greater world access to
Japanese financial markets.
The Role of the NICs
The newly industrializing countries of Asia must also
participate more fully in the external adjustment process. Their
external surpluses, particularly in the case of Korea and Taiwan,
are impeding the adjustment of global imbalances and adding to
protectionist pressures. Significant structural changes are
required to improve the balance between domestic and foreign
demand.
Specific reforms are required in the areas of exchange
rates, trade, taxation, deregulation, investment, and capital
market access, particularly in Korea and Taiwan. These changes
are in the long-term best interests of those countries. The
changes are also necessary if they are to assume a degree of
responsibility for maintaining the international trading system
that is commensurate with their own rapidly growing economic
strength.
Cooperation in Trade and in Science and Technology
In addition to these tasks, preserving an open trading system
is crucial in today's interdependent world. To achieve greater
trade liberalization, particularly in agriculture, we strongly
support the work of the Uruguay Round and are committed to
working toward a successful round. All countries, however, are
responsible for the ultimate success of the round, not simply the
industrial nations.
I want to take a moment to bring your attention to the
policy recommendation to member states on a "General Framework
of Principles for International Cooperation in Science and
Technology" which was adopted by the OECD Council last month.
Adequate investment in dynamic research and development programs
will play an increasingly important role in assuring the sustainability of economic growth in the OECD countries. This Framework
represents a major achievement for this Organization. It has the
potential for a far-reaching impact on an increasingly important
aspect of international economic relations. I urge you to join
me in endorsing this document in our final communique tomorrow.

-5International Debt
Let me turn to our cooperative efforts in another area —
easing the burden of international debt. The growth-oriented,
case-by-case approach we have pursued since 1985 has helped move
us a considerable distance toward our goals and remains the only
practical approach acceptable to all parties. Our strategy is
an evolutionary one and this has been reflected in the further
development during the past year of a "menu" of financing options
for commercial bank packages. In contrast, we strongly oppose
any approach — including the creation of an international debt
facility — which is generalized, global, financed by creditor
governments or mandatory in nature. Such schemes are both
impractical and counterproductive. With respect to the poorest
countries, we welcome the positive steps that have been taken
this year to support their adoption of economic reform programs.
Conclusion
In conclusion, Mr. Chairman, although we have accomplished
much in recent years, major tasks are still before us. The agenda
remains a challenging one and further progress will require
continued cooperation.
The great French social philosopher, Alexis de Tocqueville,
observed in 1835 that the advantage of each individual member of a
community consisted in working for the good of all — a principle
he called "self-interest rightly understood." Let us follow
de Tocqueville's advice and put aside narrow self-interests for
the general good of the international community.
So let us use this meeting to revitalize our spirit of
cooperation.
Let us enhance policy coordination, eliminate trade
barriers, and remove structural impediments to growth. Let us
you.
move Thank
forward
together toward a more properous and hopeful world.

TREASURY NEWS
Deportment
of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
May 18, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR 2-MONTH NOTES
TOTALING $15,250 MILLION
The Treasury will raise about $5,100 million of new cash
by issuing $8,250 million of 2-year notes and $7,000 million
of 5-year 2-month notes. This offering will also refund $10,144
million of 2-year notes maturing May 31, 1988. The $10,144
million of maturing 2-year notes are those held by the public,
including $1,017 million currently held by Federal Reserve Banks
as agents for foreign and international monetary authorities.
The $15,250 million is being offered to tne public, and
any amounts tendered by Federal Reserve Banks as agents for
foreign and international monetary authorities will be added to
that amount. Tenders for such accounts will be accepted at the
average price of accepted competitive tenders.
In addition to the public holdings, Government accounts and
Federal Reserve Banks, for their own accounts, hold $761 million
of the maturing securities that may be refunded by issuing additional amounts of the new notes at the average price of accepted
competitive tenders.
If, under Treasury's usual operating procedures, the auction
of 5-year 2-month notes results in the same interest rate as the
outstanding 8-5/8% bonds of August 15, 1993, the new notes will
be issued with an 8-1/2% or an 8-3/4% coupon. The 8-3/4% coupon
will apply if the auction results in a yield in a range of 8.68%
through 8.85%.
Details about each of '-he new securities are given in the
attached highlights of the offerings and in the official offering
circulars.
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TREASURY NEWS
Deportment
of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE UPON DELIVERY
Expected at y:30 A.M., HUT

TESTIMONY OF THE HONORABLE
GEORGE D. GOULD
UNDER SECRETARY FOR FINANCE
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
SUBCOMMITTEE ON TELECOMMUNICATIONS AND FINANCE
OF THE
COMMITTEE ON ENERGY AND COMMERCE
U.S. HOUSE OF REPRESENTATIVES
MORNING, MR.THURSDAY,
CHAIRMAN,MAY
AND19,
MEMBERS
1988 OF THE SUBCOMMITTEE.

GOOD
IT IS A PLEASURE TO RETURN HERE TO DISCUSS THE PROGRESS
THE PRESIDENT'S WORKING GROUP ON FINANCIAL MARKETS.

MADE BY

DURING THE PAST TWO MONTHS, THE PRINCIPAL MEMBERS OF THE
WORKING GROUP AND OUR RESPECTIVE STAFFS HAVE ANALYZED AND
DISCUSSED THE EXTENSIVE INFORMATION AND RECOMMENDATIONS
EMANATING FROM LAST OCTOBER'S MARKET DECLINE. FAR FROM BEING A
STALLING DEVICE AS SOME HAVE CRITICIZED, THE WORKING GROUP HAS
MOVED FORWARD, AFTER MUCH DELIBERATION, ON A NUMBER OF CRITICAL
ISSUES TO PRESERVE THE INTEGRITY, COMPETITIVENESS AND EFFICIENCY
OF OUR NATION'S FINANCIAL MARKETS. COLLECTIVELY, THESE
RECOMMENDATIONS ADDRESS BASIC SAFETY AND SOUNDNESS ISSUES, SHOULD
LESSEN THE RISK OF SYSTEMIC PROBLEMS, AND AS A RESULT, WORK TO
THE BENEFIT OF ALL INVESTORS. THE KEY ISSUES -- IDENTIFIED BY
THE BRADY COMMISSION, THE GENERAL ACCOUNTING OFFICE (GAO), THE
SECURITIES AND EXCHANGE COMMISSION (SEC), THE COMMODITY FUTURES
TRADING COMMISSION (CFTC), AND OTHERS -- ON WHICH THE WORKING
GROUP HAS TAKEN CONSTRUCTIVE ACTION INCLUDE:
0 AN AGREEMENT ON COORDINATED "CIRCUIT BREAKERS"
ACROSS MARKETS TO ALLOW FOR COOLING-OFF PERIODS
DURING TIMES OF EXTREME PRICE DECLINES;
0 RECOMMENDATIONS AND CONCLUSIONS ON THE
CREDIT, CLEARING, AND PAYMENTS SYSTEM TO
ENSURE THE NECESSARY COORDINATION OF
INFORMATION AND OPERATIONS WITHIN AND BETWEEN
MARKETS AND TO AVOID SYSTEMS GRIDLOCK;
B-1417

- 2-

AGREEMENT THAT CURRENT MINIMUM MARGIN REQUIREMENTS
PROVIDE AN ADEQUATE LEVEL OF PRUDENTIAL PROTECTION TO
THE FINANCIAL SYSTEM; AND

0 AGREEMENT ON CONTINGENCY PLANNING, INCLUDING
THE CONTINUATION OF THE WORKING GROUP, TO
ENSURE COORDINATION AND CONSULTATION IN THE
EVENT OF FUTURE, RAPID MARKET DISTURBANCES.
I ALSO AM PLEASED TO REPORT THAT THE SECURITIES, FUTURES,
AND OPTIONS INDUSTRIES ALREADY ARE MAKING -- AND SHOULD CONTINUE
TO MAKE -- SIGNIFICANT EFFORTS TO ENHANCE OPERATIONAL CAPACITY,
TO INCREASE INDIVIDUAL FIRM AND CLEARINGHOUSE CAPITAL, AND TO
IMPROVE THE FAIRNESS AND QUALITY OF ORDER EXECUTIONS FOR ALL
INVESTORS, LARGE AND SMALL.

THE NEED TO REDUCE SYSTEMIC PROBLEMS
THE SPECIFIC CONCLUSIONS AND RECOMMENDATIONS ARE CONTAINED
IN THE WORKING GROUP'S INTERIM REPORT TO THE PRESIDENT, WHICH
ACCOMPANIES MY TESTIMONY. IT IS ESSENTIAL, HOWEVER, TO
UNDERSTAND THE PREMISE FROM WHICH THESE CONCLUSIONS EVOLVED.
THE WORKING GROUP VIEWS ITS PRIMARY MISSION AS TAKING
COLLECTIVE, SAFETY AND SOUNDNESS ACTIONS WHICH WOULD
SUBSTANTIALLY LESSEN POSSIBLE SYSTEMIC DANGERS TO THE U.S.
FINANCIAL SYSTEM IF WE WERE AGAIN TO ENCOUNTER A SEVERE STOCK
MARKET DECLINE. CONSEQUENTLY, THE WORKING GROUP -- ACTING ON THE
MOST SIGNIFICANT SUGGESTIONS OF THE BRADY REPORT AND OTHERS -VIEWS COORDINATED CIRCUIT BREAKERS, PRUDENTIAL MARGINS ACROSS
MARKETS, THE PROPER FUNCTIONING OF CREDIT, CLEARING, AND PAYMENT
SYSTEMS, AND CONTINGENCY PLANNING AS KEY INGREDIENTS TO PREVENT
STOCK MARKET DECLINES FROM DEGENERATING INTO SELF-FEEDING PANICS.
WHILE MARKETS WILL ALWAYS REACT TO CHANGES IN FUNDAMENTAL
ECONOMIC INFORMATION, IT IS IMPORTANT TO ASSURE ALL INVESTORS AS
TO THE PROPER FUNCTIONING OF THE FINANCIAL SYSTEM WHILE SUCH
INFORMATION IS BEING DIGESTED IN TERMS OF MARKET PRICING.
INDEED, REDUCING CONCERNS OVER THE VIABILITY OF THE MECHANICS AND
INFRASTRUCTURE OF THE SYSTEM COULD MITIGATE THE EXTENT OF MARKET
DECLINES BY REDUCING THE RISK PREMIUM INHERENT IN THOSE EXTREME
SITUATIONS WHERE MARKET PARTICIPANTS WORRY ABOUT RECEIVING FULL
AND TIMELY PAYMENTS. HENCE, OUR EMPHASIS ON SAFETY AND SOUNDNESS
ISSUES FIRST DURING THESE PAST 60 DAYS.
DAILY VOLATILITY IS NOT A SYSTEMIC THREAT
THE ISSUE OF DAILY VOLATILITY, ALTHOUGH AN EXPRESSED PUBLIC
CONCERN, IS NOT IN THE CATEGORY OF SYSTEMIC THREAT, IN MY
OPINION. HOWEVER DISCONCERTING SUCH VOLATILITY CAN BE ON A

- 3-

SHORT-TERM BASIS, IT IS IMPORTANT NOT TO ATTEMPT CURES THAT CAN
DO MORE HARM THAN GOOD. MARKETS MUST BE ALLOWED TO ADJUST TO NEW
PRICE LEVELS WITHOUT IMPEDIMENTS TO EFFICIENCY THAT IN THEMSELVES
CAUSE DISRUPTIVE MARKET ACTION. NARROW PRICE LIMITS FOR CIRCUIT
BREAKERS, CAUSING FREQUENT MARKET SHUT DOWNS, WOULD BE AN EXAMPLE
OF SUCH SELF-DEFEATING "CURES".
MOREOVER, VOLATILITY IS A SUBJECT WHICH OFTEN HAS BEEN
TREATED PUBLICLY WITH MORE EMOTION THAN ANALYSIS. I T MUST BE
NOTED THAT, WITH THE EXCEPTION OF THE PERIOD OCTOBER 1987 THROUGH
JANUARY 1988,
THERE IS NO EVIDENCE OF ANY INCREASE IN DAILY
VOLATILITY. VOLATILITY FROM 1983 THROUGH 1986, DURING WHICH TIME
THE FUTURES MARKET WAS GROWING RAPIDLY, WAS MODERATE TO LOW AS
COMPARED TO SIMILAR PRIOR PERIODS. THIS IS ILLUSTRATED IN
EXHIBIT A. I SHOULD NOTE THAT SINCE FEBRUARY 1988, DAILY PRICE
VOLATILITY HAS RETURNED TO LEVELS SUCH AS WERE SEEN IN 1973,
1974, 1975, 1980, AND 1982, AND WHICH ARE STATISTICALLY
INDISTINGUISHABLE FROM THE NORM FOR 1971 THROUGH 1986. IN ANY
CASE, WE MUST BE CAUTIOUS IN ASCRIBING EVENTS OF THOSE FEW MONTHS
OF EXTRAORDINARY VOLATILITY TO CHANGES WHICH HAVE BEEN IN PLACE
FOR SOME TIME OR IN EXTRAPOLATING THAT THOSE EVENTS WILL BE THE
NEW NORM IN THE FUTURE.
SOME OBSERVERS BELIEVE THE INDIVIDUAL INVESTOR HAS LEFT THE
MARKET BECAUSE OF A PERCEPTION OF INCREASED VOLATILITY.
IT IS
EQUALLY POSSIBLE THAT MUCH OF THE RETREAT IS IN FACT INVESTORS'
COLLECTIVE VIEWS THAT THE BULL MARKET HAS PAUSED OR THAT MORE
ATTRACTIVE ALTERNATIVE INVESTMENTS ARE AVAILABLE. INDIVIDUAL
INVESTORS HAVE "LEFT THE MARKET" IN THE WAKE OF OTHER MAJOR
MARKET DECLINES (E.G., IN THE MID 1970S). THOSE INDIVIDUALS WHO
WANT TO OWN EQUITIES BUT ARE CONCERNED ABOUT COMPETING WITH
LARGE, SOPHISTICATED POOLS OF CAPITAL CAN, IF THEY WISH, INVEST
THROUGH THEM (E.G., MUTUAL FUNDS AND PENSION FUNDS) RATHER THAN
TRYING TO COMPETE WITH THEM.
WE MUST RECOGNIZE THAT INVESTOR WITHDRAWAL DURING SUCH BEAR
MARKETS IS A FACT OF LIFE, REAFFIRMED RECENTLY IN A NEW YORK
TIMES ARTICLE WHICH STATES IN PART:
INVESTOR DISILLUSIONMENT WITH THE STOCK MARKET IS NOT
A NEW PHENOMENON. TYPICALLY, INVESTORS WITHDRAW EACH
TIME THERE IS A BEAR MARKET -- CONTRIBUTING TO THE
BLEAK MOOD. AFTER THE ALMOST 50 PERCENT DROP IN THE
VALUE OF STOCKS DURING THE 1973-74 BEAR MARKET, FOR
INSTANCE, MANY INDIVIDUALS FLED THE MARKET AND STAYED
OUT UNTIL THE BULL MARKET OF THE 1980'S.
THE NUMBER OF INDIVIDUAL SHAREHOLDERS WHO OWNED STOCKS
ON THE NEW YORK STOCK EXCHANGE FELL TO 25.2 MILLION IN
1975 FROM 30.8 MILLION IN 1970.
THE NUMBER OF

-4 SHAREHOLDERS OF MUTUAL FUNDS DROPPED TO 7.8 MILLION IN
1980 FROM 8.4 MILLION IN 1970, ACCORDING TO ESTIMATES
BY THE INVESTMENT COMPANY INSTITUTE.
NUMEROUS FACTORS CAUSE MARKETS TO REACT MORE QUICKLY TODAY
THERE ARE NUMEROUS FACTORS THAT HAVE MADE MARKETS REACT
MORE QUICKLY TODAY TO CHANGES IN THE FUNDAMENTAL DETERMINANTS OF
STOCK PRICES. FIRST, THE NATURE OF STOCK OWNERSHIP HAS CHANGED
SUBSTANTIALLY OVER THE PAST TWENTY YEARS, LED BY PRIVATE AND
PUBLIC PENSION FUNDS. THERE HAVE EVOLVED VERY LARGE INDIVIDUAL
AGGREGATIONS OF CAPITAL OF A SIZE UNKNOWN IN AN EARLIER PERIOD.1/
THIS, IN TURN, HAS LED TO CHANGES IN THE TECHNIQUES OF MANAGING
SUCH CAPITAL, OFTEN WITH AN EMPHASIS ON THE MARKET AS A WHOLE
(E.G., THE S&P 500) RATHER THAN INDIVIDUAL STOCKS. IN THE CASE
OF MAJOR BROKER/DEALERS, THE NEED FOR TRADING LIQUIDITY BY LARGE
BODIES OF CAPITAL HAS ALSO INCREASED THE NEED FOR HEDGING
TECHNIQUES BY CORPORATE TREASURERS AND MONEY MANAGERS. THUS, THE
STOCK INDEX FUTURES MARKETS HAVE EVOLVED AS THE LOWEST COST, MOST
EFFICIENT RESPONSE TO THESE CHANGED NEEDS. "TRADING THE MARKET"
AND HEDGING ARE NOT IN AND OF THEMSELVES EITHER GOOD OR BAD -THEY ARE ECONOMIC FACTS THAT ARE NOT GOING TO GO AWAY.2/
SECOND, BENEFITS OF ACTIVE FUTURES MARKETS ARE REAL: FOR
EXAMPLE, THEY APPLY DIRECTLY TO THE TREASURY SECURITIES MARKET.
TREASURY FUTURES ARE USED AS HEDGING VEHICLES AND AS A COSTSAVING MEANS TO ADJUST POSITIONS IN THE UNDERLYING SECURITIES.
THESE RISK-REDUCING BENEFITS OF FUTURES MARKETS LEAD TO A
REDUCTION OF THE RISK PREMIUM INVESTORS REQUIRE ON THE UNDERLYING
TREASURY SECURITIES AND THUS TO LOWER INTEREST COSTS FOR THE
FEDERAL GOVERNMENT.
FOR AN EXCELLENT DISCUSSION OF THE INCREASINGLY SIGNIFICANT
ROLE OF DERIVATIVE PRODUCTS -- PARTICULARLY FUTURES ON STOCK
1/
AT THE
END
OFSECURITIES
1987, U.S.MARKETS,
PRIVATE MEMBERS
PENSION OF
FUND
ASSETS
INDEXES
-- IN
THE
THE
SUBCOMMITTEE
TOTALLED ALMOST $L.5 TRILLION AND U.S. PUBLIC PENSION FUND
ASSETS WERE APPROXIMATELY ANOTHER $500 BILLION. BY
COMPARISON, TOTAL PENSION FUND ASSETS WERE APPROXIMATELY
$820 BILLION AT THE END OF 1980.
2/

1987 STATISTICS FOR THE LARGEST 200 PENSION FUNDS SHOW THAT
A GROWING PERCENTAGE OF THEIR ASSETS (11.8%) IS IN STOCK
INDEX FUNDS. A GROWING PERCENTAGE OF THESE PENSION FUNDS
(36%) ALSO USES STOCK INDEX FUTURES.

-5 REALLY SHOULD REVIEW CHAPTER THREE OF THE SEC'S STAFF REPORT "THE
EFFECTS OF DERIVATIVE PRODUCTS" (THE OCTOBER 1987 MARKET BREAK)
WHICH I HAVE ATTACHED AS EXHIBIT B OF MY STATEMENT.
THIRD, WITH THE INDEX FUTURES MARKETS HAVING EXHIBITED
GREATER VOLUME IN THE UNDERLYING STOCKS THAN THE CASH MARKET
EXCHANGES, IT CAN BE ARGUED THAT THE CHICAGO MERCANTILE EXCHANGE
(CME) HAS BECOME A LEADER -- RATHER THAN A FOLLOWER -- IN PRICE
DISCOVERY OF EQUITY MARKET VALUE LEVELS. CASH MARKET PRICES ARE
NOW OFTEN FOLLOWING, RATHER THAN LEADING, THE SO-CALLED
DERIVATIVE MARKET. THE BRADY REPORT AND OTHERS HAVE UNDERSCORED
THE CLOSE ECONOMIC LINKAGE BETWEEN THESE MARKETS. THUS, THE
PUBLIC DEBATE OVER THE ROLE OF INDEX ARBITRAGE IS OFTEN
MISDIRECTED. INDEX ARBITRAGE ONLY TAKES PLACE WHEN THERE IS A
DIFFERENCE OF PRICE LEVEL BETWEEN THE CASH AND FUTURES MARKETS,
AND SUCH ARBITRAGE, AS IN ITS AGE OLD ROLE, HELPS EQUATE THOSE
PRICE LEVELS.
FOURTH, WHILE IT IS TRUE THAT INDEX ARBITRAGE CAN TRANSLATE
BUYING OR SELLING PRESSURE FROM ONE MARKET TO ANOTHER, IF THOSE
MARKETS ARE TRULY ECONOMICALLY LINKED AND RESPONDING TO THE SAME
FUNDAMENTALS, THEN SUCH ARBITRAGE SERVES THE USEFUL PURPOSE OF
QUICKLY EQUALIZING THE PRICE LEVELS BETWEEN THE MARKETS. IT IS
WORTH NOTING IN THIS CONTEXT THAT THE PROPOSAL OF THE NEW YORK
STOCK EXCHANGE (NYSE) FOR TRADING BASKETS OF STOCK ON THE NYSE
WOULD ITSELF PRODUCE "INDEX ARBITRAGE" BETWEEN THE VALUE OF THE
BASKET AND THE UNDERLYING STOCKS -- BUT THIS ARBITRAGE WOULD BE
WITHIN THE NYSE. WHAT OFTEN IS OVERLOOKED IN DISCUSSIONS OF
ARBITRAGE IS THAT IF THERE WERE NO LINKAGE OF THE MARKETS, THEN
MORE SELLING OR BUYING COULD SPILL OVER INTO THE CASH MARKETS
DIRECTLY. THE BRADY REPORT TAKES NOTE OF SUCH SELLING WHEN THE
LINKAGE BROKE DOWN IN OCTOBER.
MUCH PUBLIC CRITICISM OF INDEX ARBITRAGE IS A CLASSIC CASE
OF WANTING "TO SHOOT THE MESSENGER" THAT BRINGS THE BAD NEWS OF
SELLING ON THE CME TO THE FLOOR OF THE NYSE. IF SELLING IS
GOING TO TAKE PLACE TO A DEGREE THAT PUSHES PRICES DOWN SHARPLY,
THEN CASH MARKETS WILL NOT BE MADE IMMUNE BY ELIMINATING INDEX
ARBITRAGE. THE EMPHASIS, THEREFORE, SHOULD BE ON INCREASING THE
CAPACITY OF SYSTEMS LIKE THE DESIGNATED ORDER TURNAROUND (DOT)
SYSTEM OF THE NYSE SO THAT THE PUBLIC HAS FAIR AND EQUAL ACCESS
TO ORDER TRANSMISSION, RATHER THAN ON RESTRICTING MECHANICAL
LINKAGES BETWEEN ECONOMICALLY-LINKED MARKETS.
PUT ANOTHER WAY, IF THERE WERE NO INDEX FUTURES MARKET,
THEN THERE WOULD BE NO INDEX ARBITRAGE. BUT THERE IS NO EVIDENCE
THAT SUCH A CONDITION WOULD GIVE THE CASH MARKETS IMMUNITY FROM

- 6SELLING PRESSURE GENERATED BY RESPONSES TO FUNDAMENTAL EVENTS -AND NO LIKELIHOOD THAT HAVING DEVELOPED TO MEET A LARGE AND
IMPORTANT INVESTMENT NEED THERE WILL NOT BE A VIABLE INDEX
FUTURES MARKET, WHETHER HERE OR ABROAD.
FIFTH, THE VOLATILITY MANY PEOPLE BLAME ON INDEX ARBITRAGE
COULD ALSO BE EVIDENT FROM DIRECT SELLING IN THE CASH MARKET.
IN FACT, PRESSURES DIRECTLY ON CASH MARKETS ARE CLEAR FROM
HISTORY. EARLIER IN THE POSTWAR PERIODS BEFORE THE INDEX FUTURES
MARKETS CAME INTO EXISTENCE IN 1982, THE DOW JONES INDUSTRIAL
AVERAGE (DJIA) HAD A NUMBER OF SIGNIFICANT DECLINES AS OUTLINED
IN EXHIBIT C OF MY TESTIMONY. IN FACT, THE 1973-74 BEAR MARKET
WAS WORSE THAN THE 1987 DECLINE; WHILE IT TOOK LONGER, THE END
RESULT WAS THAT PRICE LEVELS REACTED TO FUNDAMENTAL PERCEPTIONS
AND ADJUSTED ACCORDINGLY. WHILE INDIVIDUAL SHARE OWNERSHIP IS AN
IMPORTANT PART OF OUR FINANCIAL SYSTEM AND SHOULD BE ENCOURAGED,
WE CANNOT EXPECT TO BE ABLE TO LEGISLATE NORMAL HUMAN BEHAVIOR -ANY MORE THAN WE SHOULD BE EXPECTED TO PROTECT THE REVENUES OF
BROKERAGE FIRMS BY ATTACKING SYMPTOMS RATHER THAN CAUSES.
SIXTH, THE AGGREGATION OF CAPITAL IS A FACTOR IN TODAY'S
GLOBAL MARKETS, JUST AS THE PHENOMENON OF RAPID INFORMATION
DISSEMINATION ALSO IS IMPORTANT TO RECOGNIZE. THE WORLD NOW HAS
THE TECHNOLOGICAL SYSTEMS -- AND THEREFORE THE ABILITY
FOR
ALMOST INSTANTANEOUS RESPONSE TO ANY EVENT. THIS PROVIDES
ANOTHER TYPE OF AGGREGATION IN THE FORM OF CONCERTED BUYING OR
SELLING. WHILE MARKET LIQUIDITY HAS INCREASED GREATLY IN RECENT
YEARS, CLEARLY SOME GREATER VOLATILITY CAN BE INTRINSIC TO
CONCERTED ACTION. ELIMINATING INFORMATION TECHNOLOGY -- EITHER
BY LEGISLATION OR REGULATORY FIAT -- HARDLY SEEMS LIKE A
REALISTIC REACTION TO CONCERNS ABOUT VOLATILITY.
FINALLY, THE WALL STREET BROKER/DEALER/SPECIALIST BUSINESS
HAS BECOME INCREASINGLY CAPITAL-INTENSIVE. SINCE 1975, WHEN
FIXED-RATE COMMISSIONS WERE ENDED, A NOTABLY LARGER PERCENTAGE OF
REVENUES ARE NOW A FUNCTION OF CAPITAL RETURNS RATHER THAN
COMMISSION INCOME. WLTH CAPITAL RISK THUS LESS PROTECTED BY A
CUSHION OF COMMISSION INCOME, THERE IS A TENDENCY FOR BLOCK
HOUSES AND SPECIALISTS TO BECOME MORE RISK AVERSE IN THEIR BIDS
DURING UNCERTAIN TIMES. THIS, TOO, CAN LEAD TO GREATER
VOLATILITY.
EVOLUTION IN THE FACE OF CHANGE IS NECESSARY
IF I MAY BE PERMITTED A PERSONAL COMMENT, I WOULD LIKE TO
POINT OUT THAT WHEN I STARTED IN WALL STREET IN 1951, A MILLION
SHARES TRADED ON THE NYSE IN ONE DAY WAS A BIG EVENT. WALL
STREET WAS LIKE A PRIVATE CLUB, AND A RATHER EXCLUSIONARY CLUB AT
THAT.
INDIVIDUALS
NO ONE
WERE
WORKED
AS IMPORTANT
TOO HARD,AS
COMPETITION
INSTITUTIONS,
WAS LIMITED,
THE U.S. ECONOMY

- 7-

WAS DOMINANT, AND THE NYSE WAS JHE MARKET OF THE WORLD. THERE IS
MORE THAN A LITTLE NOSTALGIA FOR THOSE TIMES THAT INFLUENCES
TODAY'S DEBATES ABOUT HOW MARKETS SHOULD FUNCTION. I WOULD
SUGGEST, HOWEVER, THAT THE WALL STREET OF AN EARLIER TIME ALSO
HAD ITS DRAWBACKS AND NEVER COULD HAVE ACCOMMODATED THE DEMANDS
OF A GROWING U.S. ECONOMY WITHOUT ITSELF CHANGING. THOSE CHANGES
CONTINUE, PARTICULARLY IN AN INTERNATIONALLY COMPETITIVE WORLD.
IT WOULD BE A MISTAKE TO FOCUS ONLY ON THE FALL-OUTS OF THOSE
FUNDAMENTAL CHANGES WHEN ATTEMPTING TO DETERMINE WHETHER
STRUCTURAL MODIFICATIONS ARE NEEDED FOR THE MARKETS THEMSELVES.
STRONG AGENCY AND SRO ACTION NEEDED AGAINST FRONTRUNNING AND
MARKET MANIPULATION
BEFORE I TURN TO OUR RECOMMENDATIONS, I WANT TO TAKE A
MINUTE TO COMMENT ON AN ISSUE ABOUT WHICH I FEEL STRONGLY.
VIRTUALLY ALL OF THE REPORTS VOICED CONCERNS ABOUT CUSTOMER
PROTECTION, PARTICULARLY IN THE AREAS OF INTERMARKET FRONTRUNNING
AND MARKET MANIPULATION. FOR EXAMPLE, THE BRADY REPORT
RECOMMENDED DEVELOPMENT OF AN EXTENSIVE TRADING INFORMATION
SYSTEM FOR THE STOCK MARKETS TO BETTER DIAGNOSE DEVELOPING
PROBLEMS AND UNCOVER ABUSES. THE COMMODITY FUTURES TRADING
COMMISSION (CFTC) STAFF URGED ESTABLISHMENT OF STANDARDS FOR
IDENTIFYING POTENTIAL INTERMARKET FRONTRUNNING TRADING PATTERNS
AND A MECHANISM -- PERHAPS THE INTERMARKET SURVEILLANCE GROUP -FOR THE TIMELY AND EFFECTIVE COMMUNICATION OF MARKET SURVEILLANCE
DATA RELATED TO POSSIBLE FRONTRUNNING ACTIVITY AMONG ALL
EXCHANGES WITH COMMON SELF-REGULATORY INTERESTS. THE SECURITIES
AND EXCHANGE COMMISSION (SEC) RECOMMENDED STRENGTHENING CURRENT
PROHIBITIONS AND WORKING WITH THE CFTC AND SELF-REGULATORY
ORGANIZATIONS (SROS) TO ENSURE THAT ADEQUATE INTERMARKET
INFORMATION IS AVAILABLE TO PURSUE SUCH MATTERS.
THE ADMINISTRATION FULLY AGREES THAT VIGOROUS ACTION AGAINST
PROBLEMS OF INTERMARKET FRONTRUNNING AND MARKET MANIPULATION IS
ESSENTIAL. ALONG WITH THE BENEFITS OF NEW PRODUCTS,
TECHNOLOGIES, AND TRADING STRATEGIES HAVE COME INCREASED
OPPORTUNITIES FOR ABUSE BY MARKET PROFESSIONALS AND INSIDERS.
THESE ABUSES HAVE HIDDEN ECONOMIC COSTS IN ADDITION TO THEIR MORE
OBVIOUS EFFECT ON SMALLER INDIVIDUAL AND INSTITUTIONAL INVESTORS
WHO COME TO BELIEVE THAT THE RULES ARE RIGGED AGAINST THEM. WE
DEPLORE THIS SITUATION AND EXPECT THE REGULATORS AND SROS, WHO
ARE IN THE BEST POSITION TO TAKE AFFIRMATIVE ACTION, TO CONTINUE
TO DO so. THEY ALREADY HAVE MADE SIGNIFICANT PROGRESS:
o THE CME HAS JUST CIRCULATED A PROPOSED DEFINITION OF
FRONTRUNNING TO FUTURES INDUSTRY REPRESENTATIVES;
o THE NYSE RECENTLY NOTIFIED ITS MEMBERS THAT TRADING
FUTURES BASED ON KNOWLEDGE OF IMPENDING ORDERS IN THE

- 8STOCK MARKET IS A VIOLATION OF EXCHANGE RULES. THE
NYSE PLANS TO PROVIDE THE FUTURES EXCHANGES WITH AUDIT
TRAIL INFORMATION ON STOCK TRADING THAT WOULD ENABLE
THE CHICAGO FUTURES MARKETS TO CONDUCT ONGOING
SURVEILLANCE FOR FRONTRUNNING; AND
o THE AMERICAN STOCK EXCHANGE (AMEX) HAS RECENTLY
IMPLEMENTED SYSTEMS TO AUTOMATICALLY MONITOR OPTION
TRADING FOR FRONTRUNNING, MINI-MANIPULATION, AND
PEGGING AND CAPPING. THE AMEX ALSO IS DEVELOPING AN
EXPERT SYSTEM WHICH USES ARTIFICIAL INTELLIGENCE
SOFTWARE TO ANALYZE POTENTIAL INSIDER TRADING MARKET
MANIPULATION CASES.
IT IS IN THE BEST INTEREST OF ALL INVESTORS CONCERNED THAT
THE PROBLEMS OF FRONTRUNNING AND MARKET MANIPULATION BE RESOLVED
QUICKLY AND EFFECTIVELY BY THE AGENCIES AND SROS. SUCH ACTION IS
CRUCIAL IF WE TAKE SERIOUSLY THE CHARGE THAT MARKETS ARE RIGGED
TO THE DISADVANTAGE OF THE SMALL INVESTOR.

RECOMMENDATIONS
LET ME NOW BRIEFLY SUMMARIZE THE WORKING GROUP'S
RECOMMENDATIONS AND CONCLUSIONS. OUR EFFORTS HAVE FOCUSED SO FAR
ON SIX SUBJECTS WHICH ARE DESCRIBED IN MORE DETAIL IN OUR REPORT
TO THE PRESIDENT.
1. CONTINUING COORDINATION
THE WORKING GROUP BELIEVES THAT ITS CONTINUATION IS AN
EXCELLENT WAY TO COORDINATE WHAT SHOULD BE AN ON-GOING PROCESS
TO ADDRESS INTERMARKET ISSUES. THE BRADY REPORT AND OTHERS HAVE
RECOMMENDED THAT SOME ADDITIONAL REGULATORY MECHANISM BE
ESTABLISHED TO RESOLVE THESE ISSUES. RECOGNIZING THIS CONCERN
FOR COORDINATION, WE BELIEVE COOPERATIVE EFFORTS UNDER THE
EXISTING REGULATORY STRUCTURE WILL CONTINUE TO BE EFFECTIVE, AND
IN LARGE MEASURE, FULFILL THE INTENT OF SEVERAL LEGISLATIVE
PROPOSALS. THE VERY EXISTENCE OF THIS GROUP HAS HELPED TO KEEP
THE PRESSURE ON THE VARIOUS SROS AND MARKET PARTICIPANTS TO
DEVISE AND IMPLEMENT NECESSARY REFORMS ON THEIR OWN.
2. CIRCUIT BREAKERS
IN ADDRESSING COORDINATED TRADING HALTS AND REOPENINGS, SOCALLED CIRCUIT BREAKERS, THE WORKING GROUP HAS FOCUSED ON MARKET
EVENTS THAT ARE SO DRAMATIC AS TO TRIGGER AD HOC CLOSINGS OF
EQUITY MARKETS AND TO POSE POTENTIAL SYSTEMIC RISKS TO OUR
FINANCIAL SYSTEM. THE WORKING GROUP HAS DEVISED A CROSS-MARKET
MECHANISM TO AVOID AD HOC AND DESTABILIZING MARKET BREAKS,
RECOGNIZING THAT ANY DISRUPTION OF TRADING IS UNDESIRABLE.

- 9-

OUR PROPOSAL IS DESIGNED TO SUBSTITUTE PLANNED FOR
UNPLANNED, AD HOC TRADING HALTS, WITHOUT INCREASING THE OVERALL
FREQUENCY OF SUCH DISRUPTIONS. PLANNED HALTS SHOULD ALLOW TIME
FOR THE DISSEMINATION OF INFORMATION AND CONSIDERATION OF
DECISION TO BUY OR SELL IN RARE SITUATIONS IN WHICH PANIC
CONDITIONS THREATEN.
3. PRUDENTIAL MARGIN REQUIREMENTS
THE WORKING GROUP REACHED AGREEMENT ON SEVERAL KEY POINTS
REGARDING PRUDENTIAL MARGINS AND CONCLUDED THAT:
0 CURRENT MINIMUM MARGIN REQUIREMENTS PROVIDE AN
ADEQUATE LEVEL OF PROTECTION TO THE FINANCIAL
SYSTEM, ALTHOUGH THEY DO NOT COVER ALL POSSIBLE
PRICE MOVEMENTS, AND THAT MARGINS SUFFICIENT TO
COVER ALL POSSIBLE PRICE MOVEMENTS WOULD HAVE
UNACCEPTABLE COSTS FOR THE LIQUIDITY AND
EFFICIENCY OF MARKETS;
0 THERE ARE ADDITIONAL PROTECTIVE CUSHIONS IN PLACE
FROM CAPITAL REQUIREMENTS AND SURVEILLANCE FOR
FIRMS AND CLEARINGHOUSES,* AND
0 GIVEN DIFFERENCES IN PRICE VOLATILITY OF STOCKS
AND INDEXES AND GRACE PERIODS FOR SETTLING
MARGINS, A CONSISTENT AND HARMONIOUS MARGIN
REGIME AMONG MARKETS WOULD PRODUCE SIGNIFICANTLY
HIGHER LEVELS OF MARGIN FOR STOCKS THAN FOR
FUTURES.
THE POSITIONS OF THE WORKING GROUP MEMBERS ON THE NEED FOR
MARGINS IN EXCESS OF THE PRUDENTIAL LEVEL, AND OF THE NEED FOR
FEDERAL OVERSIGHT, ARE SET FORTH IN THE REPORT TO THE PRESIDENT.
4. CREDIT, CLEARING, AND SETTLEMENT
As FORMER SENATOR NICHOLAS BRADY, WHO CHAIRED THE
PRESIDENT'S TASK FORCE ON MARKET MECHANISMS, INDICATED RECENTLY,
EXTREME STRESS ON OUR CLEARING AND CREDIT SYSTEMS CAME CLOSE TO
DAMAGING OUR FINANCIAL SYSTEM LAST OCTOBER. WHILE A COMPLICATED
AND TECHNICAL AREA, OUR FINANCIAL SYSTEM'S NETWORK OF CLEARING,
CREDIT, AND SETTLEMENT PROCEDURES TRULY IS THE NUTS-AND-BOLTS
THAT ALLOW HUNDREDS OF MILLIONS OF TRANSACTIONS TO BE CONDUCTED
AND FINANCED ON A DAILY BASIS.
THE WORKING GROUP HAS REVIEWED EXISTING CLEARING, PAYMENTS,
AND SETTLEMENT SYSTEMS TO IDENTIFY AND SET PRIORITIES FOR
MEASURES THAT THEY RECOMMEND BE TAKEN TO REDUCE UNCERTAINTY,

- 10 INCREASE COORDINATION, TO ASSURE CONFIDENCE IN THE INTEGRITY OF
SUCH SYSTEMS, AND TO FACILITATE THEIR SMOOTH OPERATION IN
VOLATILE MARKETS.
THE WORKING GROUP ENDORSES THE VIEW THAT THE PROPER
FUNCTIONING OF THESE SYSTEMS IS INTEGRAL TO THE PROPER
FUNCTIONING OF THE FINANCIAL MARKETS AS A WHOLE AND IS PLEASED TO
REPORT THAT SIGNIFICANT PROGRESS HAS BEEN MADE IN THIS AREA. AS
MORE FULLY SET FORTH IN THE REPORT TO THE PRESIDENT, THE WORKING
GROUP IS PROPOSING AN AGENDA OF ADDITIONAL MEASURES TO BE PURSUED
TO ACHIEVE THE GOAL OF MORE PERFECTLY COORDINATED SYSTEMS.
5. CONTINGENCY PLANNING
THE WORKING GROUP BELIEVES THAT THE PURPOSE OF CONTINGENCY
PLANNING IS TO ENSURE THAT REGULATORY AGENCIES AND THE SROS HAVE
IN PLACE SYSTEMS WHICH WILL ALLOW THEM TO IDENTIFY EMERGING
PROBLEMS QUICKLY AND TO REACT APPROPRIATELY IN THE EVENT OF A
MARKET CRISIS. IN AN IMPORTANT SENSE, THE WORKING GROUP
RECOMMENDATIONS FOR IMPLEMENTING CIRCUIT BREAKERS, IMPROVING
INFORMATION FLOWS, CLARIFYING CREDIT ARRANGEMENTS, AND
STRENGTHENING THE CLEARING AND SETTLEMENT PROCESS CAN BE VIEWED
AS A KEY PART OF CONTINGENCY PLANNING. BY IMPROVING THE MARKET
SYSTEM'S ABILITY TO WITHSTAND AND REACT TO SHOCKS, THESE MEASURES
WILL ENHANCE THE SYSTEM'S FIRST LINE OF DEFENSE.
GOING BEYOND THIS, THE WORKING GROUP HAS GIVEN HIGH PRIORITY
TO ENHANCING CHANNELS OF COMMUNICATION AMONG STAFFS OF THE
RESPECTIVE REGULATORY AGENCIES AND THE TREASURY. IN ADDITION,
STAFF OF THE THREE AGENCIES ARE WORKING JOINTLY TO IMPROVE
INFORMATION SHARING ACROSS THE AGENCIES, WITH PARTICULAR EMPHASIS
ON A FRAMEWORK FOR COORDINATED MONITORING OF EXPOSURES AND
DEVELOPMENTS AT MAJOR MARKET PARTICIPANTS. FINALLY, REGARDING
INTERNATIONAL POLICY COORDINATION, STEPS ARE BEING TAKEN BY THE
VARIOUS AGENCIES TO STRENGTHEN EXISTING CONTACTS WITH THEIR
COUNTERPART AUTHORITIES IN OTHER MAJOR MARKET CENTERS TO FURTHER
IMPROVE THIS ASPECT OF MARKET SURVEILLANCE.
6. CAPITAL ADEQUACY AND SYSTEMS CAPACITY ENHANCEMENT
MARKET PARTICIPANTS, SROS, AND REGULATORY AGENCIES HAVE
TAKEN OR ARE PLANNING A NUMBER OF SIGNIFICANT ACTIONS TO ENHANCE
FINANCIAL INTEGRITY AND IMPROVE AUTOMATED SYSTEMS -- TWO OF THE
ISSUES THE WORKING GROUP, THE BRADY REPORT, THE GAO AND OTHERS
HAVE IDENTIFIED AS CRITICAL TO THE FINANCIAL INTEGRITY AND SMOOTH
FUNCTIONING OF THE MARKETS.
OUR REPORT TO THE PRESIDENT CITES
THE MANY CONSTRUCTIVE STEPS ALREADY TAKEN IN THESE AREAS. THE
WORKING GROUP ENCOURAGES THESE EFFORTS AND WILL CONTINUE TO
MONITOR DEVELOPMENTS TO ENSURE THAT NEEDED IMPROVEMENTS ARE MADE.

- 11 CONCLUSIONS
IN SUMMARY, MR. CHAIRMAN AND MEMBERS OF THE SUBCOMMITTEE,
THE WORKING GROUP HAS COMMENCED ACTION ON A NUMBER OF SIGNIFICANT
STEPS THAT COLLECTIVELY WILL WORK TO REDUCE SYSTEMIC THREATS TO
OUR FINANCIAL MARKETS. IN SO DOING, WE HAVE PURSUED A SIZEABLE
PORTION OF THE AGENDA DEFINED IN LARGE MEASURE BY THE
PRESIDENTIAL TASK FORCE ON MARKET MECHANISMS, THE GAO, THE SEC,
THE CFTC AND OTHER MARKET OBSERVERS. INDEED, SENATOR BRADY
CONCLUDED HIS RECENT PUBLIC LETTER WITH A POSITION THAT IN FACT
HAS BEEN THE OPERATING BASIS OF THE WORKING GROUP:
WE ARE NOT ATTEMPTING TO LEGISLATE AGAINST DECLINE OR
INTERFERE WITH THE SMOOTH FUNCTIONING OF THE MARKETS.
THE MARKET WILL ALWAYS SEEK ITS LEVEL GROUND; WE ARE
ONLY TRYING TO ASSURE THAT IT GETS THERE SAFELY.
THE COLLECTIVE AND COORDINATED ACTIONS RECOMMENDED BY THE WORKING
GROUP -- AND CORRECTIVE STEPS ALREADY TAKEN BY OTHERS -- HELP TO
ASSURE THAT THE MARKET DOES IN FACT "GET THERE SAFELY" WHEN IT
MOVES FOR WHATEVER REASONS.
WE CANNOT LEGISLATE AGAINST MARKET DECLINES. REGULATORY
DICTATES CANNOT ELIMINATE VOLATILITY. EXECUTIVE FIAT IS NO MORE
EFFECTIVE. PRICE CONTROLS AND CAPITAL CONTROLS HAVE NEVER
WORKED EFFECTIVELY IN THIS COUNTRY AND NO AMOUNT OF GOVERNMENT
CONTROL CAN SWAY MARKETS IF UNDERLYING ECONOMIC FUNDAMENTALS -OR INVESTOR PERCEPTIONS OF THOSE SAME FUNDAMENTALS -- TAKE THE
MARKET ONE DIRECTION OR ANOTHER.
MOREOVER, IT IS UNREALISTIC AND ULTIMATELY COUNTERPRODUCTIVE
TO ATTEMPT TO ROLL BACK DEVELOPMENTS IN FINANCIAL MARKETS BROUGHT
ABOUT BY ADVANCEMENTS IN TELECOMMUNICATION AND COMPUTER
TECHNOLOGY AND BY CHANGES IN INVESTMENT NEEDS. WE CANNOT GO BACK
TO THE DAYS OF THE ABACUS OR MECHANICAL ADDING MACHINES. IF WE
DID -- BY TRYING TO LEGISLATE AGAINST PARTICULAR PRODUCTS OR
INVESTOR PREFERENCES OR MARKET STRATEGIES, FOR EXAMPLE -- THEN WE
WOULD ULTIMATELY LOSE WHATEVER COMPETITIVE EDGE WE NOW HAVE TO
PLACES LIKE TORONTO, TOKYO, OR LONDON.
MR. CHAIRMAN, I WOULD BE REMISS IF I DID NOT COMMEND THE
COOPERATIVE ACTIONS AND CONSTRUCTIVE DIALOGUE ON THE PART OF THE
WORKING GROUP MEMBERS. AS YOU REQUESTED AT OUR LAST HEARING, WE
HAVE SPENT CONSIDERABLE TIME AND ENERGY TO ARRIVE AT OUR INITIAL
RECOMMENDATIONS. THE MEMBERS OF THE WORKING GROUP HAVE
DEMONSTRATED THAT IT IS POSSIBLE TO ADDRESS MAJOR, COMPLEX ISSUES
IN A COOPERATIVE FASHION -- EVEN THOUGH WE BRING DIFFERENT

- 12 PERSPECTIVES AND PREFERENCES TO THE TABLE -- AND IN A REASONABLY
SHORT TIME FRAME. DISAGREEMENTS ON SOME MATTERS HAVE NOT BLOCKED
SIGNIFICANT AGREEMENTS THAT ARE APPARENT UPON CAREFUL EXAMINATION
OF THE PACKAGE WE HAVE PRESENTED TO THE PRESIDENT.
THE PUBLIC ALSO HAS BEEN WELL SERVED BY THE WORKING GROUP'S
HIGH CALIBER STAFF AND THEIR PROFESSIONAL ANALYSES, AND I SALUTE
THEM.
WE HAVE MADE PROGRESS ON BASIC ELEMENTS THAT ARE ESSENTIAL
TO THE SAFETY AND SOUNDNESS AGENDA THAT WE VIEW AS A PRIORITY.
MORE WORK WILL BE DONE, AND WE WELCOME THE CONTINUING CHALLENGE.

* * * * * * * * * * * * * *

TREASURY NEWS
Deportment off the Treasury • Washington, D.c. • Telephone 566-2041
Text as Prepared
For Release Upon Delivery
Expected at 10:00 a.m. EST
Testimony of James E. Ammerman
Director, Office of International Banking and Portfolio Investment
U.S. Department of the Treasury
before the
Committee on Banking, Housing and Urban Affairs
United States Senate
Washington, D.C.
May 20, 1988
Financial Services in the U.S.-Canada Free Trade Agreement
Mr. Chairman, I appreciate this opportunity to appear before
your Committee to discuss the Financial Services Chapter of the
Canada Free Trade Agreement (FTA). Let me say in advance that if
you, Mr. Chairman, or any members of your Committee, have any
questions which can't fully be answered this morning, I will be
more than happy to follow up.
The U.S.-Canada Free Trade Agreement is the most comprehensive
trade agreement ever negotiated between two countries, and it is
one that breaks new ground with respect to financial services,
other services, investment, and technology. The agreement on
financial services is by itself a landmark in that it is the first
binational agreement entered into by the United States covering
the entire financial sector. And the investment agreement is the
first of its type entered into by Canada with any country, as my
colleague, Mr. Canner, will shortly discuss.
The Financial Services Negotiations
Let me now turn to the Financial Services section of the Free
Trade Agreement and discuss its background, what it means and what
the implications are for the financial sectors in our two
countries.
Our objective in these negotiations was to make significant
progress in obtaining equality of competitive opportunity for U.S.
financial firms operating in or wishing to enter Canada. Put in
another way, we sought treatment equivalent to that accorded
domestic Canadian financial institutions. In a Treasury DepartB-1418

-2-

ment report prepared for this Committee in December 1986, we highlighted the barriers that existed in Canada's financial sector.
This document, the "National Treatment Study," served as the road
map in our quest for equal treatment for U.S. firms. We strove
for, and believe we have achieved, an agreement yielding highly
satisfactory results.
Mr. Chairman, let me now summarize the actual agreement and
the commitments made by each country.
Canadian Commitments
For the U.S., there will be a substantial removal of discriminatory treatment in Canada. U.S. commercial banks operating in
Canada will be relieved from onerous limits on their ability to
compete and grow. Currently, the domestic assets of foreign bank
subsidiaries operating in Canada (known as Schedule B banks) are
limited to 16 percent of all domestic assets of the Canadian
banking system. In addition, foreign bank subsidiaries face
individual capital and leveraging limits and other restraints such
as restrictions on the sale of loans to the parent bank. When the
Financial Services Chapter of the Free Trade Agreement goes into
effect, U.S. commercial bank subsidiaries in Canada will be exempt
from the current discriminatory restrictions on market share,
asset growth, and capital expansion, in the same way as Canadian
banks are exempt. U.S. commercial banks will also be allowed to
establish or acquire securities firms or federally-regulated
Canadian insurance and trust companies, again in the same manner
as Canadian banks.
In addition to helping U.S. commercial banks compete on a more
equal basis in Canada, the agreement also has substantial benefits
for U.S. financial institutions other than commercial banks. In
particular, all U.S. financial institutions will be better able to
grow and take full advantage of Canada's financial market liberalization due to removal of the so-called "10/25" rule. This rule
prevents a nonresident from acquiring more than a 10 percent
ownership interest in certain types of Canadian financial services
companies; a group of nonresidents is limited in the aggregate to
a 25 percent interest. Under current regulations, U.S. and other
foreign insurance companies have perhaps been the most disadvantaged because of the "10/25" rule; under this agreement, U.S.
firms will receive the same rights as Canadian companies to diversify in the financial sector by establishing or acquiring federally-regulated insurance companies, trust companies, Schedule B
banks, or securities firms.
While Ontario, Quebec, and other provinces have liberalized
their securities markets and have welcomed foreign investors, the
federal government implemented a policy of reciprocity which has
held up the applications for entry by U.S. securities firms and
banks. Under this agreement, these applications will be reviewed
strictly on a prudential basis, just as for Canadian firms, and
not on a reciprocity basis.

To summarize the Canadian commitments, U.S. commercial banks,
securities firms, insurance companies, and other financial institutions will be granted significantly better treatment that will
allow them to compete more effectively in Canada with domestic
firms.
U.S. Commitments
Under the agreement, the U.S. also made a number of specific
commitments. First, the U.S. agreed to guarantee the right of
Canadian banks to retain their multi-state branches in the United
States that were grandfathered under the International Banking Act
of 1978.
Second, if the Glass-Steagall Act is amended, we committed to
extend the same benefits we grant our own firms to Canadian financial institutions in the United States.
Third, in an effort to be responsive to reasonable Canadian
concerns regarding the treatment of U.S. subsidiaries of Canadian
banks and securities firms which merge in Canada, the U.S. agreed
to allow Canadian banks, as well as U.S. and other foreign banks,
in the United States to underwrite and deal in debt obligations
guaranteed by the Government of Canada, or its political subdivisions. This is a new measure for U.S., Canadian and other foreign
banks that is consistent with the existing ability of banks to
deal in securities of the U.S. Government or its political subdivisions .
Commitments by Both Countries
In addition to these specific measures, the United States and
Canada both made an important commitment to continue liberalizing
our markets and extending the liberalization to firms of the other
party after the Free Trade Agreement goes into effect, contingent
upon the other party fulfilling its commitment to liberalize. We
have established a formal consultative mechanism between the U.S.
Department of the Treasury and the Canadian Department of Finance
to oversee this liberalization and to resolve disputes arising
from commitments already concluded in the Financial Services Part
of the Free Trade Agreement.
Dispute Settlement for Financial Services
The Financial Services Chapter is excluded from the overall
FTA dispute settlement mechanism. In its place, we created a
consultative mechanism between the U.S. Treasury and the Canadian
Department of Finance to serve both as the vehicle for resolving
disputes and for seeking further liberalizations. We felt that a
different mechanism from that in the overall FTA was necessary in
the financial services area. In our view, financial services are
fundamentally different from most other services and from the
tradeable goods sector because prudential and regulatory concerns

— *i —

play such an important role. Accordingly, we tried to tailor a
consultation and dispute settlement mechanism that reflected the
different and special nature of the financial services sector.
I would be happy to answer any questions at this time.
Thank you very much.

TREASURY NEWS
Department of th« Treasury • Washington, D.c. • T«l«phon« 566-2041
Text as Prepared

Remarks by Secretary of the Treasury
James A. Baker, III
To the Council on Foreign Relations
Paris, France
Friday, May 20, 1988
Economic Policy Coordination and
International Monetary Reform
It is my privilege to join representatives of a group
that has done so much to promote international understanding
and cooperation in the 20th century. ^Tae Council on Foreign
Relations has a unique blend of scholarly and practical
perspectives which has made it an especially useful forum
for considering key issues in international affairs. So I'm
delighted to have a chance to discuss international economic
policy coordination and international monetary reform with
you today.
The Development of Economic Policy Coordination
We have just concluded the 1988 Ministerial meeting of
the OECD, an organization founded on the principle of close
cooperation among the industrial countries.
Economic cooperation takes many forms, of course. Today,
however, I would like to focus my remarks on economic policy
coordination — placing it in the context of the search, since
the second World War, for a better international monetary system.
This search led our predecessors to create the Bretton Woods
institutions and the post-war monetary system in the 1940s. They
put together and open trade and payments system that provided a
solid framework for growth and reconstruction.
Strains in the system emerged, however, in the late 1950s and
1960s prompting renewed efforts to improve it. These efforts
notwithstanding, the rigidities of the adjustment process under
the Bretton Woods system, along with divergences in economic
performance, ultimately res-ulted in the breakdown of the system
in the early 1970s.
B-1419

-2This led to an intensive effort to define a new international
monetary order. The huge imbalances which emerged following the
oil price increases of the early 1970s, however, terminated this
effort and thus was born the flexible or floating exchange rate
system. This system was based on the principle that global
growth and international economic stability basically derived
from sound domestic economic and financial policies in the major
countries, rather than external constraints imposed through rigid
exchange rates.
The principle was sound and remains valid today. But this
was not enough to make the new system effective. Its
implementation lacked a sense of direction and discipline.
There was no political mechanism to encourage needed policy
actions, and there were very few rules of the game. Countries
were able to focus on domestic objectives, without adequate
incentive to give due regard to international implications.
These weaknesses in the flexible rate system allowed the
development of large, unsustainable imbalances which threatened
continued global growth and financial stability.
Given these developments, interest in international monetary
reform began to grow once again in the early 1980s. Progress on
this front did not emerge, however, until efforts were initiated
in 1985 to strengthen international economic policy coordination
among the industrial countries. Why have these efforts to
strengthen coordination taken on added importance and urgency?
I would offer four main reasons why this might be the case:
o First, the global integration of capital markets and
increased trade linkages have heightened our awareness
of the interdependence of our economies. This, in turn,
reinforced the need to take international considerations
more into account when formulating domestic economic
policies.
o Second, it became increasingly clear that the flexible
rate system did not have mechanisms to identify problems
at an early stage and prompt efforts to resolve them.
Some discipline and structure were needed.
o Third, more and more people recognized that in spite of
the shortcomings of the flexible rate system, a return
to a rigid system of fixed rates was impractical. Thus,
coordination was a practical way forward that could avoid
the pitfalls of either extreme.
o Fourth, this effort went beyond the notion of international
economic cooperation which had characterized international
discussions for years, to the more demanding task of
coordination — entailing additional commitments to active
and close collaboration.

-3Against this background, enhanced international economic
coordination became a pragmatic approach to reforming and
strengthening the flexible or floating exchange rate system.
And now I think we have mustered the necessary political will
to give this process impetus and meaning.
Building the Process
The 1985 Plaza Agreement represented the first major step in
this coordination effort. It involved an agreement in the G-5
on the direction national economic policies and exchange rates
should take to facilitate growth and external adjustment. More
fundamentally, it represented a new commitment by the major
industrial countries to work together more intensely to achieve
global economic prosperity, and thereby to enable each country
to better achieve its own domestic objectives.
The success of the Plaza Agreement created momentum that
led to further progress. At the Tokyo Summit, we developed a
framework for multilateral surveillance of our economies using
economic indicators. The IMF Managing Director was invited to
participate in these meetings, thus assuring that a truly global
perspective is taken. Further, a new group was formed, the G-7,
in order to bring to bear the political leadership of the Heads
of State or Government on the coordination effort. This
commitment at the highest political levels has been crucial to
progress to date, and it will be essential for maintaining
momentum in the period ahead.
At the Venice Summit last year, the coordination process was
strengthened further by the adoption of arrangements involving
the development of medium-term objectives and performance
indicators to assess policies and performance.
Thus the major industrial countries have now developed a
political mechanism to enhance their ability to coordinate
economic policies. And although the process is still very young,
there is already ample evidence that it is bearing fruit. Both
fiscal and monetary policies are being framed in an international
as well as a domestic context. As a consequence, the United
States has taken measures to reduce the budget deficit, increase
domestic savings and improve competitiveness. The major surplus
countries, Japan and Germany, have taken steps to improve
domestic demand and reduce reliance on export-led growth.
There have been coordinated interest rate actions. Cooperation
in exchange markets has been intensified based on specific
understandings.
As a result, the world economy is on a much more solid
footing. Growth continues, but is now more balanced and is
supportive of the adjustment process. Inflation remains low,
and external imbalances are being reduced. The U.S. trade
figures for March provide evidence that these imbalances are
now declining in nominal as well as real terms.

-4The Louvre Accord and G-7 Statement of this past December
both marked important milestones in the coordination effort.
At the Louvre, we strengthened our commitments on underlying
policies, while promoting greater exchange rate stability.
This has produced results which furthered the credibility of
the process.
The coordination process was seriously tested this fall in
the wake of the October stock market crash. It would have been
easy for each of us to turn inward, and focus on short-term
measures to address immediate domestic needs. Instead, the G-7
pulled together and intensified its efforts to find a compatible
and reinforcing set of policies to achieve common goals. These
efforts (which were conducted privately between Ministers and
Governors over a period of weeks) were reflected in the December
statement of the G-7, thereby demonstrating the resilience of the
coordination process in the face of adversity. Since that time,
strengthened underlying policy actions have been reflected in
enhanced stability of exchange markets.
Strengthening Coordination and Reforming the System
As this process of coordination has been developing,
questions continue to be raised about the need for "more
fundamental monetary reform." This is-natural. We certainly
do not have a perfect monetary system, nor total coordination
of our policies. We cannot afford to rest on our laurels and
become complacent. We need further strengthening and reform
of the system, but what form and direction should this take?
It is tempting, and in fact can be instructive, to consider
sweeping, revolutionary changes in the system — particularly
the exchange rate part of the system. But it is far from
clear that such changes are desirable or practical.
While it may be difficult to recognize reform when it
emerges gradually in a step-by-step fashion, I think that
further strengthening of our process of coordination is the
best means of achieving further reform of the monetary system.
What are the characteristics of this step-by-step or
incremental approach to monetary reform which make it the best
option available?
o First, it combines flexibility with greater commitment
and obligation. Countries have committed to this process
at the highest political level, and they have obligations
to develop medium-term economic objectives, along with
performance indicators to assess progress toward the
objectives. At the same time, it involves no ceding of
sovereignty.
o Second, it recognizes that reform of the system is not
simply a matter of exchange rates or reserve assets.
Exchange rates certainly are a key variable. Ultimately,
however, the test of an international monetary system is
whether it can help foster an open and growing world
economy. This involves appropriate fiscal, monetary and
structural policies as well as exchange rates. The
indicator
system we have developed covers this full range
of
policies.

-5o

Third, the system can encourage corrective policy action
through the use of indicators and peer pressure without
relying on automatic trigger devices.
o Fourth, the burden of adjustment is not biased toward or
away from domestic policies or exchange rates, as was the
case in the par value and early flexible rate regimes,
respectively. In 1985 and 1986, coordination stressed the
role of exchange rates. In 1987 and so far in 1988, the
emphasis has shifted to changes in underlying policies.
It is no mean feat that this shift was conducted without
a major breakdown in the system.
o Fifth, the coordination and indicator process contains
symmetry by focusing on surplus as well as deficit
countries. Symmetry is a long sought after — and
necessary — element in international monetary
arrangements. Efforts to build it into the system through
various automatic techniques have failed in the past, and
would likely fail again. In contrast, the indicator
system now in place provides a structured but judgmental
framework for accessing the need for actions by deficit
and surplus countries alike.
This brings me to the sixth and final attribute that I
would cite — credibility. In today's era of global economic
integration and instant communications, credibility is key.
An attempt to make an abrupt or major change in the structure
of the system by imposing a detailed set of formal constraints
might well be viewed by the markets as overly ambitious and
unsustainable, and such an approach might not give adequate
regard to political realities or the force of financial flows.
The global economy is too dynamic, and the forces of change
too strong, to be able to look ahead with great certainty and
envision a highly defined international monetary structure that
will fit the world economy of 1995 as well as that of 2005.
We must therefore move cautiously but steadily ahead, always
alert to further improvements in the process and the system. In
this connection, the major industrial countries agreed last month
to develop a commodity price indicator. This indicator will
supplement the existing national indicators in assessing and
reaching judgments about economic policies and performance. It
will be used as an analytical tool in examining global price
trends, not as an automatic trigger for policy action or an
anchor for currencies.
We will need to continue to consider other measures to
advance coordination on a step-by-step basis and to further
institutionalize the process.
o For instance, we need to consider broadening the
coordination process to cover structural reform. The
Summit countries are identifying priority areas where
structural reforms need to be pursued. These include such
areas as tax reform, financial market liberalization, and
deregulation of labor markets.

-6o

We should refine the means of assessing whether an
economy's performance is significantly deviating from an
appropriate path, suggesting the need for consultation and
possible actions. This might involve consideration of
"monitoring zones" for key indicators such as growth,
trade balances and so forth.
Conclusion
So to conclude, I would submit that our process of
international economic policy coordination has reformed and
strengthened the floating rate system. We have created a
political mechanism that has brought discipline and structure
to international economic policy-making. And our approach has
worked — not perfectly of course. But I strongly suspect the
world economy is better off today than we would have been had
we not followed this course. And I think additional progress
will be achieved in the future.
Many of those who earlier had doubted this process have seen
its benefits. As a result, coordination now has broader support
and momentum that should carry it into the future, well beyond
the terms of current administrations in the G-7 countries.
We have come a long way in a few short years, and policy
coordination should provide a sound framework for achieving
Thank you.
meaningful
and effective reform during the years ahead.

TREASURY NEWS

Department off the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT:

FOR IMMEDIATE RELEASE
May 23, 1988

Office of Financing
202/376-4350

RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $6,420 million of 13-week bills and for $6,425 million
of 26-week bills, both to be issued on
May 26, 1988,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13- -week bills
maturing August 25, 1988
Discount Investment
Rate
Rate 1/
Price 6.33%
6.34%
6.34%

6.52%
6.53%
6.53%

26- -week bills
maturing November 25, 1988
Discount Investment
Rate
Rate 1/
Price

98.400
98.397.
98.397

6.69%
6.71%
6.71%

7.02%
7.04%
7.04%

96.599
96.589
96.589

Tenders at the high discount rate for the 13-week bills were allotted 86%
Tenders at the high discount rate for the 26-week bills were allotted 35%
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
Accepted
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Accepted

$
38,415
23,751,135
26,490
37,005
47,500
29,700
1,882,850
18,470
6,095
40,190
37,210
1,524,320
330,765

$
38,395
5,593,280
26,490
36,930
32,500
29,700
54,150
18,470
6,095
36,540
27,210
189,320
330,765

$
25,205
21,281,615
17,695
28,615
132,065
26,085
1,079,445
17,900
8,425
34,065
28,110
1,104,960
333,060

$
25,205
5,702,365
15,695
28,615
67,065
26,085
55,195
17,900
8,425
34,065
18,110
93,460
333,060

$27,770,145

$6,419,845

. $24,117,245

$6,425,245

$24,337,105
939,955
$25,277,060

$2,986,805
939,955
$3,926,760

$19,427,200
>'
778,545
: $20,205,745

$1,735,200
778,545
$2,513,745

2,437,885

55,200

$27,770,145

$6,419,845

1/ Equivalent coupon-issue yield.

R-1420

Received

2,100,000

•

1,811,500

: $24,117,245

$6,425,245

TREASURY NEWS

Dtpartment off the Treasury • Washington, D.C. • Telephone 566-2041

Text as Prepared
For Release Upon Delivery
Expected at 2:00 p.m. EST
Testimony of Thomas J. Berger
Deputy Assistant Secretary for International Monetary Affairs
U.S. Department of the Treasury
before the
Committee on Banking, Finance and Urban Affairs
United States House of Representatives
Washington, D.C.
May 24, 1988
Financial Services in the U.S.-Canada Free Trade Agreement
Mr. Chairman, I appreciate this opportunity to appear before
your Committee to discuss the Financial Services Chapter of the
Canada Free Trade Agreement (FTA). Let me say in advance that if
you, Mr. Chairman, or any members of your Committee, have any
questions which can't fully be answered this morning, I or my
staff will be more than happy to follow up.
The U.S.-Canada Free Trade Agreement is the most comprehensive
trade agreement ever negotiated between two countries, and it is
one that breaks new ground with respect to financial services,
other services, investment, and technology. The agreement on
financial services is by itself a landmark in that it is the first
binational agreement entered into by the United States covering
the entire financial sector. And the investment agreement is the
first of its type entered into by Canada with any country, as my
colleague, Mr. Cornell, will shortly discuss.
The Financial Services Negotiations
Let me now turn to the Financial Services section of the Free
Trade Agreement and discuss its background, what it means and what
the implications are for the financial sectors in our two
countries.
Our objective in these negotiations was to make significant
progress in obtaining equality of competitive opportunity for U.S.
financial firms operating in or wishing to enter Canada. Put in
another way, we sought treatment equivalent to that accorded
domestic Canadian financial institutions. In a Treasury DepartB-1421

-2-

ment report prepared for the Congress in December 1986, we highlighted the barriers that existed in Canada's financial sector.
This document, the so-called "National Treatment Study," served as
our road map in our quest for equal treatment for U.S. firms. We
strove for, and believe we have achieved, an agreement yielding
highly satisfactory results.
Mr. Chairman, let me now summarize the actual agreement and
the commitments made by each country.
Canadian Commitments
For the U.S., there will be a substantial removal of discriminatory treatment in Canada. U.S. commercial banks operating in
Canada will be relieved from onerous limits on their ability to
compete and grow. Currently, the domestic assets of foreign bank
subsidiaries operating in Canada (known as Schedule B banks) are
limited to 16 percent of all domestic assets of the Canadian
banking system. In addition, foreign bank subsidiaries face
individual.capital and leveraging limits and other restraints such
as restrictions on the sale of loans to the parent bank. When the
Financial Services Chapter of the Free Trade Agreement goes into
effect, U.S. commercial bank subsidiaries in Canada will be exempt
from the current discriminatory restrictions on market share,
asset growth, and capital expansion, in the same way as Canadian
banks are exempt. U.S. commercial banks will also be allowed to
establish or acquire securities firms or federally-regulated
Canadian insurance and trust companies, again in the same manner
as Canadian banks.
In addition to helping U.S. commercial banks compete on a more
equal basis in Canada, the agreement also has substantial benefits
for U.S. financial institutions other than commercial banks. In
particular, all U.S. financial institutions will be better able to
grow and take full advantage of Canada's financial market liberalization due to removal of the so-called "10/25" rule. This rule
prevents a nonresident from acquiring more than a 10 percent
ownership interest in certain types of Canadian financial services
companies; a group of nonresidents is limited in the aggregate to
a 25 percent interest. Under current regulations, U.S. and other
foreign insurance companies have perhaps been the most disadvantaged because of the ^10/25" rule; under this agreement, U.S.
firms will receive the same rights as Canadian companies to diversify in the financial sector by establishing or acquiring federally-regulated insurance companies, trust companies, Schedule B
banks, or securities firms.
While Ontario, Quebec, and other provinces have liberalized
their securities markets and have welcomed foreign investors, the
federal government implemented a policy of reciprocity which has
held up the applications for entry by U.S. securities firms and
banks. Under this agreement, these applications will be reviewed
strictly on a prudential basis, just as for Canadian firms, and
not on a reciprocity basis.

-3-

To summarize the Canadian commitments, U.S. commercial banks,
securities firms, insurance companies, and other financial institutions will be granted significantly better treatment that will
allow them to compete more effectively in Canada with domestic
firms.
U.S. Commitments
Under the agreement, the U.S. also made a number of specific
commitments. First, the U.S. agreed to guarantee the right of
Canadian banks to retain their multi-state branches in the United
States that were grandfathered under the International Bankinq Act
of 1978.
Second, if the Glass-Steagall Act is amended, we committed to
extend the same benefits we grant our own firms to Canadian financial institutions in the United States.
Third, in an effort to be responsive to reasonable Canadian
concerns regarding the treatment of U.S. subsidiaries of Canadian
banks and securities firms which merge in Canada, the U.S. agreed
to allow Canadian banks, as well as U.S. and other foreign banks,
in the United States to underwrite and deal in debt obligations
guaranteed by the Government of Canada, or its political subdivisions. This is a new measure for U.S., Canadian and other foreign
banks that is consistent with the existing ability of banks to
deal in securities of the U.S. Government or its political subdivisions .
Commitments by Both Countries
In addition to these specific measures, the United States and
Canada both made an important commitment to continue liberalizing
our markets and extending the liberalization to firms of the other
party after the Free Trade Agreement goes into effect, contingent
upon the other party fulfilling its commitment to liberalize. We
have established a formal consultative mechanism between the U.S.
Department of the Treasury and the Canadian Department of Finance
to oversee this liberalization and to resolve disputes arising
from commitments already concluded in the Financial Services Part
of the Free Trade Agreement.
Dispute Settlement for Financial Services
The Financial Services Chapter is excluded from the overall
FTA dispute settlement mechanism. In its place, we created a
consultative mechanism between the U.S. Treasury and the Canadian
Department of Finance to serve both as the vehicle for resolving
disputes and for seeking further liberalizations. We felt that a
different mechanism from that in the overall FTA was necessary in
the financial services area. In our view, financial services are
fundamentally different from most other services and from the
tradeable goods sector because prudential and regulatory concerns

-4-

TREASURY NEWS

Deportment
off theUPON
Treasury
FOR RELEASE
DELIVERY• Washington, D.c. • Telephone 566-2041
Expected at 10:00 A.M., EDT

TESTIMONY OF THE HONORABLE
GEORGE D. GOULD
UNDER SECRETARY FOR FINANCE
U.S. DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
TUESDAY, MAY 24, 1988
Good morning, Mr. Chairman, Senator Garn, and Members of the
Committee. It is a pleasure for me to testify on the progress
made by the President's Working Group on Financial Markets.
During the past two months, the principal members of the
Working Group and our respective staffs have analyzed and
discussed the extensive information and recommendations
emanating from last October's market decline. Far from being a
stalling device as some have criticized, the Working Group has
moved forward, after much deliberation, on a number of critical
issues to preserve the integrity, competitiveness and efficiency
of our nation's financial markets.
Our focus has been on positive actions that can be taken now
— immediately — as contrasted with possible legislative
restructuring that is subject to protracted debate and possible
delay. Fortunately, the Working Group identified ways to act
affirmatively, without legislation. Although this Committee has
an enviable record of moving legislation, Mr. Chairman — as
witnessed by the 94 to 2 vote on the Proxmire Financial
Modernization Act — the Members of this Committee will recall
that it took two years to enact the Administration's proposal to
recapitalize the Federal Savings and Loan Insurance Corporation.
Even then, we did not get the full amount requested to resolve
insolvent institutions and today we hear numerous cries for a
taxpayer bailout.
Collectively, the Working Group's action proposals address
basic safety and soundness issues, should lessen the risk of
systemic problems, and as a result, work to the benefit of all
investors. The key issues ~ identified by the Brady Commission,
the General Accounting Office (GAO), the Securities and Exchange
Commission (SEC), the Commodity Futures Trading Commission
(CFTC), and others — on which the Working Group has agreed
unanimously and has taken constructive action include:
o an agreement on coordinated "circuit breakers"
across markets to allow for cooling-off periods
during times of extreme price declines;
B-1422

- 2 -

recommendations and conclusions on the
credit, clearing, and payments system to
ensure the necessary coordination of
information and operations within and between
markets and to avoid systems gridlock;
o agreement that current minimum margin requirements
provide an adequate level of prudential protection to
the financial system; and
o agreement on contingency planning, including
the continuation of the Working Group, to
ensure coordination and consultation in the
event of future, rapid market disturbances.
I also am pleased to report that the securities, futures,
and options industries already are making — and should continue
to make — significant efforts to enhance operational capacity,
to increase individual firm and clearinghouse capital, and to
improve the fairness and quality of order executions for all
investors, large and small.
THE MEED TO REDUCE SYSTEMIC PROBLEMS
The specific conclusions and recommendations are contained
in the Working Group's interim report to the President, which
accompanies my testimony. It is essential, however, to
understand the premise from which these conclusions evolved.
The Working Group views its primary mission as taking
collective, safety and soundness actions which would
substantially lessen possible systemic dangers to the U.S.
financial system if we were again to encounter a severe stock
market decline. Consequently, the Working Group — acting on the
most significant suggestions of the Brady Report and others —
views coordinated circuit breakers, prudential margins across
markets, the proper functioning of credit, clearing, and payment
systems, and contingency planning as key ingredients to prevent
stock market declines from degenerating into self-feeding panics.
While markets will always react to changes in fundamental
economic information, it is important to assure all investors as
to the proper functioning of the financial system while such
information is being digested in terms of market pricing.
Indeed, reducing concerns over the viability of the mechanics and
infrastructure of the system could mitigate the extent of market
declines by reducing the risk premium inherent in those extreme
situations where market participants worry about receiving full
and timely payments. Hence, our emphasis on safety and soundness
issues first during these past 60 days.

3 -

Daily Volatility Is Not A Systemic Threat
The issue of daily volatility, although an expressed public
concern, is not in the category of systemic threat, in my
opinion. However disconcerting such volatility can be on a
short-term basis, it is important not to attempt cures that can
do more harm than good. Markets must be allowed to adjust to new
price levels without impediments to efficiency that in themselves
cause disruptive market action. Narrow price limits for circuit
breakers, causing frequent market shut downs, would be an example
of such self-defeating "cures11.
Moreover, volatility is a subject which often has been
treated publicly with more emotion than analysis. It must be
noted that, with the exception of the period October 1987 through
January 1988, there is no evidence of any increase in daily
volatility. Volatility from 1983 through 1986, during which time
the futures market was growing rapidly, was moderate to low as
compared to similar prior periods. This is illustrated in
Exhibit A. I should note that since February 1988, daily price
volatility has returned to levels such as were seen in 1973,
1974, 1975, 1980, and 1982, and which are statistically
indistinguishable from the norm for 1971 through 1986. In any
case, we must be cautious in ascribing events of those few months
of extraordinary volatility to changes which have been in place
for some time or in extrapolating that those events will be the
new norm in the future.
Some observers believe the individual investor has left the
market because of a perception of increased volatility.
It is
equally possible that much of the retreat is in fact investors'
collective views that the bull market has paused or that more
attractive alternative investments are available. Individual
investors have "left the market" in the wake of other major
market declines (e.g., in the mid 1970s). Those individuals who
want to own equities but are concerned about competing with
large, sophisticated pools of capital can, if they wish, invest
through them (e.g., mutual funds and pension funds) rather than
trying to compete with them.
We must recognize that investor withdrawal during such bear
markets is a fact of life, reaffirmed recently in a New York
Times article which states in part:
Investor disillusionment with the stock market is not
a new phenomenon. Typically, investors withdraw each
time there is a bear market — contributing to the
bleak mood. After the almost 50 percent drop in the
value of stocks during the 1973-74 bear market, for

- 4

instance, many individuals fled the market and stayed
out until the bull market of the 1980's.
The number of individual shareholders who owned stocks
on the New York Stock Exchange fell to 25.2 million in
1975 from 30.8 million in 1970. The number of
shareholders of mutual funds dropped to 7.8 million in
1980 from 8.4 million in 1970, according to estimates
by the Investment Company Institute.
Numerous Factors Cause Markets to React More Quickly Today
There are numerous factors that have made markets react
more quickly today to changes in the fundamental determinants of
stock prices. First, the nature of stock ownership has changed
substantially over the past twenty years, led by private and
public pension funds. There have evolved very large individual
aggregations of capital of a size unknown in an earlier period.1/
This, in turn, has led to changes in the techniques of managing
such capital, often with an emphasis on the market as a whole
(e.g., the S&P 500) rather than individual stocks. In the case
of major broker/dealers, the need for trading liquidity by large
bodies of capital has also increased the need for hedging
techniques by corporate treasurers and money managers. Thus, the
stock index futures markets have evolved as the lowest cost, most
efficient response to these changed needs. "Trading the market"
and hedging are not in and of themselves either good or bad —
they are economic facts that are not going to go away.2/
It is not the futures products themselves that are called
into question; rather, it is the behavior of large institutional
investors and large traders (e.g., Fortune 500 companies, union
pension funds, mutual funds, etc.) that comes into play. I must
admit, too, that I have some difficulty in my own mind when it
comes to legislating behavior modifications of that magnitude.
1/
At the end of 1987, U.S. private pension fund assets
totalled almost $1.5 trillion and U.S. public pension fund
assets were approximately another $500 billion. By
comparison, total pension fund assets were approximately
$820 billion at the end of 1980.
2/ 1987 statistics for the largest 200 pension funds show that
a growing percentage of their assets (11.8%) is in stock
index funds. A growing percentage of these pension funds
(36%) also uses stock index futures.

Second, benefits of active futures markets are real: for
example, they apply directly to the Treasury securities market.
Treasury futures are used as hedging vehicles and as a costsaving means to adjust positions in the underlying securities.
These risk-reducing benefits of futures markets lead to a
reduction of the risk premium investors require on the underlying
Treasury securities and thus to lower interest costs for the
Federal Government.
For an excellent discussion of the increasingly significant
role of derivative products — particularly futures on stock
indexes — in the securities markets, members of the subcommittee
really should review Chapter Three of the SEC's Staff Report "The
Effects of Derivative Products" (The October 1987 Market Break)
which I have attached as Exhibit B of my statement.
Third, with the index futures markets having exhibited
greater volume in the underlying stocks than the cash market
exchanges, it can be argued that the Chicago Mercantile Exchange
(CME) has become a leader — rather than a follower — in price
discovery of equity market value levels. Cash market prices are
now often following, rather than leading, the so-called
derivative market. The Brady Report and others have underscored
the close economic linkage between these markets. Thus, the
public debate over the role of index arbitrage is often
misdirected. Index arbitrage only takes place when there is a
difference of price level between the cash and futures markets,
and such arbitrage, as in its age old role, helps equate those
price levels.
Fourth, while it is true that index arbitrage can translate
buying or selling pressure from one market to another, if those
markets are truly economically linked and responding to the same
fundamentals, then such arbitrage serves the useful purpose of
quickly equalizing the price levels between the markets. It is
worth noting in this context that the proposal of the New York
Stock Exchange (NYSE) for trading baskets of stock on the NYSE
would itself produce "index arbitrage" between the value of the
basket and the underlying stocks — but this arbitrage would be
within the NYSE. What often is overlooked in discussions of
arbitrage is that if there were no linkage of the markets, then
more selling or buying could spill over into the cash markets
directly. If the futures market were to disappear from this
country, pressures on the stock market would only increase. The
Brady Report takes note of such selling when the linkage broke
down in October.
Much public criticism of index arbitrage is a classic case
of wanting "to shoot the messenger" that brings the bad news of
selling on the CME to the floor of the NYSE. If selling is

- 6

going to take place to a degree that pushes prices down sharply,
then cash markets will not be made immune by eliminating index
arbitrage. The emphasis, therefore, should be on increasing the
capacity of systems like the Designated Order Turnaround (DOT)
system of the NYSE so that the public has fair and equal access
to order transmission, rather than on restricting mechanical
linkages between economically-linked markets.
Put another way, if there were no index futures market,
then there would be no index arbitrage. But there is no evidence
that such a condition would give the cash markets immunity from
selling pressure generated by responses to fundamental events —
and no likelihood that having developed to meet a large and
important investment need there will not be a viable index
futures market, whether here or abroad.
Fifth, the volatility many people blame on index arbitrage
could also be evident from direct selling in the cash market.
In fact, pressures directly on cash markets are clear from
history. Earlier in the postwar periods before the index futures
markets came into existence in 1982, the Dow Jones Industrial
Average (DJIA) had a number of significant declines as outlined
in Exhibit C of my testimony. In fact, the 1973-74 bear market
was worse than the 1987 decline; while it took longer, the end
result was that price levels reacted to fundamental perceptions
and adjusted accordingly. While individual share ownership is an
important part of our financial system and should be encouraged,
we cannot expect to be able to legislate normal human behavior —
any more than we should be expected to protect the revenues of
brokerage firms by attacking symptoms rather than causes.
Sixth, the aggregation of capital is a factor in today's
global markets, just as the phenomenon of rapid information
dissemination also is important to recognize. The world now has
the technological systems — and therefore the ability
for
almost instantaneous response to any event. This provides
another type of aggregation in the form of concerted buying or
selling. While market liquidity has increased greatly in recent
years, clearly some greater volatility can be intrinsic to
concerted action. Eliminating information technology — either
by legislation or regulatory fiat — hardly seems like a
realistic reaction to concerns about volatility.
Finally, the Wall Street broker/dealer/specialist business
has become increasingly capital-intensive. Since 1975, when
fixed-rate commissions were ended, a notably larger percentage of
revenues are now a function of capital returns rather than
commission income. With capital risk thus less protected by a
cushion of commission income, there is a tendency for block

- 7 -

houses and specialists to become more risk averse in their bids
during uncertain times. This, too, can lead to greater
volatility.
Evolution in the Face of Change is Necessary
If I may be permitted a personal comment, I would like to
point out that when I started in Wall Street in 1951, a million
shares traded on the NYSE in one day was a big event. Wall
Street was like a private club, and a rather exclusionary club at
that. No one worked too hard, competition was limited,
individuals were as important as institutions, the U.S. economy
was dominant, and the NYSE was the market of the world. There is
more than a little nostalgia for those times that influences
today's debates about how markets should function.
I would suggest, however, that the Wall Street of an earlier
time also had its drawbacks and never could have accommodated the
demands of a growing U.S. economy without itself changing. Those
changes continue, particularly in an internationally competitive
world. It would be a mistake to focus only on the fall-outs of
those fundamental changes when attempting to determine whether
structural modifications are needed for the markets themselves.
Strong Agency and SRO Action Needed Against Frontrunning and
Market Manipulation
Before I turn to our recommendations, I want to take a
minute to comment on an issue about which I feel strongly.
Virtually all of the reports voiced concerns about customer
protection, particularly in the areas of intermarket frontrunning
and market manipulation. For example, the Brady Report
recommended development of an extensive trading information
system for the stock markets to better diagnose developing
problems and uncover abuses. The CFTC staff urged establishment
of standards for identifying potential intermarket frontrunning
trading patterns and a mechanism — perhaps the Intermarket
Surveillance Group — for the timely and effective communication
of market surveillance data related to possible frontrunning
activity among all exchanges with common self-regulatory
interests. The SEC recommended strengthening current
prohibitions and working with the CFTC and self-regulatory
organizations (SROs) to ensure that adequate intermarket
information is available to pursue such matters.
The Administration fully agrees that vigorous action against
problems of intermarket frontrunning and market manipulation is
essential. Along with the benefits of new products,
technologies, and trading strategies have come increased
opportunities for abuse by market professionals and insiders.

- 8

These abuses have hidden economic costs in addition to their more
obvious effect on smaller individual and institutional investors
who come to believe that the rules are rigged against them. We
deplore this situation and expect the regulators and SROs, who
are in the best position to take affirmative action, to continue
to do so. They already have made significant progress:
o The CME has just circulated a proposed definition of
frontrunning to futures industry representatives;
o The NYSE recently notified its members that trading
futures based on knowledge of impending orders in the
stock market is a violation of exchange rules. The
NYSE plans to provide the futures exchanges with audit
trail information on stock trading that would enable
the Chicago futures markets to conduct ongoing
surveillance for frontrunning; and
o The American Stock Exchange (Amex) has recently
implemented systems to automatically monitor option
trading for frontrunning, mini-manipulation, and
pegging and capping. The Amex also is developing an
expert system which uses artificial intelligence
software to analyze potential insider trading market
manipulation cases.
It is in the best interest of all investors concerned that
the problems of frontrunning and market manipulation be resolved
quickly and effectively by the agencies and SROs. Such action is
crucial if we take seriously the charge that markets are rigged
to the disadvantage of the small investor.
RECOMMENDATIONS
Let me now briefly summarize the Working Group's
recommendations and conclusions. Our efforts have focused so far
on six subjects which are described in more detail in our report
to the President.
1. Continuing Coordination
The Working Group believes that its continuation is an
excellent way to coordinate what should be an on-going process
to address intermarket issues. The Brady Report and others have
recommended that some additional regulatory mechanism be
established to resolve these issues. Recognizing this concern
for coordination, we believe cooperative efforts under the
existing regulatory structure will continue to be effective, and
in large measure, fulfill the intent of several legislative
proposals. The very existence of this group has helped to keep

- 9

the pressure on the various SROs and market participants to
devise and implement necessary reforms on their own.
2. circuit Breakers
In addressing coordinated trading halts and reopenings, socalled circuit breakers, the Working Group has focused on market
events that are so dramatic as to trigger ad hoc closings of
equity markets and to pose potential systemic risks to our
financial system. The Working Group has devised a cross-market
mechanism to avoid ad hoc and destabilizing market breaks,
recognizing that any disruption of trading is undesirable.
Our proposal is designed to substitute planned for
unplanned, ad hoc trading halts, without increasing the overall
frequency of such disruptions. Planned halts should allow time
for the dissemination of information and consideration of
decision to buy or sell in rare situations in which panic
conditions threaten.
3. Prudential Margin Requirements
The Working Group reached agreement on several key points
regarding prudential margins and concluded that:
o current minimum margin requirements provide an
adequate level of protection to the financial
system, although they do not cover all possible
price movements, and that margins sufficient to
cover all possible price movements would have
unacceptable costs for the liquidity and
efficiency of markets;
o there are additional protective cushions in place
from capital requirements and surveillance for
firms and clearinghouses; and
o given differences in price volatility of stocks
and indexes and grace periods for settling
margins, a consistent and harmonious margin
regime among markets would produce significantly
higher levels of margin for stocks than for
futures.
The positions of the Working Group members on the need for
margins in excess of the prudential level, and of the need for
federal oversight, are set forth in the report to the President.

10 -

Credit, Clearing, and Settlement

As former Senator Nicholas Brady, who chaired the
President's Task Force on Market Mechanisms, indicated recently,
extreme stress on our clearing and credit systems came close to
damaging our financial system last October. While a complicated
and technical area, our financial system's network of clearing,
credit, and settlement procedures truly is the nuts-and-bolts
that allow hundreds of millions of transactions to be conducted
and financed on a daily basis.
The Working Group has reviewed existing clearing, payments,
and settlement systems to identify and set priorities for
measures that they recommend be taken to reduce uncertainty,
increase coordination, to assure confidence in the integrity of
such systems, and to facilitate their smooth operation in
volatile markets.
The Working Group endorses the view that the proper
functioning of these systems is integral to the proper
functioning of the financial markets as a whole and is pleased to
report that significant progress has been made in this area. As
more fully set forth in the report to the President, the Working
Group is proposing an agenda of additional measures to be pursued
to achieve the goal of more perfectly coordinated systems.
5. Contingency Planning
The Working Group believes that the purpose of contingency
planning is to ensure that regulatory agencies and the SROs have
in place systems which will allow them to identify emerging
problems quickly and to react appropriately in the event of a
market crisis. In an important sense, the Working Group
recommendations for implementing circuit breakers, improving
information flows, clarifying credit arrangements, and
strengthening the clearing and settlement process can be viewed
as a key part of contingency planning. By improving the market
system's ability to withstand and react to shocks, these measures
will enhance the system's first line of defense.
Going beyond this, the Working Group has given high priority
to enhancing channels of communication among staffs of the
respective regulatory agencies and the Treasury. In addition,
staff of the three agencies are working jointly to improve
information sharing across the agencies, with particular emphasis
on a framework for coordinated monitoring of exposures and
developments at major market participants. Finally, regarding
international policy coordination, steps are being taken by the

11 -

various agencies to strengthen existing contacts with their
counterpart authorities in other major market centers to further
improve this aspect of market surveillance.
6. Capital Adequacy and Systems Capacity Enhancement
Market participants, SROs, and regulatory agencies have
taken or are planning a number of significant actions to enhance
financial integrity and improve automated systems — two of the
issues the Working Group, the Brady Report, the GAO and others
have identified as critical to the financial integrity and smooth
functioning of the markets.
Our report to the President cites
the many constructive steps already taken in these areas. The
Working Group encourages these efforts and will continue to
monitor developments to ensure that needed improvements are made.
CONCLUSIONS
In summary, Mr. Chairman and Members of the Committee, the
Working Group has commenced action on a number of significant
steps that collectively will work to reduce systemic threats to
our financial markets. In so doing, we have pursued a sizeable
portion of the agenda defined in large measure by the
Presidential Task Force on Market Mechanisms,3/ the GAO, the
SEC, the CFTC and other market observers. Indeed, Senator Brady
concluded his recent public letter with a position that in fact
has been the operating basis of the Working Group:
We are not attempting to legislate against
decline or interfere with the smooth functioning
of the markets. The market will always seek its
level ground; we are only trying to assure that it
gets there safely.
The collective and coordinated actions recommended by the Working
Group — and corrective steps already taken by others — help to
assure that the market in fact does "get there safely" when it
moves for whatever reasons.

See, for example, the summary comparison of the
recommendations in the Brady report and the actions taken by
the Working Group in Exhibit D.

We cannot legislate against market declines, regulatory
dictates cannot eliminate volatility, and executive fiat is no
more effective. Price controls and capital controls have never
worked effectively in this country and no amount of government
control can sway markets if underlying economic fundamentals —
or investor perceptions of those same fundamentals — take the
market one direction or another.
Moreover, it is unrealistic and ultimately counterproductive
to attempt to roll back developments in financial markets brought
about by advancements in telecommunication and computer
technology and by changes in investment needs. We cannot go back
to the days of the abacus or mechanical adding machines. If we
did — by trying to legislate against particular products or
investor preferences or market strategies, for example — then we
would ultimately lose whatever competitive edge we now have to
places like Toronto, Tokyo, or London.
Mr. Chairman, I would be remiss if I did not commend the
cooperative actions and constructive dialogue on the part of the
Working Group members. As you requested at our last hearing, we
have spent considerable time and energy to arrive at our initial
recommendations. The members of the Working Group have
demonstrated that it is possible to address major, complex issues
in a cooperative fashion — even though we bring different
perspectives and preferences to the table — and in a reasonably
short time frame. Disagreements on some matters have not blocked
significant agreements that are apparent upon careful examination
of the package we have presented to the President.
The public also has been well served by the Working Group's
high caliber staff and their professional analyses, and I salute
them.
We have made progress on basic elements that are essential
to the safety and soundness agenda that we view as a priority.
More work will be done, and we welcome the continuing challenge.
* * * * * * * * * * * * * *

TREASURY NEWS

Deportment off the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
Hay 24, 1988

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued June 2, 1988.
This offering
will result in a paydown for the Treasury of about $800
million, as
the maturing bills are outstanding in the amount of $13,592 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Daylight Saving time, Tuesday, May 31, 1988.
The two series offered are as follows:
91 -day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
September 3, 1987, and to mature September 1, 1988
(CUSIP No.
912794 PZ 1 ), currently outstanding in the amount of $16,647 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,4 00 million, to be dated
June 2, 1988,
and to mature December 1, 1988
(CUSIP No.
912794 QV 9 ).
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be Issued for cash and in exchange for Treasury
bills maturing June 2, 1988.
Tenders from Federal Reserve
Banks for their own account and as agents for foreign and international monetary authorities will be accepted at the weighted
average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to Federal Reserve Banks,
as agents for foreign and international monetary authorities, to
the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. Federal
Reserve Banks currently hold $1,594 million as agents for foreign
and international monetary authorities, and $4,316 million for their
own account. Tenders for bills to be maintained on the book-entry
records of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week series).
B- 1423

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
10/87
of
the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

rREASURY NEWS
tpartment off the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Address by
Gerald L. Hilsher
Deputy Assistant Secretary
(Law Enforcement)
U.S. Department of the Treasury
American Banker's Association:
National Operation and Automation Conference
May 24/ 1988
Taking the Starch ou£ of
Money Laundering: ' The Role of the Bank Secrecy Act
Introduction
Thank you for asking me to speak with you today on the subject of
the Bank Secrecy Act. It is my intention to explore with you the
application of the Bank Secrecy Act against the professional
money launderers that support organized criminal activity, such
as drug trafficking. Contrary to the popular perception of many
banking professionals, the Bank Secrecy Act truly is a "tool"
against the illegal activities of narcotics traffickers, money
launderers, and tax evaders. Enforcement of the Bank Secrecy Act
is not meant to "pick on" the financial industry. The purpose of
Bank Secrecy Act compliance examinations by your regulators, and
the criminal and civil penalties levied for noncompliance is to
ensure that the tool is kept sharp and that the financial
database captures information of use to law enforcement. Through
careful compliance with the Bank Secrecy Act, you can help take
the starch out of money laundering and help to remove the profits
from the dope dealers.
I will also discuss the efforts of Treasury's Office of Financial
Enforcement to provide informative educational materials to the
financial industry on the requirements of the Act through
administrative rulings and government publications, such as the
soon to be published Exemption Handbook.
B-1424

—

-2I will also share with you the findings of the IRS pilot project
on magnetic tape filing of CTRS, Project "Merit" which acronym
stands for Magnetic/Electronic Reporting of Information
Transactions. The success of the pilot project resulted in its
being made a permanent method of filing CTRs, as announced last
December.
Overview of Reporting Requirements
First, by way of background, it was in 1970, that the U.S.
Congress passed the Currency and Foreign Transactions Reporting
Act, which, together with certain recordkeeping provisions, has
become popularly known as the Bank Secrecy Act. The Bank Secrecy
Act is really a misnomer. A better name would probably be the
Anti-Bank Secrecy Act. The Act requires the disclosure of
information regarding large currency transactions and is
specifically designed to aid in the attack against organized
criminal activity by creating a "paper jtrail" to trace drug and
other proceeds back to their illegal sources.
The Act provides that the Secretary of the Treasury shall
promulgate regulations requiring the filing of reports, a*s well
as the maintenance of records, that are determined to have a high
degree of usefulness in criminal, tax, and regulatory
investigations or proceedings. The Secretary has delegated to
the Assistant Secretary (Enforcement) overall responsibility for
Bank Secrecy Act enforcement. By further delegation, the
responsibility for coordination of Bank Secrecy Act enforcement
and policymaking rests with the Office of Financial Enforcement,
which reports to me, the Deputy Assistant Secretary (Law
Enforcement). The Office of Financial Enforcement is also
responsible for the imposition of civil penalties for
noncompliance with the Bank Secrecy Act, which I will discuss
shortly.
The Bank Secrecy Act, through the implementing regulations that
Treasury has issued, require the routine filing of several types
of reports:
1. The Currency Transaction Report or ("CTR"). A
financial institution, other than a casino, must file a CTR, IRS
Form 4789, for "each deposit, withdrawal, exchange of currency,
or other payment or transfer by, through, or to such financial
institution which involves a transaction in currency of more than
$10,000."
"Financial institution," as that term is used in the statute and
regulations, includes not only banks, but also securities
brokers, currency exchange houses, check cashers and even

-3individuals who provide services traditionally conducted at
financial institutions. A similar report, called a "Currency
Transaction Report by Casinos, or CTRC, is required to be filed
by casinos when they engage in transactions like those described
above.
2. The Report of International Transportation of Currency
or Monetary Instruments ("CMIR"). A person must file a CMIR,
Customs Form 4790, when he "physically transports, mails, ships,
or causes to be physically transported, mailed or shipped,
currency or other monetary instruments in an aggregate amount
exceeding $10,000 on any one occasion," whether that
transportation is into or out of the United States; or when he
receives in the United States currency or other monetary
instruments in an aggregate amount exceeding $10,000 that have
come from outside the United States and on which no CMIR was
filed.
3. The Report of Foreign Bank and Financial Accounts
("FBAR"). A person subject to the jurisdiction of the United
States (including a U.S. citizen residing abroad) must file an
FBAR, Treasury Form TD T 90-22.1, if that person had, at any time
during the year, a financial interest in, or signature or other
authority over, one or more bank accounts, securities accpunts,
or other financial accounts in foreign countries, and the
aggregate value of the accounts exceeded $10,000.
Finally, the Act and the regulations require financial
institutions to maintain a variety of records (such as copies of
signature cards, bank statements, and checks drawn for more than
$10 0) for a five-year period. Records required to be kept under
the Act, unlike the BSA reports, generally may be examined by law
enforcement authorities only for the purpose of assuring
compliance with the Act's requirements; in other cases, the
The
Financial
Database
authorities
must
obtain subpoenas or comply with other legal
provisions.
The
CTRs, CTRCs, and the FBARs are all filed with the Internal
Revenue Service and placed on computer at the IRS Detroit Data
Center. The CMIR reports are filed with the U.S. Customs Service
and are processed in Newington, VA. These reports, when
combined, form what we call the Treasury Financial Database. The
Financial Database is accessible to Customs and IRS agents and
financial analysts for targeting suspicious currency
transactions, investigative case support, tax examination and
collection, and a host of other law enforcement uses.
Both Customs and the IRS have rule-based, artificial intelligence
systems massaging the data contained in the financial database,

-4along with data received from the field. These A-I systems are
based on rules of suspicious indicators, for instance, persons
whose many CTRs list differing occupations, social security
numbers, and addresses, and whose transactions involve multiple
accounts at a variety of financial institutions. Certain
occupations are more suspicious than others, according to the
expert rules used by the A-I system, and these more suspect
occupations are measured against the levels of financial
transactions. CTRs filed by financial institutions for amounts
below the $10,000 reporting threshold, e.g. a $9,900 CTR, is a
suspicious circumstance to the A-I computer, drawing on our
experience that the bank filing such a report believes the
currency transaction to be suspicious.
The A-I computer applies these and other rules against the
database automatically and highlights certain "targets" for
further analysis by human financial intelligence analysts, and
ultimately for referral to the field for further investigation.
To date, over 270 targets representing reportable CTR activity
exceeding $201.9 million and reportable CMIR activity exceeding
$21.6 million have been generated by the A-I systems.
*

The Treasury Financial Database can be used for law enforcement
purposes unrelated to tracking suspicious financial transactions.
Project Warrant is an operation being conducted through the
Customs Financial Intelligence Division which seeks to match
information on fugitives against the database in hopes of
locating escapees, and persons under indictment or for whom an
arrest warrant has been issued. One notable success story for
Project Warrant was the arrest, in November of 1987, of an
escaped convicted murderer who had been a fugitive since 1984.
The leads provided to the state police from the financial
activity identified in the Project Warrant report culminated in
the subject's arrest at the residence of one of his children.
The address was obtained from a CTR filed in 1984 when the
subject conducted a financial transaction.
I have been asked by many in the financial community, "Does
anyone even look at the information that we send to Detroit?" I
Utility
Bank
Act
hope you of
can
seeSecrecy
now that
we do, and furthermore, how very
important
is that
the identity
of financial
your customer
be verified
Now
that Iithave
described
how the
intelligence
and
that the
is filled
inreview
completely,
including
divisions
of CTR
IRS and
Customs
and analyze
thisthe
information,
occupation
and
address
blanks.
I would like to describe how these reports have proved highly
useful fo*r civil and criminal law enforcement purposes.

-5Particularly in recent years, these reports have provided law
enforcement authorities with investigative leads, information
that corroborates other sources of information about criminal
activities, and probative evidence in Federal criminal cases.
Perhaps the most prominent example of the reports' utility can be
found in United States v. Badalamenti (also known informally as
the "Pizza Connection" case). That case involved the smuggling
of substantial quantities of heroin into the United States by
members of Italian and U.S. organized criminal groups. In the
course of their investigation of heroin trafficking, Federal
authorities discovered a number of CTRs that reflected large cash
transactions by a Swiss national with stockbrokers in New York.
These reports eventually led to the discovery of an extensive
money-laundering operation that involved the transfer of tens of
millions of dollars through investment houses and banks in New
York City to financial institutions in Switzerland and Italy.
Ultimately, twenty individuals involved in the heroin network and
money laundering enterprise were convicted in Federal court on
various charges, including heroin trafficking, conspiracy, racketeering and Bank Secrecy Act violations. All received prison
sentences ranging from fifteen to fortyrfive years. In addition,
the Swiss national was convicted and imprisoned by Swiss
authorities for violations of Swiss law relating to his money
laundering activities.
The Government has also made substantial use of the Bank Secrecy
Act to prosecute a number of leading money launderers in the
United States and abroad. In recent years, for example, the
Government has successfully prosecuted Isaac Kattan-Kassin, whose
money laundering organization handled gross proceeds estimated at
$2.00 million to $250 million per year; Ramon Milian-Rodriguez,
who transported approximately $146 million in cash from the
United States to Panama over a nine-month period; Eduardo Orozco,
whose money laundering organization laundered more than $150
million over a four-year period; and Barbara Mouzin, who
masterminded and operated a large West Coast money laundering
business for cocaine traffickers.
In some instances, even a single CTR can provide significant
investigative leads for criminal investigators. In one case, the
Internal Revenue Service ("IRS") analyzed a single CTR and
determined that the individual listed on the CTR had not filed a
tax return. Subsequent investigation disclosed the existence of
a massive heroin distribution and money laundering organization,
operating primarily throughout southern California, which
provided false information to the financial institutions that
filed CTRs on their transactions. Eventually, the IRS arrested
more than a dozen persons associated with the organization,
seized and
in excess
$2 million
in currency
at various
domestic
banks,
chargedofthe
organization
with income
tax evasion

-6involving $27 million in income over a three-year period.
Although many of the examples cited above involved large-scale
money laundering for drug traffickers, Bank Secrecy Act reports
are also highly useful in identifying or proving other types of
financial crimes, for instance bank fraud and embezzlement. In
one recent case, for example, analysis of reports filed by a bank
provided a number of leads as to the disposition of tens of
millions of dollars that had been embezzled from the bank through
such devices as illegal loans. In another recent case, Federal
investigators discovered that a husband and wife had failed to
file a CMIR form for the $125,000 in cash that they took out of
the United States. Further investigation determined that the
wife had embezzled millions of dollars from the savings and loan
association in Texas at which she had been employed.
These examples amply demonstrate the substantial utility of Bank
Secrecy Act reports. In addition, unlike grand jury subpoenas or
court orders, the reports provide a constant stream of data on
large domestic and international movements of cash and ensures
that law enforcement agents obtain valuable information on
suspicious transactions in a timely fashion.
Bank Secrecy Act Dissemination
Treasury has taken a number of administrative actions to make the
Financial Database more readily accessible to law enforcement and
supervisory agencies. The Office of Financial Enforcement is now
working out arrangements with the regulatory agencies to provide
those agencies with "on-line" access as well.
Treasury has also extensively revised the guidelines under which
the U.S. Customs Service and the Internal Revenue Service may
disseminate Bank Secrecy Act Data, to minimize procedural
difficulties for other law enforcement agencies and make those
data more readily available. In addition, Treasury has concluded
an agreement with the Office of the Attorney General in
California for transmission of magnetic tapes of Currency
Transaction Reports that have been filed by California financial
institutions. This agreement will allow the State of California*
to carry out its responsibilities under its anti-money laundering
Enforcement
the BankCalifornia
Secrecy Actfinancial institutions to file
law, without of
requiring
duplicate copies of CTRs with the State.
As I mentioned in my introduction, I view the Bank Secrecy Act as
a law enforcement "tool," and the enforcement of its provisions
as the "grinding wheel" that sharpens the tool. Thus, in the
past three years, Treasury has been more vigorous than ever

-7before in initiating investigations and levying civil penalties
against financial institutions for civil violations of the Bank
Secrecy Act. Since June, 1985, Treasury has levied civil
penalties totalling approximately $16 million for Bank Secrecy
Act violations in thirty-eight cases involving financial
institutions. It is important to note that in a number of cases,
the civil penalty was negotiated with a bank holding company that
owned more than one bank that had violated the Act. This means
that these thirty-eight penalties actually involved one hundred
and seven banks that Treasury concluded had violated the Act.
Moreover, twenty-nine of these penalties exceeded $100,000 — an
indication that the violations to which the penalties pertained
were neither isolated nor infrequent.
The Internal Revenue Service - Criminal Investigation Division
has been delegated the authority for criminal enforcement of the
CTR provisions of the Bank Secrecy Act. In the past five years,
the IRS-CID has steadily increased the number of investigations
and prosecutions for criminal violations of the Bank Secrecy Act.
The number of indictments have increased from 29 in 1982 to 236
in 1987 and convictions have also increased from 25 to 153 during
that same time period.
I believe there is a real salutary effect in the imposition of
civil and criminal penalties against noncompliant financial
institutions. Since the criminal conviction of the Bank of
Boston in 1985 and the imposition of civil penalties against
other financial institutions, the phenomenon of cardboard boxes
full of cash arriving at the back doors of banks in South Florida
has been virtually eliminated. The publicity of a few
multi-million dollar penalties is a great deterrent against
laxity in complying with the Bank Secrecy Act. The increased
compliance with the requirements of the Bank Secrecy Act by
financial institutions is mirrored by the increased number of
CTRs filed annually. In 1984, before the Bank of Boston case,
706,000 CTRs were filed; in 1985—1,832,000 CTRs were filed; in
1986—3,700,000; and in 1987 4,974,000. Currently, approximately
600,000 are being filed each month.
Another aspect of Bank Secrecy Act enforcement that is sometimes
overlooked, but is no less vital for an effective compliance
program, is the commitment of the United States Customs Service
to enforcement of the Bank Secrecy Act requirements for Reports
of International Transportation of Currency or Monetary
Instruments (also known as the "CMIR" requirements). During
Fiscal Year 1987, Customs conducted a total of 213 8 seizures of
currency and monetary instruments totalling $192,382,985 for
violations of the CMIR requirements. Through April, in Fiscal
Year 1988, Customs has conducted a total of 641 seizures
totalling $56,323,737, for violations of the CMIR requirements.

-8Although Treasury is firmly committed to rigorously enforcing the
Act, in order to obtain information on large currency
transactions and create the necessary evidentiary paper trail for
prosecution, we are equally committed to fostering a partnership
between financial institutions and the Federal law enforcement
authorities and to seeking creative solutions to the problem of
money laundering. Your institutions should not be the unwitting
accomplice of international drug lords and money launderers. By
identifying, seizing, and otherwise interrupting the flow of
narco-dollars, we can remove a vital component of the trafficking
operation. Many of you have recognized this essential fact, as
evidenced by the general improvement in Bank Secrecy Act
compliance, and also by the ever-increasing, timely reports of
suspicious transactions to IRS and Customs.
Rather than rely exclusively on mere compliance with the Bank
Secrecy Act to take on the money laundering problem, Treasury has
been advising financial institutions that observe suspicious
financial activity to telephone the local office of the IRS and
report that activity in conformity with^ the Right to Financial
Privacy Act. Some of the Banking regulators now impose a duty
on your institutions to report suspicious activity as well. This
is particularly important for suspected incidents of structuring
transactions to evade the reporting requirements of the Bank
Secrecy Act, which is now a criminal offense under Title 31, USC,
section 5324.
Treasury and the IRS believe that the availability of a toll-free
number will enhance the ability of financial institutions to
report possible structuring or money laundering activities on a
timely basis, and allow the IRS to coordinate its responses to
these contacts more efficiently. Such a toll-free number will
soon be installed at the Detroit Data Center - the number is
1-800-BSA-CTRS. A press release will be issued when the number
is operational.
In addition, Treasury recently sent letters to the chief
executive officers of U.S.-based financial institutions with
foreign branches. These letters call to the attention of the
financial institutions the risks associated with international
money laundering, identify certain patterns of activity that
should be considered suspicious, and encourage the foreign
branches of those institutions to report any suspicious transactions to overseas Treasury law enforcement representatives in a
manner consistent with the laws of the country where the branch
operates. These initiatives, may well provide U.S. law enforcement authorities with additional leads in money laundering and
Bank Secrecy Act cases, and should help to persuade U.S.
financiallaw
institutions
abroad
that expanded
cooperation
Federal
interest
of
enforcement
their legitimate
authorities
customers.
is in their
interestwith
and the

-9That concludes that portion of my talk on the "why" of the Bank
Secrecy Act. I hope that I have convinced you that like your own
neighborhood watch programs, we need your support in watching out
for the financial transactions and transactors that keep this
terrible drug plague alive and operating. Now let me tell you a
little about the educational programs we have undertaken at
Treasury to make your dealing with the requirements of the Act
more efficient and effective.
Guidelines on Exemptions
Treasury has completed the drafting of a booklet that will
explain to banks the process for exempting certain types of
customers and currency transactions from the CTR reporting
requirements, as permitted under the regulations. Treasury and
the IRS have observed that many banks, largely because of their
concern that they may be heavily penalized if they mistakenly
place ineligible customers on their exemption lists, have sharply
reduced or eliminated their exemption lists and file CTRs on all
currency transactions over $10,000. This practice has caused
these banks to file more CTRs that the regulations require. The
exemption handbook is now being printed by the Government
Printing Office. Information on ordering copies of the
exemption handbook will be forthcoming through the regulatory
agencies and, hopefully, the ABA. This handbook should help to
alleviate banks' concerns about the use of the exemption
provisions of the regulations, and minimize confusion about the
application of these provisions in the more common situations
that banks encounter in handling reportable currency
transactions.
Administrative Rulings
Treasury has begun to draft and will soon issue a series of
formal administrative rulings on various provisions of the Bank
Secrecy Act regulations. These rulings are being issued pursuant
to a revision in the Bank Secrecy Act Regulations, issued on
September 22, 1987, that explains the process for seeking
administrative rulings from Treasury. As Treasury responds to
various requests for rulings, or issues rulings on its own
initiative, it will be able to develop an expanding range of
explanations of the regulations and provide the financial
community with clearer guidelines on the meaning of regulations.
Training Seminars
The Office of Financial Enforcement is pleased to send
representatives to training seminars to speak on the subject of
the Bank Secrecy Act. We do have to be selective and will accept

-10only those invitations that offer a broad audience. Many
professional associations have offered to compensate members of
my staff for appearances before association members, however, the
Office can only accept reimbursement for travel expenses from
certified 501 (c) (3) organizations and must decline honorarium.
PROJECT MERIT (Magnetic/Electronic Reporting of Information
Transactions)
Although Treasury is committed to achieving full compliance with
the Bank Secrecy Act in all sectors of the financial community,
we also recognize that we should take appropriate measures to
ensure that the reporting and recordkeeping burden on financial
institutions is no greater than necessary to provide law
enforcement authorities with the information they need.
In March, 1987, Treasury announced a pilot program (Project
Merit) in which financial institutions could file CTRs on
magnetic tape. Over the next few months, twenty-five banking
organizations have passed the technical* standards for acceptance
of their magnetic tape filings, and were certified to file on
magnetic tape by the end of July, 1987. I would like to m
emphasize that the fact that a bank has been approved for
magnetic filing does not mean that their system for insuring
compliance with the BSA has been approved. Approval means only
that the format on the tape meets the requirements necessary for
magnetic as opposed to paper filing.
The major purposes of Project Merit were to confirm the benefits
of magnetic filing of CTRs, that is, an increase in the accuracy
of data being reported with a reduction in processing costs; to
gauge the receptivity of the financial institutions to this
method of filing; and to identify and test the modifications to
IRS systems and procedures necessary for magnetic filing.
The following are IRS' findings from its evaluation of
Project Merit:
a. The magnetic tape reporting system reduced the
processing time of CTRs, measured from date of transaction to
date first available for agent review, from approximately 45 days
to 18 days, an overall reduction of 27 days.
b. Based on projections over a 10-year period, magnetic
filing will provide an estimated cumulative net savings to the
Federal government of over $22,000,000.
c. Less than 5% of the CTRs filed by magnetic tape
contained data inconsistencies or format errors. In the paper
system, approximately 52% of all CTRs received by the Data Center

-11require some manual perfection. Of these 52%, approximately 15%
require further correction or result in correspondence seeking
clarification.
d. Magnetic filing enabled the IRS to automate the
front-end of the manual pipeline; i.e., the labor-intensive steps
required to receive, control, number, code and edit, and
transcribe CTRs. Magnetic filing also enabled the IRS to
acknowledge to the filer receipt of the reports, and to automate
the correspondence process and the storage and retrieval of the
reports.
e. Twenty-five of the 45 organizations which applied for
admission to Project Merit passed the acceptance standards and
were certified to file magnetically by the end of July, 1987.
There are two banks and a multi-bank corporation on magnetic
tapes- Commercial National Bank, Shreveport, LA, Branch Bank &
Trust Co., Raleigh, N C ; and First Security Service Company of
Utah.
f. Benefits to the participating- financial institutions
were automation of internal processes, improving Title 31
compliance controls, and providing a better historical file
complete with an acknowledgement record from the IRS. Although
savings for the participating financial institutions were
difficult to quantify absolutely, one bank estimated the cost
benefit to be in excess of $50,000 annually.
g. No major systemic flaws in magnetic filing were
revealed during the pilot program. Those flaws that were
discovered have been or are capable of being corrected easily.
h. The pilot program confirmed that the filing of CTRs by
magnetic tape media will provide cost benefits and other
advantages to the government and to participating financial
institutions.
As a result of these findings, Treasury published a Federal
Register notice on December 31, 1987, that announced the
establishment of a permanent program for participating financial
institutions to file CTRs on magnetic tape with the IRS Data
Center. We encourage as many financial institutions as possible
to participate in the program. You should contact the Detroit
Data Center for further information on how to qualify.
Contact: Roger Hatcher
CTR Magnetic Media Coordinator
IRS Data Center
1300 John Lodge Drive
Detroit, Michigan 48226

-12Closing
Thank you again for asking me to speak with you today. Together,
as active partners, we can take the starch out of money
laundering. I wish you much success with the remainder of your
conference.

TREASURY NEWS
Deportment off the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE

May 25, 1988

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of April 1988.
As indicated in this table, U.S. reserve assets amounted to
$42,730 million at the end of April, down from $43,186 million in
March.

U.S . Reserve Assets
( in millions of dollars)

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing
Rights 2/3/

Foreign
Currencies

43,186
42,730

11,063
11,063

9,899
9,589

11,579
11,275

Reserve
Position
in IMF 2/

1988
Mar.
Apr.

10,645
10,803

1/ Valued at $42.2222 per fine troy ounce
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
selected member countries. The U.S. SDR holdings and reserve
position in the IMF also are valued on this basis beginning July
1974.
3/ Includes allocations of SDRs by the IMF plus transactions in SDRs.
4/ Valued at current market exchange rates.

B-1425

TREASURY NEWS

Department off the Treasury • Washington, D.c. • Telephone 566-20
Text as Prepared
For Release Upon Delivery
Expected at 2:00 p.m. EST
Testimony of Stephen J. Canner
Director, Office of International Investment
U.S. Department of the Treasury
before the
House Committee on Banking, Finance and Urban Affairs
Washington, D.C.
May 24, 1988
Investment in the U.S.-Canada Free Trade Agreement
Thank you, Mr. Chairman.
I am pleased to be here today to discuss with you and other
members of this Committee the investment provisions of the
U.S.-Canada Free Trade Agreement. The Agreement dramatically
reduces barriers and establishes rules of conduct for a broad
range of economic activities. When implemented, it will provide
greater opportunities for U.S. traders a"nd investors, higher
paying jobs for producers, and lower priced but higher guality
goods for consumers. By opening our markets, our economies will
prosper and our goods will become more competitive
internationally.
We are especially pleased with this Free Trade Agreement in that
it is the first of its kind to include provisions governing
investment in the two countries. This is an historic
breakthrough which will benefit us in our bilateral economic
relations with Canada and serve to strengthen our efforts in the
Uruguay Round of trade negotiations in the GATT to reduce and
eliminate distortions to trade arising from host country
investment policies.
Let me share with you our thinking as we approached the task of
negotiating an Investment chapter.
WHAT WE FACED
We and the Canadians brought very different perspectives to the
negotiating table. The United States has for two centuries
maintained an open investment policy. That policy has meant
capital flows to the United States, and with it increased
employment, more efficient production, and better and less
expensive products for the consumer. Our open investment policy
has meant that, over the past five years, foreigners have made
about $20 billion of eguity investments annually. Cumulative
foreign investment in the U.S. rose from $108 to $209 billion
from 1981 to 1986 — a significant figure but still a small
percentage of our total investment and still less than the
$260 billion which U.S. investors have placed abroad.
B-1426

-2-

President Reagan indeed reaffirmed the importance of an open
investment climate in his investment policy statement of
September 3, 1983. In my own experience as the Director of the
Office of International Investment in the Treasury, I can tell
you that this policy has worked. I know of no "downside" risks
of foreign investment which cannot be adeguately taken care of
under existing laws.
The Canadians brought a very different viewpoint to the
bargaining table. In the 1970's — for nationalistic and
political reasons — Canada decided to adopt a restrictive policy
toward foreign investment, and to screen foreign investment under
the auspices of the Foreign Investment Review Agency.
Bureaucrats would second-guess the market and would decide which
investments would be admitted, which would be blocked, and which
would be admitted on condition that the investor fulfilled
various performance reguirements. And the Trudeau Administration
added even more restrictive policies, such as the discriminatory
and expropriatory provisions of the National Energy Program
(NEP) .
The market told Canada what it thought Qf these and other
restrictive, inward-looking economic policies. In large part due
to FIRA, net foreign direct investment into Canada declined from
an annual average of C$684 million in 1970-75 to C$372 million in
1976-80. Promulgation of the NEP in 1980 compounded the
disincentives, and in fact triggered disinvestment (i.e., net
outflows of foreign direct investment) of C$1,275 billion per
year on average from 1981 to 1985.
A study conducted by the Conference Board of Canada in 1984
further revealed the negative impact of the government's
policies. Some 33 companies (11 percent of the survey sample)
stated that they had been deterred from investing in Canada
because of foreign investment controls. And one-half of the
respondents indicated that their perceptions of the screening
process worsened while their applications were under
consideration. They cited a number of reasons, the most
important of which were delays, perceived rigidity of the format,
lack of transparency, and alleged unreasonable demands and
political interference.
Since being elected in late 1984, the Mulroney Administration has
taken steps to liberalize Canada's economic and foreign
investment laws and policies. From the outset, it ceased
blocking foreign investments. In 1985, the Mulroney
Administration replaced FIRA with a new agency, Investment
Canada, that is formally charged with promoting foreign
investment. Foreign investors making greenfield investments and
smaller acguisitions no longer reguire official approval.
Rather, they need only to notify the authorities of their
intention to invest. The Mulroney Administration also
systematically dismantled most of the NEP. At least partly in
response to these significant shifts in policy, net foreign

-3-

investment rebounded sharply, to C$1.6 billion in 1986 and a
record C$4.3 billion in 1987. After further liberalization in
connection with the FTA, Canad a will retain the right to review
only very large direct acquisi tions by U.S. investors and
investments of a particularly sensitive nature in the cultural
and energy sectors.
WHAT OUR OBJECTIVES WERE
Our investment objectives in the FTA therefore were first, to
prevent any backsliding by the Canadians and second, to build
upon the liberalization already effected by the Mulroney
Administration. We wanted to push the Canadians as far as we
could to liberalize their standards, policies, and laws regarding
foreign investment. We obviously did not achieve as much as we
would have liked....nor for that matter did the Canadians, who
resisted further liberalization mightily. But we achieved a
substantial and important — even critical — measure of success
which will significantly benefit the citizens and workers of both
Canada and the United States.
WHAT WE GOT
Each side agreed to a standstill on existing restrictions that
would treat foreigners worse than domestic investors. Simply
put, this means that neither side will adopt more restrictive
discriminatory laws, rules, and regulations regarding existing
investments in each of our countries. One aspect of this is to
freeze in the current Canadian practice of not screening new
greenfield investments. This commits Canada to maintain its
"hands off" policy with respect to greenfield investment.
Since the screening provisions for takeovers and acquisitions
constitute a significant portion of the investment chapter, I
would like to address those provisions in detail.
Screening of Foreign Investment
The agreement limits greatly the screening and blocking of direct
acquisitions by U.S. investors. Specifically, Canada agrees
that, after a phase-in period, the asset threshold for screening"
direct acquisitions will rise from the existing level of $5
million (Canadian, current dollars) to $150 million (Canadian,
constant dollars). For a country that was screening greenfield
investments and virtually all takeovers just three years ago,
Canada has taken a giant, step forward. When fully phased-in,
this liberalization means that direct takeovers of only about the
600 largest firms in Canada will be subject to screening. Viewed
alternatively, the higher threshold removes U.S. direct takeovers
of some 6900 Canadian firms from screening; this is a reduction
of over 90 percent from the universe of Canadian firms whose
direct acquisition is currently screened.

-4-

It is important to note that, while the existing threshold for
screening of takeovers is denominated in current Canadian
dollars, the new threshold will be denominated in constant
Canadian dollars. This means that we do not accept a decreasing
level of threshold imposed upon us over time by the eroding
effects of inflation.
Most of the attention in the press has focused on the screening
liberalization for takeovers by U.S. firms. Yet there is another
equally important aspect regarding sales of Canadian subsidiaries
by U.S. parents. Under existing law, if a U.S. parent were to
sell its subsidiary to another foreign firm, that foreign firm
would be subject to the screening and blocking authority of
Investment Canada if the subsidiary were larger than existing
thresholds (C$5 million for direct and C$50 million for indirect
takeovers). Under the FTA, the higher screening thresholds will
apply to direct and indirect sales by U.S. firms of their
Canadian subs. This provides fairness and symmetry for our
investors on both the buying and selling side of the takeover
transactions.
The provisions for indirect takeovers also merit attention. An
indirect takeover occurs when a U.S. firm, firm "A", acquires
another U.S. firm, firm "B" , and firm "B" has a Canadian
subsidiary. Under existing law, the indirect acquisition of the
Canadian subsidiary would be screened if the subsidiary's assets
exceeded $50 million (Canadian current dollars). By the terms
of the agreement, there will be no screening — or blocking —
of the indirect acquisition of the Canadian company after a three
year phase-out.
Performance Requirements
Let me now turn to the matter of performance requirements, which
are placed on the U.S. (or other foreign) investor at the time
an investment is reviewed by Investment Canada. These
performance requirements have consisted of commitments to export
a certain amount of production, to acquire a certain portion of
inputs from the local market, to produce products that substitute
for imports in the local market, etc. The list has been fairly
long and imaginative. These performance requirements were a very
disturbing element for U.S. investors, often involving changes in
product line and location of production. We have been told that,
in many instances, they were costly to the U.S. investor, but
that the cost was grudgingly accepted by U.S. investors as a
hidden cost of doing business in Canada.
Under the FTA, we made significant progress in reducing or
eliminating the use of performance requirements. First, Canada
(and the U.S.) agree not to impose export, local content, local
sourcing, or import-substitution performance requirements on each
other's investors. Second, both countries will refrain from
placing such requirements on third country investors when any

-5-

significant impact on U.S.-Canadian trade could result. The
operative word here is could; it is not necessary for our side to
prove injury in the classic trade sense. A reasonable charge by
us that a performance requirement on a third country trade could
have a significant impact on bilateral trade is sufficient "to
make our case. Third, all performance requirements on those
transactions not subject to screening by Investment Canada at the
new, higher threshold, will ipso facto be eliminated.
Given the estimate that all indirect acquisitions and sales and
direct acquisitions and sales of some 6900 firms will be taken
out of the screening net when the agreement is fully phased-in,
and that no greenfield investments will ever be screened, the
overall burden of performance requirements on the U.S. economy is
drastically reduced by the provisions of the FTA. We are proud
of this accomplishment.
National Treatment
By the provisions of the agreement, the U.S. and Canada agree not
to adopt any new discriminatory measures, with respect to each
other's investors, restricting the establishment of new
businesses; the acquisition of existing businesses; and the
conduct, operation and sale of businesses after establishment.
This "national treatment" provision is extremely important. In
economic and legal parlance, it means that each party is to treat
investors of the other party at least as favorably as its own
investors in like circumstances with respect to the establishment
of new businesses and the acquisition of existing businesses and
with respect to the conduct, operation, and sale of business
enterprises located in its territory. The FTA gives concrete
meaning to this principle in two areas that have been problematic
in the past. It provides that neither party can force divestiture by reason of the investor's nationality or establish minimum
equity requirements for nationals of the host country.
We were particularly pleased with this comprehensive national
treatment provision. It assures that investment and investors
can respond to market forces, and that U.S. and Canadian
investors can compete on virtually the same terms free from
discriminatory government action. In today's day and age, we
need more of this type of liberalizing and strengthening of
market forces, not less.
Other Provisions
There are numerous other provisions which go a long way towards
enhancing the flow of investment and commerce between the two
countries. Regarding expropriation, we agreed that expropriation
can only be taken in accordance with international law standards.
Those standards provide for, inter alia, payment of prompt,
adequate and effective compensation at the fair market value of
the expropriated properties. There are also provisions
prohibiting either party from preventing an investor from

-6-

transferring profits, earnings from an investment, or sales and
liquidation proceeds (with only limited exceptions relating, for
example, to limitations on dividend payments set by bankruptcy
laws) .
EXCEPTIONS
Certain measures are excluded from the agreement, in general,
existing measures are grandfathered, such as U.S. laws
restricting foreign investment in atomic energy and communications and the Canadian laws restricting foreign investment in
communications.
While these and other grandfathered measures remain in force,
they cannot be made more restrictive. And if any liberalization
measures occur in these grandfathered sectors in the future, that
new level of liberalized measures cannot then be made more
restrictive. We thus have built in an upward "ratchet" for
liberalization of existing grandfathered measures both here and
in Canada*
The cultural industries in Canada were exempted from the FTA as a
whole, including the investment chapter. However, the Agreement
greatly alleviates a key problem for U.S. investors: it commits
Canada, when an indirect acquisition occurs and Canada wants to
Canadianize the Canadian cultural subsidiary involved, to fully
indemnify the acquiring U.S. parent firm by outright GOC purchase
of the subsidiary at a fair international market price independently and impartially determined. This is significant in that
it removes a long-standing irritant of U.S. investors who
recently acquired cultural industries through indirect acquisi_.. tions. This irritant pressured U.S. investors to sell at less
than market prices. Should this occur in the future, the U.S.
parent will no longer face this pressure; he can be assured of a
market price for his asset.
RECIPROCITY
At this point, Mr. Chairman, I would like to address head-on the
question of reciprocity. Some have suggested that, because
Canada can block any direct acquisitions over the threshold level
by a U.S. firm, the United States should be able to block
comparable direct acquisitions of a U.S. company by a Canadian
firm. To put it more bluntly, some have suggested that, if
Canada retains the rights to keep a "restrictive" investment
climate, we should retain comparable rights to have a
"restrictive" climate.
That approach, in my view, is contrary to our national interests.
We have had an open investment climate for two centuries, and it
has worked for us. Canada, on the other hand, has learned
first-hand the costs of a restrictive investment climate, and,
recognizing those costs, has moved quickly to liberalization,
even if it has not gotten to the point of total liberalization.

-7-

It simply does not make sense to abandon an open investment
climate — which has helped stimulate economic growth in the
U.s. — because a treaty partner has chosen, for nationalistic
reasons, to sacrifice some of the benefits of foreign investment
flows.
That concludes my formal statement. I would be happy to answer
any of your questions.

TREASURY NEWS

Oipartment off the Treasury • Washington,
D.C. • Telephone 566-2041
CONTACT: Office of Financing
FOR IMMEDIATE RELEASE
202/376-4350
May 25, 1988
RESULTS OF AUCTION OF 2-YEAR NOTES
The Department of the Treasury has accepted $8,266 million
of $23,519 million of tenders received from the public for the
2-year notes, Series AB-1990, auctioned today. The notes will be
issued May 31, 1988, and mature May 31, 1990.
The interest rate on the notes will be 8-1/8%. The range
of accepted competitive bids, and the corresponding prices at the
8-1/8% rate are as follows:
Yield
Price
Low
8.15%*
99.955
High
8.18%
99.900
Average
8.18%
99.900
•Excepting 1 tender of $10,000.
Tenders at the high yield were allotted 72%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
Totals

Received
76,155
$
19 ,693,190
45,430
115,620
130,950
80,905
1 ,607,025
130,950
47,080
146,675
29,520
1 ,403,770
11,295
$23 ,518,565

Accepted
$
76,155
6,770,630
45,150
97,820
93,790
68,625
545,145
99,310
47,080
145,295
29,520
236,490
11,295
$8,266,305

The $8,266
million of accepted tenders includes $1,330
million of noncompetitive tenders and $6,936 million of competitive tenders from the public.
In addition to the $8,266 million of tenders accepted in
the auction process, $54 7
million of tenders was awarded at
the average price to Federal Reserve Banks as agents for foreign
and international monetary authorities. An additional $761
million of tenders was also accepted at the average price from
Government accounts and Federal Reserve Banks for their own
account in exchange for maturing securities.
B-1427

TREASURY NEWS
Deportment off the Treasury • Washington, D.C. • Telephone 566-2041
TEXT AS PREPARED
EMBARGOED FOR RELEASE UPON DELIVERY
EXPECTED AT 1:00 P.M., EDST
Remarks by
The Honorable Charles H. Dallara
Senior Deputy Assistant Secretary for International Economic
Policy
United States Department of the Treasury
Before the U.S.-Korea Society
New York, New York
May 26, 1988
KOREA'S CHANGING ROLE IN THE WORLD ECONOMY
Introduction
It's an honor to be the guest of the U.S.-Korea Society,
and to have the opportunity to speak before a group that has
done so much to build mutual understanding and friendship
between these two important countries and societies.
Of
course, it may seem presumptous of me even to speak of these
two societies in the same breath. By the time Columbus
arrived on the shores of this continent near the end of the
15th century, Korea had over 750 years of a unified political
structure, and was well into the fourth dynasty in its rich
history.
Our two nation-states have a much briefer history, but as
we approach the 40th anniversary of the Republic of Korea —
which will be celebrated on August 15 of this year — we can
take pride in the friendship and alliance which has developed
between the United States and the Republic of Korea. During a
time of changing economic relationships and occasional
economic tensions, it is useful to remind ourselves of the
strong bonds of friendship and mutual respect which
characterize our relationship today, and which we expect will
grow and deepen in the future.
I will concentrate my remarks on Korea's economy. Three
decades ago, this economy was struggling to find a path toward
self-sustained growth. It was agriculturally based, and
B-1428
therefore largely reliant upon the outside world for

- 2 manufactured goods and technology. Korea's per capita income
level and standard of living were relatively low, and the
international trade position weak, leaving it heavily
dependent upon external capital.
The ensuing three decades have brought dramatic changes
in the Korean economy. Real economic growth has been high and
sustained. Korea is now industrially based, exporting
manufactured goods throughout the world. Its trade position
has improved tremendously, to the point that Korea now exports
capital as well as goods, and is building a large external
surplus. These changes have been accompanied by a rapid
expansion of jobs and income, as well as improvements in
economic welfare.
Korea's dynamism has also transformed its role in the
world economy. It is now a major economic force globally, a
leader among developing nations, and an economy whose
policies and performance have implications which extend well
beyond its borders.
This new reality implies new opportunities, new challenges, and the new responsibilities for
Korea. How Korea responds will have an impact not only on the
future of the Korean economy, but on the world economy as
well.
Evolution of the Korean Economy
In order to understand Korea's economic role today, one
must first appreciate the full extent and pace of Korea's
impressive economic progress over the last three decades. The
following facts illustrate this progress.
o Real GNP Growth. Korea's real GDP growth has been one
of the highest in the world, averaging 8.7% from 1961
to 1985. This compares with an average of 4.7% for
all non-oil developing countries. Remarkably, since
1961, Korea has experienced only one year of negative
real growth, in 1980.
o Per Capita Income. Given this steady real growth in
the economy and moderate population growth, per capita
income has grown from less than $100 at current
exchange rates in 1961, to $2,800 in 1987.
o Structure of Economy. The structure of the economy
has also changed dramatically. In 1960, agriculture
accounted for 37% of GDP, and manufacturing only 14%.
By 1987, the ratios were reversed, with manufacturing
accounting for 35% and agriculture only 12%.
o Growth of Exports. The growth of Korea's exports has
also been striking. In 1961, its exports accounted
for less than 0.1% of total non-oil developing
countries' exports. By 1986, Korea's share in this

- 3 total had grown to 9.1%. There has been a steady
shift in the composition of exports from items such as
processed foods, textiles, and other processed raw
materials with low value added, to increasingly
sophisticated capital equipment, heavy machinery, and
finished consumer goods.
Of course, this progress was not achieved without some
adverse developments.
First, Korea became excessively dependent upon exports
for growth. In 1971, exports of goods and nonfactor services
accounted for only 16% of GDP. By 1986, this ratio had grown
to 41%.
Second, Korea accumulated substantial external debt to
finance its current account deficits and high rates of
investment. By 1985, external debt had reached $46.8 billion,
nearly 56% of GNP, and the fourth highest nominal debt among
all developing countries.
Both of these developments have a bearing on Korea's
current policy stance, a point to which I will return.
Korea's Economic Policy Framework
Korea's tremendous progress has brought to it special
status and recognition throughout the world, generating
commendation and acclaim from many quarters. I wish to join
those who have expressed deep admiration for the accomplishments of the Korean people. These accomplishments are all the
more extraordinary when one considers that they have been
achieved in spite of the constant presence of the military
threat from the North.
These accomplishments — and the praise they have
generated — are not by chance. They have been earned.
Although external conditions have generally been favorable,
Korea — like other developing countries — has at times faced
adverse interest rates, high oil prices, low foreign demand
and protectionism. It was Korea's persistent commitment to an
outward-looking development strategy, generally supported by
sound macroeconomic policies and combined with its disciplined
and committed work force, that has made the difference.
This strategy was oriented toward promoting exports while
restraining imports and domestic consumption in order to
strengthen the external accounts. A range of specific
policies have played a role in this strategy.
o Fiscal policy has generally been conservative to
restrain domestic demand and support the objective of
strengthening the balance of payments. Since 1973,
the central government deficit has averaged only 1.8%

- 4 of GDP in Korea, compared with 4.3% for the non-oil
developing countries as a whole.
o Wages and incomes policies have also been geared in
part toward strengthening competitiveness.
o The government has also controlled interest rates to
discourage consumer and mortgage lending. High excise
taxes have also been used to discourage consumption.
o Industrial policy has played a central role, with the
government providing a wide variety of incentives for
industries targetted for export development. The
government has channeled capital at preferential rates
to major exporters for investment, plant expansion,
export financing, and debt service. Foreign direct
investment in certain sectors has also been prohibited
or limited.
o Trade policy has been used to protect Korea's growing
industrial capacity and to discourage imports. A wide
range of bans, restrictive quotas, tariffs, and
licensing requirements has been employed. Industry
associations have been influential in decisions on
approval of import licenses. Tariff levels have been
skewed in favor of inputs for exports, and away from
consumption and possible competition for exports.
o Lastly, exchange rate policy has provided special
incentives for exports and disincentives for imports,
particularly in this decade. Since 1978, the real
exchange rate has depreciated by over 18%.
These policies have certainly contributed to Korea's
achievements, but a number of them have outlived their
usefulness and are inappropriate in light of the changing
circumstances of Korea's economy, and its role in the world
economy.
New Opportunities, Challenges, and Responsibilities
Since 1985 there has been an important and rather
fundamental change in Korea's economic performance. The
savings/investment gap has been reversed, with savings now
exceeding investment, resulting in the emergence of current
account surpluses. From 1980 to 1985, Korea had made steady
progress in reducing the size of its current account deficits.
Therefore, the shift into surplus was not a total surprise,
The magnitude and speed of this shift, however, was
unexpected. The current account surpluses in both 1986 and
1987 were roughly double the government's initial forecasts,
reaching $4.6 billion in 1986 and $9.8 billion in 1987,
following a deficit of about $900 million in 1985.

- 5 These surpluses have permitted Korea to reduce its
external debt to an extent unparalleled in the developing
world. By the end of 1987, Korea's external debt had dropped
$11.2 billion from the level at the end of 1985, and stood at
only 30% of GNP, a reduction of some 26 percentage points
compared with 1985.
But this rising surplus also suggests the pressing need
for Korea to review and adapt its policies. Such action is
needed for the Koreans to meet their own objectives in the
years ahead, and also for the correction of global imbalances.
In 1986, Korea's current account surplus was equal to 4.9% of
GNP compared with 4.4% for Japan and Germany. In 1987,
Korea's current account surplus grew to the equivalent of 8.3%
of GNP, more than double the corresponding ratios for Germany
and Japan. At a time when other major imbalances in the world
economy are starting to shrink,the continued growth of Korea's
current account surplus — more than 39% in the first three
months of the year — is a particular source of concern.
The trade imbalance between the United States and Korea
has also grown rapidly. From near balance in 1980, the trade
account showed a U.S. trade deficit of $9.4 billion in 1987,
up 34% over 1986 alone. In the first £hree months of 1988,
the U.S. trade deficit with Korea has continued to grow at a
rate of 17%.
Korea's global current account surplus has, in fact, come
to symbolize the opportunities, challenges, and responsibilities that lie ahead. This surplus is unsustainable and
undesirable for the Korean people, the Korean economy, and the
global economy. It has inhibited growth in income domestically and added to protectionist pressures and market strains
globally.
o The principal opportunity is for much faster
liberalization of the trade and exchange rate regimes
and for broad deregulation of the economy, including
its financial sector. Such liberalization and
deregulation will enable Korea to rid itself of
restrictions and rigidities, advance the pace of
improving the economic welfare of the Korean people,
and position the economy to take advantage of global
opportunities in the 1990s.
o The principal challenge is to implement these with
policy changes with sufficient speed and breadth, while
avoiding disruption in the Korean economy and altering
the "deficit mentality," which will not disappear
overnight.
o The major responsibility is to assume a larger interna tibliaT—roTe in contributing to the process of global

- 6 adjustment and in preserving the open world trading
system from which it has benefited so greatly. The
magnitude of global adjustment that is necessary
requires Korea's full cooperation and participation.
In referring to Korea's changing responsibilities, I would
like to make clear that this is not meant to suggest that the
United States does not have an essential and major role to
play in the reduction of global imbalances — a role that is
obviously much larger and more demanding than that of Korea.
Indeed, without strong efforts on our part — and on the part
of the other industrial nations — the desired contribution to
the process of global adjustment that Korea can make would be
largely lost.
The main focus of U.S. efforts has been and will continue
to be reducing the fiscal deficit, resisting protectionism,
and bringing the growth of domestic demand below the growth of
real GNP. These efforts are being carried out within the
framework of international economic policy coordination that
has been developed since 1985. Important progress has been
achieved by the United States and other industrial countries
within this context, but continued efforts will be needed.
This being said, the importance of Korean efforts should
not be minimized. Korea can no longer afford to view itself
as a small developing country whose actions are largely
irrelevant to the world economy, and which therefore can
pursue policies solely with domestic considerations in mind.
Rather, it must recognize that Korea not only benefits from an
open and growing world trading system, but will also have a
hand in determining whether that system is preserved.
I am encouraged by indications that Korea not only
understands these new realities, but is beginning to come to
grips with their practical implications. Senior economic
policymakers have made clear Korea's own self interest in
controlling the size of its external surpluses to restrain
monetary and inflationary pressures, and to allocate resources
more efficiently. The government has announced its intention
to implement a broad range of trade and other measures to
control the size of Korea's external surpluses. Although
actual implementation of these measures has fallen short of
what is needed, in part due to rapidly changing political
conditions, there have been some important signs of progress.
o The government has accelerated implementation of its
1983 program to remove non-tariff barriers, ease
onerous licensing requirements, and reduce the level
and dispersion of tariffs. Recently, a proposal was
announced for a broad tariff reform program, to be
implemented starting in 1989 with the objective of
moving to OECD average tariff levels by 1992.

- 7 o

The Korean won has appreciated noticeably against the
U.S. dollar, including 8% since the beginning of this
year.

o Restrictions on some invisibles transactions have been
eased somewhat, consistent with the government's stated
desire to move to OECD standards in that area as well
by 1992.
o There has also been some liberalization of capital
flows, with the government increasing the size of the
offshore funds through which foreign investors can
participate in the Korean equities market. In
addition, controls on investment abroad by Koreans are
to be eased.
o Finally, excise taxes on some consumer goods have been
reduced, and I understand that tax reform may be under
consideration which could foster consumption.
These various measures should facilitate the reduction of
Korea's surplus, enhance the efficiency of the Korean economy, and
help pass on more of the benefits of Korea's success to the Korean
people. But the efforts already underway must be reinforced and
broadened, particularly given the government's stated objective of
reducing the current account surplus to $7 billion this year. A
three-part strategy is required, involving greater trade'liberalization) further exchange rate appreciation, and domestic
restructuring and liberalization. Let me address each of these in
turn.
Trade Liberalization
Bolder action is required on the trade liberalization front.
We welcome the government's commitment to obtain the National
Assembly's approval of a new tariff liberalization program.
However, stretching the reductions out over a five-year period
seems unnecessarily slow and is unlik-'y to have the required
significant near-term impact on the excernal surplus.
Other actions in the trade area also appear desirable and
feasible.
o In anticipation of implementation of the new tariff
reform program, the so-called "surveillance list,"
which gives the Korean Foreign Traders' Association
veto power over import licenses, should be eliminated
immediately rather than at the end of the year as
currently planned.
o Special laws and various administrative procedures
affect 20% of imports and allow some industry
associations to review import licenses. This kind of
protection is inconsistent with the government's stated

- 8 intention to liberalize trade and unnecessary in light
of Korea's economic conditions.
o Although the imports affected by bans and quantitative
restrictions has been significantly reduced, key items
remain controlled, including some 20% of agricultural
products. We recognize the political difficulty of
lifting such controls, but more rapid progress is in
order.
o Despite the gradual reduction in the average unweighted
tariff, scope exists for further reductions in
anticipation of the 1989 reform. For example, import
tariffs on items that are among Korea's most
competitive exports, such as footwear and steel,
remain in the range of 20-30% This is very difficult
to understand for an economy running a surplus over 8%
of GDP.
o Export incentives have also been progressively
dismantled, but there is room for further action in
this area, too. For example, special export financing
for small and medium-sized enterprises, import duty
drawbacks, and other tax incentives remain. Do Korean
exporters continue to need such special incentives?
*

Exchange Rate Appreciation
More rapid appreciation of the won must accompany
trade liberalization. Although the Korean won has appreciated
against the dollar, this appreciation is much less than that
of key competitors. Since late 1985, for example, the won has
appreciated 22% compared to 42% for the new Taiwan (NT) dollar
and 95% for the yen. This disparity has resulted in clear
competitive gains, nothwithstanding the wage increases that
have occurred in 1987 and this year. It also helps account
for the continued expansion of the U.S. trade deficit with
Korea, while our deficits with Japan and Taiwan are showing
signs of reduction. Exchange rate appreciation can be an
important tool to promote structural change in Korea's
economy, increasing the demand for imports and encouraging
investment for domestic as well as foreign markets. It can
also help dampen inflationary pressures, and pass on more of
the benefits of Korea's strong economic performance to the
Korean people.
At a time when protectionist pressures remain strong in
the United States and other countries, it is important that
We deny
were its
heartened
fasterthat
paceit of
Korea
critics by
thethe
charge
hasappreciation
an undervalued
during
the
first
quai'er
of
the
year,
which
helped
to
exchange rate. Korean producers do not need any extra
advantages to remain competitive in the world economy.

- 9 offset the lack of exchange rate movement in the second half
of last year. However, the pace of appreciation appears to
have slowed again, a move that appears to run counter to the
need to redress the growing external balance. We encourage
the authorities to allow the exchange rate to reflect the
underlying strength of the Korean economy. Further delay will
only increase the difficulty of the adjustment process.
Domestic Restructuring and Liberalization
Additional steps aimed at domestic restructuring and
liberalization are necessary to complement these trade and
exchange rate measures. These steps fall into the areas of
easing exchange controls on capital and invisibles
transactions; liberalizing the banking sector, including
improved treatment of foreign banks; further modernization of
the equities market; and other measures to permit more
balanced growth.
o Capital and Invisibles Transactions
Reinforcing the measures already adopted to ease foreign
exchange controls, both for capital and invisibles
transactions, should be an important element of Korea's
adjustment strategy. Steps taken to date have involved
changes at the margin; for example, a lowering of the minimum
wage for overseas tourism travel from 45 to 40 years.
More significantly from the perspective of increasing
Korea's integration into the world economy, a variety of
restrictions affecting the freedom of Korean businesses and
other entities to invest overseas have been eased. The size
of overseas investments automatically approved has been
increased from $500,000 to $1 million, and those under $5
million no longer require approval by the Committee on
Overseas Investment Projects.
In contrast to the easing of controls on capital outflows,
restrictions on capital inflows have generally been
tightened. Recently, the only easing of capital inflows has
been through an increase in the number of sectors open to
foreign direct investment. However, more than 20% of Korea's
industrial sectors still remain closed to foreign direct
investment, including such important service industries as
banking.
Even in the sectors that are nominally open to foreign
investment, important restrictions remain. For example,
licenses for activities not involving technology transfer are
increasingly difficult to obtain. In addition, foreign
investors are generally limited to a minority role in joint
ventures. Foreign companies are also finding it difficult to
acquire credit, due to the prohibition on borrowing abroad,
the government's requirement that Korean banks increase their

- 10 credit allocations to small and medium-sized Korean
enterprises, and foreign bank branches' own inability to
obtain adequate won to maintain their operations.
These impediments to capital inflows hinder access to new
technologies — in services as well as in manufacturing — and
raise the cost of capital to Korean businesses. They also
retard the correction of the value of the won that is required
to achieve the necessary structural shifts in the Korean
economy. This elimination could greatly benefit the Korean
economy.
o Banking Sector Reforms
Liberalizing and modernizing the banking sector is another
key reform. As the economy advances apace, the financial
sector is being left behind and is becoming a constraint on
growth, unable to provide capital in an efficient manner to an
increasingly sophisticated economy.
Controls on interest rates and on the allocation of credit
are incompatible with the development of a modern, market
economy that is fully integrated into the world economy. They
have contributed to distortions in the Korean economy, and
encourage proliferation of an unregulated informal financial
sector that poses unnecessary risks for savers and increases
the costs of financial intermediation in the economy as a
whole. The bias against consumer and mortgage finance are
also slowing the process of structural adjustment that is
required.
Treatment of foreign banks should also be improved within
the framework of a broad program to dismantle government
intervention in the domestic banking sector. A key area to
address is giving foreign bank branches access to local
currency funding on a par with domestic banks, allowing
foreign banks greater freedom with respect to establishing new
branches, and creating an interbank money market to which all
banks, domestic and foreign, would have equal access. We are
encouraged that the government appears to have these issues
under review, and hope that it will take speedy and positive
action.
o Equity Market Reforms
Further modernization of the Korean equities market is
also desirable. This market has already seen substantial
growth, partly in response to the liberalization program
announced by the government in 1984 and partly in response to
the unavailability of other equities investment opportunities
for Koreans until recently. The number of listed companies
increased 14% over 1986 and 1987, compared with less than
2% in 1985, and the number of shareholders increased 300%,

- 11 compared with less than 7% in 1985. The stock price index,
which rose only 15% in 1985, jumped 67% in 1986, and another
93% in 1987.
Other recent developments have also been positive. The
size of the offshore closed-end funds through which foreigners
can invest indirectly in Korean equities is to be increased
and a closed-end fund is also to be established to enable
Koreans to invest indirectly in foreign stocks.
The next significant step will be to allow foreigners
direct access to the Korean equities market. I understand the
government's concern that such an opening might result in a
sudden influx of capital that could destabilize the stock
market and create monetary and inflationary pressures.
However, it seems that the limits the government has
established on the share of a company's outstanding stock that
a single investor may hold goes a long way toward addressing
the first problem. The second conern could be addressed
through more rapid appreciation of the exchange rate and
liberalization of imports to reduce the monetary and
inflationary pressures resulting from the external surplus.
o Other Reforms
Other structural changes are required to permit faster
growth of domestic consumption and aid in the reduction of
Korea's external surpluses. Excise taxes still range as high
as 70%, leaving considerable room for further progress in this
regard. The reduction of interest rates on mortgage finance
and on consumer lending would also be beneficial in this
regard.
The climate for opening up Korea's economy and integrating
it into the international economy appears to be improving. I
have noted reports of support among businessmen and academicians for a lightening of the government's hand in the
economy, and for somewhat greater economic liberalization.
The government's own efforts to publicize the benefits of
greater liberalization have, no doubt, contributed to this
support, just as the process of democratization in Korea has
allowed such support to find greater and more open expression.
I understand that the prestigious Korean Development Institute
is to undertake a broad study of the need for and modalities
of economic deregulation in Korea. I would hope that this
study will contribute to a consensus within Korea that
economic liberalization and greater integration into the world
economy will be beneficial, not harmful, to the Korean
economy.

- 12 CONCLUSION
In concluding, I would note that Korea finds itself in an
apparently perplexing, even paradoxical, situation. It has
made tremendous economic strides over the last three decades.
For this it has justifiably received acclaim throughout the
world.
Like other surplus countries before it, however, Korea now
finds itself being called upon to accept greater global
responsibilities, and being criticized, some might say, for
having been "too successful." The export orientation that was
at the heart of this success is now called into question, and
long-established patterns of production, investment, and
consumption have become prime candidates for change.
Suddenly, the international community is directing attention
and concern toward what must seem to many Koreans to still be
a relatively poor and small economy.
In such circumstances, there is an inevitable temptation
to respond to these developments and pressures by turning
inward, becoming defensive, deflecting criticisms, maintaining
traditional policy stances, and stressing the responsiblities
of others which are, after all, much greater. It would be
understandable if this temptation were not fully resisted.
And yet to succumb to it would be a serious mistake.
Circumstances have changed, and what once bred success may now
only lead to difficulty. The drive, determination, and
soundness which have characterized Korea's economic policies
and performance for many decades must now be directed away
from export-led growth, and toward a more diverse base that
emphasizes domestic consumption and investment, as well as
foreign markets.
Fortunately, there are persuasive reasons to believe that
Korea can and will make the necessary adaptations in its
policies to meet the challenges and responsibilities that lie
ahead. Two reasons in particular come to mind.
o First, there is now a confluence of Korea's domestic
needs and its changing international responsibilities.
Korea's economic strength provides the ideal
opportunity for structural changes to liberalize and
deregulate its economy, spreading the benefits of its
growth more widely and laying the foundation for
continued prosperity. The policies which will help
seize this opportunity will also enable Korea to
fulfill its growing responsibility to the global
adjustment process.

- 13 o

Second, the Korean authorities have increasingly moved
toward adopting a course of action that will bring the
full range of macroeconomic and structural policies to
bear on the tasks at hand. Indeed, policy actions to
date in 1988 have gone some distance to convince the
Korean people and the world at large that Korea remains
more than equal to the economic challenges it faces.
There is, however, a third factor that gives confidence.
It is less tangible than the others, but in the long run
probably more important. It is the sense of balance and
harmony which has long been part of the Korean character and
philosopy. This sense is perhaps best symbolized by the
Korean flag, with a circle of red and blue centered over a
white background. As most of you are undoubtedly aware, the
upper red portion represents the yang and the lower blue
portion the urn. Author Edward B. Adams, who has written much
on Korea, explains that this is an ancient symbol of the
universe in perfect balance and harmony, with the two
opposites expressing the dualisms such as day and night, heat
and cold — and I might add exports and imports, surpluses and
deficits. This duality recognizes that life is often full of
contradictions — of paradoxes, if you*will, such as Korea
faces today.
As we strive together to reduce imbalances in the world
economy, I am comforted in the knowledge that we have a
partner in Korea which brings a special sense of balance and
harmony
all things. I am sure the Koreans will bring this
Thanktoyou.
perspective to bear on the difficult issues we face in the
global economy. And from this, we will all benefit.

TREASURY NEWS
Deportment off the Treasury • Washington, D.c. • Telephone 566-2^41
EMBARGOED FOR RELEASE UPON DELIVERY
Expected at 7:30 p.m. May 28 in Hawaii
(1:30 a.m. EDT, May 29, 1988)

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Remarks by David C. Mulford
Assistant Secretary for International Affairs
Department of the Treasury
at the Association Cambiste Internationale
Honolulu, Hawaii
May 28, 1988
Economic Policy Coordination and
the Foreign Exchange Marke"t
It is a pleasure to be here for the 30th anniversary of the
ACI. Profound changes have taken place in financial markets in
recent years which have dramatically altered the scope of the
foreign exchange market and the role of the currency trader.
Foreign exchange trading is now a 24-hour global business
with a daily turnover approaching $500 billion, thus dwarfing all
other financial markets. The linkages between foreign exchange
and domestic money and securities market have become so pervasive
that developments in one sector create immediate responses in the
others. And, the currency trader has become a significant force,
both positive and negative, affecting the bottom lines of the
largest financial institutions.
Tonight I want to speak about economic policy coordination
and the foreign exchange market. This is a subject of vital
importance to your day to day business on a year round basis. But
we all know that some business days are more important — and more
difficult — than others, especially in your business. Sometimes
these are associated with major public events such as a Summit or
Ministerial meeting; other times it is the release of sensitive
economic data. With the Economic Summit only three weeks away, we
are perhaps entering one of those periods where market attention
may be directed away from the fundamentals.
In recent years, the Economic Summits have produced an
important impetus for new approaches to economic issues. The
Reagan years in particular have produced a profound change in
thinking worldwide regarding the role of the government in the
economy. A consensus has emerged in the industrial nations in a
number of broad policy areas: tax reforms that increase
B-1429
incentives to work, save, and invest; deregulation in various
economic sectors; and elimination of subsidies and other measures
that distort market forces. Most important, the past two Summits

-2have produced a remarkable degree of consensus on the need for the
major countries to coordinate economic policies in order to
achieve a sound world economy and stable financial system.
Summit meetings, however, pose major problems of public
diplomacy with financial markets. They have become enormous media
events. The need to satisfy the headline writers and to meet the
limitations of the 30 second TV bite has created undesirable
pressures to oversimplify complex issues and to come up with new
initiatives and overnight success. Confrontations and controversy
have been manufactured where none exist. Expectations are created
that cannot be satisfied and financial markets respond to the
myriad of perceptions which are generated without any real
knowledge or assessment of underlying policies and policy changes.
Before the pre-Toronto hype begins in earnest, let me
indicate what I believe the main economic focus at Toronto will
be. A key Summit objective will be continued expansion of the
global economy and the maintenance of an open world trading
system. I expect, therefore, that much of the discussion will
center on the coordination of economic policies by the major
industrial countries as a means of promoting growth, reducing
trade imbalances, and fostering greater currency stability. This
process of coordination, which is still in its infancy, has major
implications for world currency markets and for the international
monetary system.
Process, policies and performance
At the 1986 winter meeting of the FOREX USA, I suggested that
the global financial revolution had forced governments to
formulate economic policies on a worldwide basis. Events since
that time have reinforced that judgment. We have seen an
intensification of efforts to strengthen and give better
definition to the process. The Tokyo Summit produced the first
step towards creating a formal framework for the economic policy
coordination process. The Louvre Accord in February 1987 was the
first public evidence within that framework of successful policy
coordination. The Venice Summit provided clear signals of
important refinements and better definition to the process, and
the G-7 statements of December 22, 1987, and April 13, 1988,
demonstrated that incremental improvements to the process are
being carried forward.
You will recall that the coordination process involves a
regular dialogue at the political level on key economic issues by
the major industrial countries. It seeks to instill greater
accountability by each participant for the international
ramifications of domestic policies. Greater discipline and rigor
is achieved by establishing mutually consistent medium-term
objectives and projections for each country and the group as a
whole. Indicators are used to assess whether current performance

-3is compatible with the agreed objectives and projections and to
determine whether there is a need to consider possible remedial
actions.
The participants have agreed on the basic indicators that
will be used, focusing this year on growth, external balances and
exchange rates. In addition, the necessary national economic data
has been compiled with the assistance of the IMF and procedures
for regular reviews have been established. In effect, we now have
an annual cycle for developing objectives and projections,
assessing performance and considering policy requirements.
The development of a coordination process with rules and
discipline serves to focus attention on the compatibility and
consistency of national policies and performance with
international adjustment requirements. As governments have become
more comfortable with the process and instances of successful
coordination emerge, confidence among the participants in the
process is building. This in turn is reinforcing the commitment
of participants to the process, thereby strengthening the
discipline and credibility of the coordination effort. Yet
national sovereignty has not been ceded and the political
realities in the participating countries have been recognized and
accommodated. Finally, success not only breeds success, but also
highlights more clearly the downside of a failure to continue the
coordination process.
Thus, the coordination process is in place and functioning.
The G-7 Finance Ministers and Central Bank Governors have agreed
on concerted economic and exchange rate policies to reduce
external imbalances while maintaining noninflationary growth.
Commitments on specific measures have been made and implemented to
achieve the intended redirection of our economies. Following the
events of last October, Ministers consulted regularly and a number
of important policy actions, such as the two year deficit
reduction package of the United States, were put in place.
These policy changes, whether fiscal or monetary, took time
to negotiate and, more importantly, to implement. The process
last autumn allowed these political realities to be dealt with
effectively and I would remind you that all this took place,
including the December 22 statement, without a formal meeting of
the G-7 Ministers. As a result, today the world economy is on a
much more solid footing than many at that time had thought
possible.
The industrial countries in fact grew faster in the second
half of 1987 than in the first half. For 1988, there is a new
optimism about growth prospects with both the IMF and OECD
forecasting another year of 3-percent growth.

-4-

Just as importantly, the composition and pattern of growth
among the major industrial countries has shifted to support
balance of payments adjustment. Domestic demand in Japan is now
growing at 5.5 percent, nearly four times as fast as in the United
States. In Europe, demand is growing twice as fast as in the
United States. This follows several years in which rapid U.S.
growth fueled the global recovery, but also contributed
importantly to the trade imbalance.
For its part, the United States is embarked on a multiyear
program to reduce and eliminate the Federal budget deficit. The
$71 billion deficit reduction achieved last year was equivalent to
nearly 2 percent of GNP. Implementation of the unprecedented
agreement between the President and the Congress last December
will provide $76 billion in budget savings in fiscal 1988 and
1989. By the end of fiscal 1990, our budget deficit should be
down to less than 2 percent of GNP, with the general government
deficit below 1 percent of GNP.
The United States is also experiencing an improvement in
private savings. The personal savings rate rose sharply in the
fourth quarter of last year to 4.8 percent. The rate remained
above 4.5 percent in the first quarter of this year. Business
savings, which accounts for 80 percent of private savings, is also
growing and should improve further as U.S. competitiveness
strengthens. Improved savings and budget deficit reduction are
creating a better balance in domestic savings and investment which
is reducing the need for foreign borrowing.
The substantial change in exchange rates that have taken
place since the dollar peaked in February, 1985 has resulted in a
significant improvement in the U.S. competitive position. The
dollar has depreciated in real, price adjusted terms by nearly
25 percent against our 13 largest trading partners which together
account for two-thirds of U.S. trade. As a result, U.S. price
competitiveness now exceeds the level at the beginning of 1981,
the last year in which the United States had a current account
surplus. This enormous change has been accomplished in the
context of the longest peacetime expansion in U.S. history, 66
months and continuing.
The combination of present growth patterns and exchange rate
changes are producing the desired adjustment of external
imbalances. In the United States, the volume of exports rose 31
percent from the third quarter of 1986 through the first quarter
of 1988, while import volume increased only 6 percent. The latest
trade figures confirm that the deficit in value terms is on a
downward trend. We are also witnessing the correction of external
imbalances in the principal surplus countries.

-5-

I do not understate the difficulties in achieving a
sustainable external position. With U.S. imports over half again
as large as exports, it will take time and continued effort to
restore a better balance. But markets focus on emerging trends
and there are a number of reasons for optimism in this regard.
Admittedly, trade imbalances have not declined as far as we
would have expected in light of the substantial exchange rate
changes that have taken place. However, I believe that the dire
predictions of imbalances on the present scale far into the future
and a loss of momentum in the adjustment process miss the mark
considerably. In part, the absence of greater adjustment to date
is due to the fact that, until recently, U.S. demand growth
substantially exceeded that of our major trading partners. As I
have already noted, that situation is now rapidly changing.
Moreover, price data indicates that foreign producers have
absorbed much of the potential loss of competitive position by
reducing profit margins and cutting costs. Their ability to do so
in the future has diminished significantly.
Furthermore, projections by international institutions and
private forecasters of large external imbalances into the 1990's
are based on the assumption of a continuation of current economic
policies. It is highly improbable, however, that the G-7
countries will take no further actions. Indeed, all are committed
to take the measures necessary to achieve sustainable external
positions. I have no doubt that additional actions will be
forthcoming.
The forecasting models are also not well suited to picking up
the effects of the important structural changes taking place in
the world economy — what I call the dynamics of structural
change. These are not well understood and are probably
substantially underestimated. The very large exchange rate
changes are having a positive impact on U.S. attitudes toward
trade, with business now much more willing to look to exports as a
source of future growth. Indeed, the increase in U.S. exports is
playing a significant role in the overall growth in the economy
this year.
Similarly, foreign producers are expanding production in the
United States. And U.S. companies that went abroad to diversify
production during the dollar's earlier rise are experiencing
greater incentives to invest and expand production in this
country. These developments will take time to be reflected in the
trade figures but are nevertheless real.

-6-

Finally, we are beginning to see a change in the situation of
the developing countries. The four Asian NICs, which had a
combined current account surplus last year of $32 billion, can no
longer expect to have a free ride. There is a growing awareness
and acceptance in the NICs that they must participate positively
in the balance of payments adjustment process by opening their
markets and allowing their currencies to fully reflect the
underlying strength of their economies.
We are also seeing improvements in the situation of those
developing countries that have experienced major debt problems.
Growth is stronger, debt and interest service ratios have fallen,
and imports this year should be tie highest since 1982.
I do not mean to suggest thac the problem is solved or that
the hardest part is behind us. The United States must continue
its efforts to reduce the budget deficit, improve domestic savings
and strengthen competitiveness by keeping inflation under control.
The major surplus countries need to continue to pursue monetary,
fiscal and structural policies to foster growth and reduce
reliance on exports. The NICs must do their part in global
adjustment before they lose the benefits of the open trading
system that has fueled their remarkable growth. And, we must
continue to encourage the debtor .lations to implement
growth-oriented reforms, supported by adequate external financing.
But very real progress is being made and more is in store.
Foreign Exchange Markets
As currency traders, you have naturally focused on the
exchange rate aspects of the coordination process. A foreign
exchange pundit is reputed to have said that the only thing worse
than excessive currency volatility is excessive stability. I read
a snippet in the London press last week that quoted a foreign
exchange trader as saying: "If volatility doesn't increase I
won't be able to make my mortgage payments."
The economic policy coordination process seeks to eliminate
the excesses while recognizing that in markets, as in life, change
is inevitable.
The achievement of more consistent policies and compatible
performance is the starting point for achieving greater currency
stability. It has already served to enhance effective cooperation
by the participants in the currency markets. There is, of course,
considerable controversy regarding the effectiveness and
desirability of government intervention in currency markets.
Clearly, the monetary authorities neither could nor should seek to
prevent exchange rates from playing their appropriate part in the
adjustment process. Hopefully, all of us have learned the lesson

-7of King Canute that you can't hold back the tide or capital flows
by wishing it so. At the same time, however, it is unrealistic to
expect governments to ignore exchange market developments given
the pervasive impact they have on other financial markets and the
domestic economy.
Recent experience suggests that exchange market operations
can play a useful, albeit limited, role in complementing our
economic policy coordination efforts. For official intervention
to have a positive effect, however, it must meet certain criteria.
First and foremost, official intervention must be supportive of
and consistent with other economic policies. It makes little
sense to attempt to stabilize exchange rates through intervention
if economic policies, including monetary policies, suggest that
underlying conditions are shifting in a manner that warrants a
change in currency values.
A second, and related, point is that market participants must
have confidence that authorities are prepared to adjust their
policies if they do not appear to be achieving their intended
effect. If markets have this confidence, they will react with
greater caution to aberrations in monthly data or indications that
one or another real or financial variable is moving less rapidly
than expected in the desired direction.
Third, the major countries need to operate in exchange
markets on a concerted and cooperative basis that reflects clear
agreements regarding the objectives and responsibilities of each
participant in particular operations. One reason that our
cooperative efforts have become more effective is that they are
the result of close, frequent consultations and reflect specific
understandings that are reviewed regularly and adjusted as
necessary in light of market conditions.
In these circumstances, we believe that intervention can have
a positive affect on market expectations. The achievement of
greater currency stability can also have important spillover
effects in domestic securities and money markets.
The greater stability in exchange markets that has emerged
since the beginning of the year is a welcome development,
reflecting both prospects for improved economic fundamentals and
more effective cooperation by governments. It remains the view of
the G-7 countries that either excessive exchange rate
fluctuations, a further decline of the dollar, or a rise that is
destabilizing to our adjustment efforts could be counterproductive. We have a common interest in stable exchange rates
and are committed to implementing policies that strengthen the
economic fundamentals to foster continued exchange rate stability.
Let me assure you also that close exchange market cooperation will
continue.

-8Improving the international monetary system
In recent years attempts to improve the international
monetary system have been seen as separate from the question of
international monetary reform. In particular, this is the result
of the breakdown in the Bretton Wood's system in the early 1970's,
which has left a body of opinion hankering after a formal system
of fixed exchange rates and automatic disciplines. Meanwhile, the
freely floating system which has had important strengths during
the period of rapid and extensive structural change in our world
has come in for heavy criticism because of extensive swings in
exchange rates and the associated rise of large global imbalances.
Most discussion on the subject leads to the conclusion that
it is not possible, practical, or even desirable that in today's
world we return to a system of fixed rates with a high degree of
automaticity and discipline. I find few people who believe, for
example, that the EMS system — as developed in Europe — could be
applied successfully today to the world as a whole.
Thus, we must concentrate on improving the present system
and, as Secretary Baker suggested last week in Paris, the G-7
coordination process provides the most flexible, credible, and
realistic approach for achieving meaningful reform of our
international monetary arrangements. There is no reason why
reform of the system cannot or should not be accomplished by the
step-by-step process that is underway. The coordination process
addresses present realities:
o It combines a careful balance of flexibility with
commitments and obligations that takes into account the
reality of national sovereignty;
o It comprehends the broad range of monetary, fiscal and
exchange rate policies necessary for achieving a sound,
open world economy;
o It can encourage corrective policy actions without relying
on mechanisms that appear to be automatic, but prove to be
excessively rigid and thus are ignored until political
pressures build up to unmanageable levels;
o It provides flexibility in utilizing different adjustment
policies, domestic or external, depending on
circumstances;
o It is symmetrical by placing adjustment pressures on both
surplus and deficit countries; and
o It represents a credible approach which, by recognizing
and taking account of political and economic realities, is
more likely to produce meaningful results than other
grandiose, but unrealistic, proposals.

-9The process is not perfect and there is scope for further
improvement, but it does address the critical issues for making
the system work. Proposals for a drastic and more formal overhaul
of our monetary arrangements may provide dramatic headlines, but
result in little real forward movement. In the competition for a
better international monetary system, one wonders if the turtle
will not run a better race than the rabbit.
In this connection, the major industrial countries have
agreed to develop a commodity price indicator as an additional
analytical instrument in the coordination process. The commodity
price indicator would supplement the existing national indicators
in order to help in assessing and reaching judgments about
economic policies and performance. It will be used as an
analytical tool, rather than as an automatic trigger for policy
changes or an anchor for currencies.
Discussions on the commodity indicator are proceeding. The
focus is on developing a price index based on a wide range of
primary commodities — foods, fibers, and metals — and weighted
on the basis of G-7 consumption. A number of issues remain to be
resolved, but it is our expectation that this work can be
completed expeditiously so that the indicator can be in operation
by the Toronto Summit.
But we cannot stop there. The Summit countries are
identifying priority areas where structural reforms need to be
pursued. This includes tax reform, financial market
liberalization, deregulation of markets and removal of barriers to
labor mobility, agriculture reform, government subsidies, and
trade barriers. We need to find ways to broaden the coordination
process to deal with these issues as a complement to our efforts
on macroeconomic policies.
We will need to consider other steps as well to refine the
means of assessing whether an economy's performance is
significantly deviating from an appropriate path, suggesting the
need for consultation and possible action. This might involve
consideration of "monitoring zones" for key variables such as
growth, trade balances and so forth.
Conclusion
The economic policy coordination process is a response to the
new realities arising from a global financial revolution that is
pushing national boundaries outward at an accelerating pace. It
represents a pragmatic and flexible means of dealing with current
problems. Slow but steady progress is being made but we are not
out of the woods. We must be alert to new opportunities to move
ahead, recognizing that strengthening the functioning of our
international monetary arrangements must be achieved in
incremental steps. The continued success of this effort provides
the only meaningful international monetary reform that makes
sense.

TREASURY NEWS
Deportment off the Treasury • Washington, D.c. • Telephone 566-2041

Remarks by
Secretary of the Treasury
James A. Baker, III
at the Central Bank for
West African States (BCEAO)
Monday, May 30, 1988
Dakar, Senegal
It is an honor to address such a distinguished group in such
impressive surroundings. This morning I had a good meeting with
President Diouf. I reiterated what'I had told my colleagues in
Washington: I could not come to West Africa without stopping
here in Dakar. I could not miss the opportunity to let you know,
and for all the world to hear, just how much we Americans admire
you and how proud we are to be your friends.
There are many ties that bind Americans and Senegalese. We
share many.values. Our two countries have a common dedication to
the principles of democracy, representative government, and the
rule of law. That dedication lies at the heart of our bilateral
relationship and serves to energize our cultural and educational
exchanges and our development activities. Over the years, our
common dedication has also facilitated the spirit of frank
dialogue that President Diouf and President Reagan have
cultivated.
Our two presidents also share a common dedication to economic
reform. They believe in government that delivers what it
promises and intrudes as little as possible on the prerogatives
of the private sector. They also understand that, in the United
States as in Africa, the process of economic reform is not an
easy one. What I'd like to do this afternoon is talk a bit about
the relationship between economic reform and democracy.
During my term as Secretary of the Treasury I've had the
opportunity to discuss the economic reform process with leaders
from every continent. It is a process that typically passes
B-1430 several stages. At first, reforms are implemented with
through
considerable urgency. They correct the worst economic
distortions in prices and markets while reducing budget and
current account deficits.

-2Improved finances and higher agricultural production are
among the early results of the reform process as farmers respond
to higher prices and market deregulation. A country typically
receives additional credits from the World Bank, the IMF, and
bilateral donors to support their efforts. With these reforms
official creditors and commercial banks frequently reschedule
debt, and, in some cases, commercial banks provide additional,
new financing.
Once the most glaring economic imbalances have been dealt
with, the political and business leadership turns its attention
to confronting the country's fundamental structural problems.
They devise further reforms that transform underlying economic
structures and institutions. This stage involves streamlining
government operations, eliminating inefficient enterprises,
removing subsidies, and improving the efficiency of individual
markets. Not surprisingly, these measures can be controversial.
They can even spur doubts about the reform process itself.
Four years ago your government embarked on a courageous
structural adjustment program designed to improve Senegal's
economic performance, to achieve greater economic self-reliance,
and to provide expanded economic opportunity for future
generations. You took some bold steps. You decided to forego
government consumption in favor of private consumption and
investment. You made both your exports and your domestic
industrial production more competitive vis-a-vis world markets.
And you reduced your reliance on imported food in favor of
competitively priced local cereals.
Compared to many other countries — some of which have a more
favorable natural-resource base than Senegal — you have made
impressive progress in achieving these objectives:
o Your economic growth, which was negative in 1984/85,
has averaged 4.3 percent over the past two years.
o Your overall budget deficit has been reduced from 4.6
percent of GDP in 1983/84 to 1.4 percent of GDP in
1986/87 and internal arrears of the government have been
reduced by 62 percent during the same period.
o Your balance of payments deficit has been cut nearly in
half — to 5.5 percent of GDP in 1986/87; and
o Since 1983/84 you have increased cereals production by
over 17 percent and peanut production by almost
13 percent.
These results have been widely admired. Your economic reform
program is among the most successful anywhere.
You have proven that the private sector can out-perform the
public sector in agriculture. Farmers preserved their seeds and
made wise economic decisions on fertilizers and other inputs.
Over 50 billion CFA Francs were pumped into the rural sector as a
result of incentive producer prices and bumper harvests.

-3For the first time, farmers — the largest and most
hard-pressed segment of your population — had the cash to buy
consumer items — a bicycle, a radio, additional fabric for
clothing. There was even a surplus to replenish personal food
stocks and help poor relatives in the cities.
Your economic reforms shifted incentives and benefits from
urban consumption to the generally poorer but more productive
agricultural sector. The policy worked. Through it Senegal has
been able to achieve adjustment with growth. But the stresses
and strains of this shift have had an impact on social and
political life in Senegal, just as they do elsewhere.
The repercussions of reform are often felt most severely in
urban areas. Senegal is no exception to this general rule. The
challenge is to use the reform process to generate jobs through
continued modernization, diversification of the economy, and
expanded private investment, both domestic and foreign.
As appropriate macroeconomic policies continue, specific
sectoral impediments to growth need to be addressed. Reform of
financial and banking systems will mobilize greater domestic
savings. That kind of reform provides adequate finance for
small- and medium-sized businesses — often the motors of
economic growth. Eliminating barriers and special arrangements
that protect domestic industries paves the way for more efficient
new enterprises. Reductions in administrative regulation and governme
nt intervention in the economy allow greater scope for
private initiative.
I know there has been much debate here, as elsewhere in both
the industrial and developing world, about the wisdom of the
structural adjustment program. One thing, however, is clear:
The choice facing countries across the globe is not whether to
adjust, but how. The alternative to managed adjustment is forced
adjustment brought on by foreign exchange shortages and fiscal
insolvency.
Obviously, substantial additional support from the
international community will be required. A developing country's
own efforts cannot be regarded as sufficient to assure success.
Economic reforms must be adequately supported by donors. That
donor support, nonetheless, can only complement a country's own
economic reform efforts; it cannot substitute for them.
To be successful, these economic reform efforts must also be
sustained. Economic reform is a continuing process — not one
that is accomplished in 3- or 5-year segments. Sustaining the
process of economic reform requires that each country regard the
economic reforms as part of its own program, not imposed from the
outside as an arbitrary requirement for assistance or debt
rescheduling. A sustained economic reform effort internalizes
the process within the country. It only succeeds when the
program is broadly accepted by the whole population.

-4The process in turn places a burden on the national political
leadership to be willing to respond to the feedback from the
process. Not only do the leaders have to understand the effects
of their policies, but they must listen and learn from the
experience of all sectors of their population through open
channels of communication. Only then can they achieve a national *
consensus on the direction and pace of the reform process itself.
It is only through such a consensus that people feel that they
have a stake in the success of economic reform.
Can developing nations achieve such a consensus? I believe
they. can. Furthermore, I believe that the democracies of the
third world have the best chance of doing so. Some say African
nations are not mature enough politically to support democracy,
let alone multiparty democracy. Such critics believe that only
Western countries with powerful economies can afford the luxury
of democratic institutions. I would argue the opposite — that
it is through democratic institutions that countries can arrive
at the consensus necessary to sustain economic reforms.
Senegal is a successful democracy. You have drawn'on the
best of your traditions, and you have learned from the
experiences of others. Your fellow democracies have watched as
your nation has opened its political life to a wide range of
political parties. Despite all the turmoil of your recent
elections, you have not retreated from your commitment to a
multiparty democracy.
Your friends in the United States and throughout the world
are heartened by the spirit of reconciliation which has become
the focus of your national political agenda. Such a spirit
offers the opportunity to address the issues still confronting
the Senegalese people. It will allow you to build the consensus
needed to sustain your impressive record.
I know that President Diouf and other leaders are dedicated
to serious economic reform, and I would not presume to speak to
you so frankly if I were not equally persuaded that the
Senegalese people will set their grievances aside and gather in a
national consensus around the central issues that confront the
nation.
As you remain dedicated to serious economic reform, America
will do its best to help Senegal help itself. As you mobilize
your own resources, your friends will also channel their
assistance resources, mobilize private investment, and open
access to world markets to facilitate your efforts. You are well
on your way toward achieving your economic goal of real
development with social justice.

-5You are also well on your way to achieving your political
goal of a more equitable, more open, and more effective
democracy. President Diouf has made it clear that he will not
retreat from the multiparty model, and I understand that there is
currently much debate, within the majority party, among the
opposition, and in your free press about electoral code reforms,
better access to the government media by the opposition, improved
voting techniques, and better voter education. We are enormously
heartened by this evidence of a rededication to the democratic
ideal.
Much is at stake here in Senegal. I know that Senegal is not
trying to be a model for anyone else — but rather you are trying
to live up to your own high ideals. That is a worthy goal.
But I hope you do realize that your ideals are shared and admired.
ur success inspires other successes. You are truly a model for the
Thank you. Wa Salaam.
st of the developing world.

TREASURY NEWS
Deportment off the Treasury • Washington, D.C. • Telephone 566
FOR IMMEDIATE RELEASE

May 26, 1988

RESULTS OF AUCTION OF 5-YEAR 2-MONTH NOTES
The Department of the Treasury has accepted $7,001 million
of $ 24,499 million of tenders received from the public for the
5-year 2-month notes, Series L-1993, auctioned today. The notes
will be issued June 1, 1988, and mature August 15, 1993.
The interest rate on the notes will be 8-3/4%. The range
of accepted competitive bids, and the corresponding prices at the
8-3/4% rate are as follows:
Yield
Price
Low
8.75%*
99.926
High
8.77%
99.843
Average
8.77%
99.843
* Excepting 1 tender of $3,000.
Tenders at the high yield were allotted 65%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
Totals

Received
$
17,623
22,153,033
12,784
22,956
41,487
17,478
1,275,216
38,006
14,162
39,051
7,617
856,339
3,271
$24,499,023

Accepted
$
17,623
6,555,271
12,784
22,956
14,487
17,477
207,466
19,005
14,162
36,551
7,617
71,939
3,271
$7,000,609

The $7,001
million of accepted tenders includes $522
million of noncompetitive tenders and $6,479 million of competitive tenders from the public.
In addition to the $7,001 million of tenders accepted in
the auction process, $335 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities.
B-1431

2041

TREASURY NEWS
Deportment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON

May 27, 1988

TREASURY'S 52-WEEK BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for approximately $8,750
million of 364-day Treasury bills
to be dated June 9, 1988,
and to mature June 8, 1989
(CUSIP No. 912794 SC 9). This issue will result in a paydown for
the Treasury of about $1,050 million, as the maturing 52-week bill
is outstanding in the amount of $9,812
million. Tenders will be
received at Federal Reserve Banks and Branches and at the Bureau
of the Public Debt, Washington, D. C. 20239, prior to 1:00 p.m.,
Eastern Daylight Saving time, Thursday, June 2, 1988.
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. This series of bills will be issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the.records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for
Treasury bills maturing June 9, 1988.
In addition to the
maturing 52-week bills, there are $13,357 million of maturing bills
which were originally issued as 13-week and 26-week bills. The disposition of this latter amount will be announced next week. Federal
Reserve Banks currently hold $2,269 million as agents for foreign
and international monetary authorities, and $7,858 million for their
own account. These amounts represent the combined holdings of such
accounts for the three issues of maturing bills. Tenders from Federal Reserve Banks for their own account and as agents for foreign
and international monetary authorities will be accepted at the
weighted average bank discount rate of accepted competitive tenders.
Additional amounts of the bills may be issued to Federal Reserve
Banks, as agents for foreign and international monetary authorities,
to the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them. For
purposes of determining such additional amounts, foreign and international monetary authorities are considered to hold $80
million
of
the
original
52-week
issue.
Tenders
for
bills
to
be
maintained
B-1432
on the book-entry records of the Department of the Treasury should
be submitted on Form PD 5176-3.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
tenders for such bills from others, unless an express guaranty of
payment by an incorporated bank or trust company accompanies the
tenders.
10/87

TREASURY NEWS
Deportment off the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON

May 27, 1988

TREASURY OFFERS $4,000 MILLION
OF 9-DAY CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice, invites
tenders for approximately $4,000 million of 9-day Treasury bills
to be issued June 7, 1988, representing an additional amount of
bills dated December 17, 1987, maturing June 16, 1988 (CUSIP No.
912794 PU 2 ) .
Competitive tenders will be received at all Federal Reserve
Banks and Branches prior to 1:00 p.m., Eastern Daylight Saving time,
Wednesday, June 1, 1988. Each tender for the issue must be for
a minimum amount of $1,000,000. Tenders over $1,000,000 must be
in multiples of $1,000,000. Tenders must show the yield desired,
expressed on a bank discount rate basis with two decimals, e.g.,
7.15%. Fractions must not be used.
Noncompetitive tenders from the public will not be accepted.
Tenders will not be received at the Department of the Treasury,
Washington.
The bills will be issued on a discount basis under competitive bidding, and at maturity their par amount will be payable
without interest. The bills will be issued entirely in book-entry
form in a minimum denomination of $10,000 and in any higher $5,000
multiple, on the records of the Federal Reserve Banks and Branches.
Additional amounts of the bills may be issued to Federal Reserve
Banks as agents for foreign and international monetary authorities
at the average price of accepted competitive tenders.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of 12:30 p.m.,
Eastern time, on the day of the auction. Such positions would
include
B-1433 bills acquired through "when issued" trading, futures,

- 2 and forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e.g., bills with
three months to maturity previously offered as six-month bills.
Dealers, who make primary markets in Government securities and
report daily to the Federal Reserve Bank of New York their positions in and borrowings on such securities, when submitting tenders
for customers, must submit a separate tender for each customer
whose net long position in the bill being offered exceeds $200
million.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities. A deposit of 2 percent of the par amount
of the bills applied for must accompany tenders for such bills from
others, unless an express guaranty of payment by an incorporated
bank or trust company accompanies the tenders.
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Those
submitting tenders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. The calculation
of purchase prices for accepted bids will be carried to three
decimal places on the basis of price per hundred, e.g., 99.923.
Settlement for accepted tenders in accordance with the bids must
be made or completed at the Federal Reserve Bank or Branch in cash
or other immediately-available funds on Tuesday, June 7, 1988. In
addition, Treasury Tax and Loan Note Option Depositaries may make
payment for allotments of bills for their own accounts and for
account of customers by credit to their Treasury Tax and Loan Note
Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76 and 27-76, and this notice, prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies of
the circulars may be obtained from any Federal Reserve Bank or
Branch.

TREASURY NEWS
Itportment off the Treasury • Washington, D.C. • Telephone 566-2041
May 31, 1988

FOR IMMEDIATE RELEASE
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

Tenders for $6,401 million of 13-week bills and for $6,410 million
of 26-veek bills, both to be Issued on
June 2, 1988,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

26--week bills

13--week bills
maturlng September 1 , 1988
Discount Investment
Price
Rate
Rate 1/
6.50%
6.53%
6.53%

6. 70%
6.73%
6.73%

98.357
98.349
98.349

maturing
Discount
Rate
:
:

December 1, 1988

Investment
Rate 1/

Price

7.16%
7.18%
7.17%

96.552
96.542
96.547

6.82%
6.84%
6.83%

Tenders at the high discount rate for the 13-week bills vere allotted 72%.
Tenders at the high discount rate for the 26-week bills vere allotted 38%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
Accepted
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
Treasury
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Received

Accepted

$
37,005
23,607,295
25,975
38,155
50,620
31,015
1,928,435
38,240
17,560
63,740
31,230
1,082,950
334,505

37,005
5,562,560
24,760
37,700
40,620
31,015
127,710
33,000
11,160
49,740
21,230
89,950
334,505

$
27,840
20,713,555
:
14,315
'•
33,315
'
40,320
25,150
:
1,616,965
:
22,655
12,285
38,220
24,460
:
.
1,383,070
330,980

$
27,840
5,325,585
14,315
33,315
40,320
25,150
120,645
20,035
9,185
38,220
16,360
407,670
330,980

$27,286,725

$6,400,955

$24,283,130

$6,409,620

$23,789,785
993,370
$24,783,155

$2,904,015
993,370
$3,897,385

:
:
.

$20,136,150
767,800
$20,903,950

$2,262,640
767,800
$3,030,440

2,315,500

2,000,000

188,070

1,379,180

$27,286,725

$6,400,955

$24,283,130

$6,409,620

An additional$106,930 thousand of 13-veek bills and an additional $830,520
thousand of 26-veek bills vill be issued to foreign official institutions for
nev cash.
1/ Equivalent coupon-issue yield.
B-1434

TREASURY NEWS
apartment off the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
TREASURY'S WEEKLY BILL OFFERING

May 31, 1988

The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$12,800 million, to be issued June 9, 1988.
This offering
will result in a paydown for the Treasury of about $550
million, as
the maturing bills are outstanding in the amount of $13,357 million.
Tenders will be received at Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m.. Eastern Daylight Saving time, Monday, June 6, 1988.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $6,400
million, representing an additional amount of bills dated
March 10, 1988,
and to mature September 8, 198 8 (CUSIP No.
912794 QL 1), currently outstanding in the amount of $7,244 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $6,400 million, to be dated
June 9, 1988,
and to mature December 8, 1988
(CUSIP No.
912794 QW 7 ).
The bills will be issued on a discount basis under competitive
and noncompetitive bidding, and at maturity their par amount will
be payable without interest. Both series of bills will be Issued
entirely in book-entry form in a minimum amount of $10,000 and in
any higher $5,000 multiple, on the records either of the Federal
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for Treasury
bills maturing June 9, 1988.
In addition to the maturing
13-week and 26-week bills, there are $9,812
million of maturing
52-week bills. The disposition of this latter amount was announced
last week. Tenders from Federal Reserve Banks for their own account
and as agents for foreign and international monetary authorities will
be accepted at the weighted average bank discount rates of accepted
competitive tenders. Additional amounts of the bills may be issued
to Federal Reserve Banks, as agents for foreign and international
monetary authorities, to the extent that the aggregate amount of
tenders for such accounts exceeds the aggregate amount of maturing
bills held by them. For purposes of determining such additional
amounts, foreign and international monetary authorities are considered to hold $1,806 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $1,886 million as
agents for foreign and international monetary authorities, and $7,8 58
million for their own account. These amounts represent the combined
B-1435
holdings of such accounts for the three issues of maturing bills.
Tenders for bills to be maintained on the book-entry records of the
Department
ofseries)
the Treasury
should
be submitted
on Form
PD 5176-1
(for 13-week
or Form
PD 5176-2
(for 26-week
series).

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 2
Each tender must state the par amount of bills bid for,
which must be a minimum of $10,000. Tenders over $10,000 must
be in multiples of $5,000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e.g., 7.15%. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1,000,000.
Banking institutions and dealers who make primary markets
in Government securities and report daily to the Federal Reserve
Bank of New York their positions in and borrowings on such securities may submit tenders for account of customers, if the names
of the customers and the amount for each customer are furnished.
Others are only permitted to submit tenders for their own account.
Each tender must state the amount of any net long position in the
bills being offered if such position is in excess of $200 million.
This information should reflect positions held as of one-half hour
prior to the closing time for receipt of tenders on the day .of the
auction. Such positions would include bills acquired through "when
issued" trading, and futures and forward transactions as well as
holdings of outstanding bills with the same maturity date as the
new offering, e.g., bills with three months to maturity previously
offered as six-month bills. Dealers, who make primary markets in
Government securities and report daily to the Federal Reserve Bank
of New York their positions in and borrowings on such securities,
when submitting tenders for customers, must submit a separate tender
for each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive bidder may not have entered into an agreement,
nor make an agreement to purchase or sell or otherwise dispose of
any noncompetitive awards of this issue being auctioned prior to
the designated closing time for receipt of tenders.
Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained on
the book-entry records of the Department of the Treasury. A cash
adjustment will be made on all accepted tenders for the difference
between the par payment submitted and the actual issue price as
determined in the auction.
No deposit need accompany tenders from incorporated banks
and trust companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches. A deposit of
2 percent of the par amount of the bills applied for must accompany
tenders
for such bills from others, unless an express guaranty of
10/87
payment by an incorporated bank or trust company accompanies the
tenders.

TREASURY'S 13-, 26-, AND 52-WEEK BILL OFFERINGS, Page 3
Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection of
their tenders. The Secretary of the Treasury expressly reserves
the right to accept or reject any or all tenders, in whole or in
part, and the Secretary's action shall be final. Subject to these
reservations, noncompetitive tenders for each issue for $1,000,000
or less without stated yield from any one bidder will be accepted
in full at the weighted average bank discount rate (in two decimals)
of accepted competitive bids for the respective issues. The calculation of purchase prices for accepted bids will be carried to
three decimal places on the basis of price per hundred, e.g.,
99.923, and the determinations of the Secretary of the Treasury
shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the maturing
bills accepted in exchange and the issue price of the new bills.
In addition, Treasury Tax and Loan Note Option Depositaries may
make payment for allotments of bills for their own accounts and
for account of customers by credit to their Treasury Tax and Loan
Note Accounts on the settlement date.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures. Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue.' Copies
of
the circulars, guidelines, and tender forms may be obtained
10/87
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.

TREASURY NEWS
jiportment off the Treasury • Washington, D.C. • Telephone 566-2041
TEXT AS PREPARED
For Release Upon Delivery
Expected at 2:00 pm DST
Remarks by Thomas J. Berger
Deputy Assistant Secretary of the U.S. Treasury
for
International Monetary Affairs
before
The York University Conference
on
The Future of the International Monetary System
Toronto, Ontario
Canada
June 2, 1988
Banks, Governments and International Debt;
Where Do We Go from Here?
I welcome this opportunity to review recent developments and
current prospects for addressing international debt problems.
The debt crisis which emerged six years ago posed potentially
serious risks to the debtor nations and the global economy.
Through mutual effort and cooperation, we have reduced these
risks and improved the debtors' prospects for a return to steady
growth and creditworthiness.
In my remarks this afternoon I would like to:
o Summarize the basic principles underlying the current
debt strategy;
o Review recent progress;
o Touch on the role of creditor governments and commercial
banks; and
o Consider with you the key issues we now have to
address.

B-1436

- 2 -

The International Debt Strategy
The strategy we embarked upon in the fall of 1985 has helped
move us a considerable distance toward our goals. It also has
provided a basis for meeting the changing circumstances of
individual countries while maintaining a steady focus on the
following four key principles:
o First, is the central importance of economic growth
in easing the debt burden over time.
o Second, in order to promote growth, market-oriented
policy reforms within the debtor nations are crucial.
o Third, to support these reforms, additional capital is
needed in the form of equity, debt, and the return of
flight capital.
o And fourth, each case should be dealt with on its own
merits, recognizing the inescapable fact that the
particular circumstances of each country are different.
I firmly believe that this strategic framework remains the
the only viable long-run approach. The logic is irrefutable. The
problems of debt and development can only be solved through the
growth of debtor countries. Growth necessitates capital and
continuing access to the credit markets. Growth also requires
durable, market-oriented economic reforms. These adjustments
will make debtor nations more attractive for future investment —
both domestic and foreign. Together with that investment, the
reforms promise stronger growth, higher standards of living, and
more productive and flexible economies.
The debt strategy's key principles are constant, but its
execution is dynamic. Indeed, one of the greatest strengths of
this approach is its adaptability. Early last year we suggested
a "menu" of financing options — which I will discuss in greater
detail later — to make sure that investment opportunities evolve
with this long-term problem. The problems of debt and development
did not arise overnight. They unfolded over a period of years,
and it will take years to solve them.
I recognize, of course, that some critics urge another
path — the development of large-scale, generalized, mandatory
debt forgiveness schemes. We strongly oppose such "quick-fix"
approaches — including the creation of an international debt
facility — for a number of reasons.
First, this approach will preclude debtors from gaining
access to credit markets for years to come — including vital
trade finance. And it would likely even exacerbate existing
problems with the flight of local capital.

- 3 -

Second, this approach would forgo the benefits of caseby-case actions, taken over time, to secure economic adjustments
to make investments more productive. It ignores that a big part
of the solution is to improve the productivity of investments,
enabling them to pay their own way. The debt burden, is one
constraint — like those posed by politics, history, culture,
sociology, and local economic structures — and it should not be
our sole preoccupation.
Third, these debt forgiveness schemes, which generally rely
on a consolidating mechanism, would irreparably politicize the
problem, distracting creditors and debtors alike from the difficult
but fundamental economic adjustment tasks.
Fourth, this method actually would encourage counterproductive
debt repudiations to depreciate the value of the debt so as to
maximize the so-called "benefits" of forgiveness.
Fifth, in addition to all these costs, this approach does
not even score well according to its supposed rationale of
delivering significant debt service savings. An across-theboard thirty percent forgiveness of all the bank debt of all
top 15 debtors would lower annual debt service by about $7
billion. To put that figure in perspective, the drop in LIBOR
interest rates since 198i saves the major debtors almost four
times as much.
Last, but perhaps most important, proposals to have the
public sector purchase private sector debt would necessitate a
large, not-to-be returned infusion of public funds, with the
continuing risk on these loans also shifted to the taxpayer.
Not only is it inappropriate for governments unilaterally to
force private financial institutions to sustain losses, but those
governments would then end up paying for debtor wards around the
globeProgress to Date
Admittedly there is fatigue among both debtor countries and
commercial banks, but contrary to those who would argue that
wholesale debt relief is the only solution, I believe the present
strategy is producing results and moving us toward resolution of
this difficult problem. Allow me to draw your attention to
the following facts:
o According to World Bank data, 8 of the 15 major debtor
countries grew at 4-5 percent or better last year,
compared with only three countries in 1985. We should
bear in mind that growth for the 15 countries was a
negative 3% in 1983.

- 4 -

Debt service ratios for the group have fallen by
one-fourth and interest service ratios by one-third
in the past few years. This is largely due to the
substantial decline in interest rates since 1982.

o Aggregate current account deficits have been sharply
reduced from a peak of $50 billion in 1982 to $15 billion
in 1986, and $8 billion in 1987.
o. Export earnings rose by 13 percent to near record highs
last year, while imports this year should be the highest
since 1982.
o The adoption of debt/equity swap mechanisms in some
countries, as well as broader policy reforms, has
encouraged the return of flight capital, while also
helping to reduce debt and debt service burdens.
On a more general basis, the concentration of resources on
the debt problem has been impressive. Since October 1985, the
World Bank has agreed to provide nearly $14 billion in new loans
to support reform efforts in the major debtor nations, while
the IMF has provided $5 billion in temporary balance of payments
assistance to these nations. Official creditors have rescheduled
some $18 billion in outstanding debt, including interest payments.
Commercial banks have committed some $17 billion in new finance.
Banks have also rescheduled over $211 billion in outstanding
debt, reduced spreads, and provided longer grace periods and
maturities.
The Role of Creditor Governments
Let me now touch upon the part being played by creditor
governments in the debt strategy. In my view, it is not
the role of governments to take the banks out of their LDC
exposures, nor to assume for their taxpayers part of the risk
on commercial bank LDC loans, nor to put up massive amounts of
funds from their budgets through a new international debt facility
to purchase existing commercial bank debt at a discount.
Furthermore, it is not the role of the international financial
institutions to offer credit enhancements more routinely;
specifically, World Bank guarantees of commercial bank debt are
exceptional and their use should remain limited.
Commercial bank numbers in terms of reschedulings may look
impressive, but we must remember that commercial banks lent more
to begin with and, therefore, have much more debt to reschedule.
Commercial banks have been rescheduling principal, while creditor
governments, through the Paris Club, have rescheduled interest as
well as principal.

- 5 -

Creditor governments have also been contributing in many
other ways. First, the major industrial nations have maintained
a sound international economic environment with sustained growth,
low inflation, and open markets. This is especially true for
the United States, which took over 50 percent of the increase
in non-oil LDC exports between 1982 and 1986.
Second, the industrial countries have provided leadership in
international efforts to address the problems of various debtor
countries, often providing bridge financing at key moments. This
has involved helping a number of countries to resume normal
relations with financial institutions and reestablish fruitful
negotiations with the IMF and World Bank. Third, we in the U.S.
and a number of other industrial nations have helped to remove
regulatory obstacles to new loans and innovative financing
techniques.
Fourth, creditor governments have provided sustained support
for the international financial institutions. In 1983 these
governments provided the major share of a quota increase for the
International Monetary Fund of $33 billion and recently have
agreed to support a $75 billion general capital increase for the
World Bank. Finally, the industrial nations have secured the
implementation of important, innovations to strengthen the debt
strategy generally.
For example, at the IMF Interim Committee on April 14th, it
was agreed in principle to establish a combined Compensatory and
Contingency Financing Facility. This new facility will help
cushion the effect on IMF standby programs of unforeseen external
developments such as weaker commodity prices, natural disasters,
or sustained higher interest rates that might force a performing
country off its economic course. We expect the new facility to
expand potential access for the 15 major debtors by more than
25 percent. -- potentially more than $12 billion, depending of
course upon external developments.
Creditor governments have also taken a number of significant
measures to assist low-income developing nations. The IMF's new
Enhanced Structural Adjustment Facility will provide concessional
resources totalling six billion SDRs to low-income countries
facing protracted balance of payments problems. In addition, donor
governments have pledged $6.4 billion of bilateral financing to
be used in cooperation with the World Bank for low-income African
countries with severe debt problems that have undertaken adjustment
programs.
The Role
Banks
WhatofisCommercial
the role of
the commercial banks at this point in
the long-term workout of the debt problem?

To facilitate commercial

- 6 -

bank financing packages, Treasury Secretary Baker proposed last
year the development of a "menu" of financing options.
Such menus can help meet the diverse interests of both debtor
nations and the banking community, and can include both new money
and debt conversion options. Some of the menu items that might
be included in future financing packages are:
o Trade and project loans to support private sector
production and growth.
o New money bonds which have some of the characteristics
of senior debt.
o Bonds or notes that are convertible into local equity.
o Exit bonds for banks wanting to exit from future new
money obligations.
o On-lending rights permitting loans to be targetted to
specific enterprises.
o Debt/equity swaps to help reduce both debt and debt
service burdens.
o Debt/charity swaps to advance health, education and
conservation programs.
o And traditional balance of payments loans.
This menu approach has gained broad acceptance as the basis
for new financing packages. The newest "option" is reflected in
the recent Mexican debt exchange offer. Through this transaction,
Mexico was able to exchange $3.7 billion in outstanding commercial
bank debt for $2.6 billion in new Mexican bonds collateralized by
a special U.S. Treasury 20-year security, for a net $1.1 billion
in debt retired and $1.6 billion in interest saved over 20 years.
We expect additional debt conversions techniques to be
developed in the period ahead. In order to be successful, such
efforts must be voluntary, privately financed, and developed
within the market to benefit commercial banks and debtor nations
alike.
In sum, the menu approach emphasizes a negotiated, marketoriented way of resolving debt problems. Both commercial banks
and debtors should actively pursue efforts to further develop the
menu approach, while creditor governments can help assure that
regulatory impediments do not stand in their way.
Unfortunately, however, it has generally been the debtor
governments rather than the commercial banks that have taken the

- 7 -

lead in developing menus and orchestrating new transactions.
This was true in the case of the Mexican debt exchange offer, the
Philippine Investment Notes and the Argentine exit bonds.
Commercial banks should not wait for innovative financing
options to be offered by debtor governments; nor should they call
on creditor governments and the international financial institutions
to "enhance" new bank credits through guarantees or other support
mechanisms. Rather, banks should challenge the most creative
minds among their executive ranks to develop financing options
that can advance common interests in dealing with the debt problem.
In addition, the banks should discuss with the international
financial institutions and debtor governments those areas where
policy reforms can best assist debtors' return to creditworthiness.
Banks must also work to improve communication within the
banking community and to further streamline the new lending
process to help assure that, new financing is made available in
a more timely fashion. In short, banks must lead rather than
react; work cooperatively rather than individually; and support
innovation in order to advance the process.
Conclusion
In conclusion, let. me summarize the tasks before us:
Indebted countries must be steadfast in their pursuit of sound
policies. Commercial banks and the international financial
institutions must be willing to support these adjustment efforts
with increased capital flows. And finally, the industrial
countries must sustain their rate of demand growth and improve
the access of debtor nations to their markets. Such a cooperative
solution to the debt problem is the only real answer.
Thank you very much.

TREASURY NEWS

Department off the Treasury • Washington, D.c. • Telephone 566-2041
Remarks of the Honorable M. Peter McPherson
Deputy Secretary of the Treasury
Before the
Debt for Development Conference •
Department of State
Washington, D.C.
May 23, 1988
Thank you. It is a pleasure to be here today to discuss
the role the United States government can play in helping to
support and facilitate debt-for-development transactions. But
first, I must commend my colleagues at A.I.D. for organizing
this conference. By bringing together the active players in
the development process, the Agency helps to foster cooperation,
information sharing and open dialogues so critical to advancing
our work.
The Strengthened Debt Strategy
To put the role of the government into perspective, I
believe it useful to review the guiding principles of the
"Program for Sustained Growth," launched by Secretary Baker in
October 1985 at the IMF/World Bank annual meetings in Seoul,
Korea. These key tenets are directly related to "debt-fordevelopment" conversions:
° First, the central importance of economic growth and
capital formation in easing the debt burden over time.
° Second, the need for market-oriented reforms in debtor
nations to achieve such growth.
° Third, new debt and equity financing, and the return of
flight capital, to help support such reforms.
° And fourth, a case-by-case approach to address the
individual needs of each debtor country.
I firmly believe that these basic principles should continue
to guide our approach in the period ahead. Developing nations
need financial resources to grow, and require sustained, marketoriented reform of their economic structures. These adjustments
will, in turn, promise stronger growth, higher standards of
living and more productive and resilient economies, with greater
resources for health, social, cultural, and educational programs.
B-1437

- 2 -

The need for economic reform in developing countries should
continue to be stressed; only with reform will these countries
be able to attract investment and mobilize domestic financial
resources. I would note that developing countries have a
greater appreciation for market-based policies to increase
economic efficiency. We have seen in a number of major debtor
countries efforts to privatize public enterprises, liberalize
import regimes, increase the market-orientation of their economies,
reform their tax systems, and establish meaningful debt/equity
and debt/charity conversion programs.
Despite these developments, additional efforts are still
needed to reduce fiscal and external deficits, control inflation,
encourage new investment and savings, and unleash the creative
potential of the private sector within debtor nations to help
catalyze new loans, equity flows, and the return of flight
capital. These are essential to improving and sustaining growth.
The Menu Approach
The debt strategy has proved itself to be both evolutionary
and innovative- For example, we have encouraged the development
of a "menu" of financing techniques to meet the diverse interests
of both debtor nations and the banking community. This approach
emphazises a negotiated, market-oriented way of resolving debt
problems, and the Treasury Department has encouraged commercial
banks and debtors alike to pursue efforts to develop the "menu"
further. This approach can help facilitate new financial
flows, while also providing a way to convert outstanding debt
obligations into alternative financing instruments.
Debt conversions, such as the Mexican debt/bond exchange
that retired $3.7 billion in commercial bank debt for $2.6 billion
in new, collateralized Mexican bonds, as well as "exit" bonds,
debt-equity swaps, and debt-charity or debt-development swaps,
also have their place in the debt strategy.
Treasury has been a strong advocate of debt-equity conversions. Greater resort to equity financing can help strengthen
the corporate sectors of many developing countries, while also
enabling both domestic and foreign investors to provide risk
capital to generate needed growth and development. This alternative to debt financing has, of course, the added sweetener of
reducing debt service burdens and the stock of debt. All told,
it is a win-win situation that helps to get countries onto
the growth path. Some $7.5 billion in debt/equity swaps have
taken place in five countries since 1985.
Efforts by commercial banks, debtor governments and private
voluntary organizations to convert voluntarily existing loan
obligations into local currency or local currency securities at
mutually satisfactory prices in an effort to reduce overall debt
burdens can play a useful role within the basic debt strategy,
and in advancing development projects in debtor countries.

- 3 Treasury's support for these debt conversion efforts, however,
should not be taken as support for general debt forgiveness
schemes. Such schemes would shift the risk of private sector
loans to the public sector and require major expenditures of
taxpayer money. We continue to firmly oppose them.
The Role of the U.S. Government in Supporting Debt Conversions
The role of the United States and other creditor governments
is, rather, to help reduce tax and regulatory obstacles to these
transactions, while preserving the soundness of the financial
system and encouraging sound economic management in developing
countries.
a. IRS Ruling
In support of debt conversions, the Internal Revenue Service
issued Revenue Ruling 87-124 in November of 1987 to provide
guidance to U.S. banks, corporations, and other institutions in
assessing the U.S. income tax consequences of entering into
debt-equity and debt-charity swaps. Gene Steuerle, Deputy
Assistant Secretary of the U.S. Treasury for Tax Analysis will
help steer us through the tax implications later in the morning.
b. Coordination with the World Bank
Further, as many of you are aware, Treasury staff are
currently working closely with World Bank staff regarding
recommendations, as outlined in the Treasury Department's recent
report to Congress, on how the Bank might help facilitate
"debt-for-nature swaps." The Bank will continue to work
with developing countries to establish priorities for conservation and environmental projects. Staff is also exploring ways that
environmental and conservation groups can "piggyback" debt swaps
onto World Bank loans and programs. The Bank might also act as
an "information broker" to help assist the start-up and
development of these initiatives. We expect to see concrete
results soon, including a pilot program to establish debt-fornature swap programs that would draw on the expertise of the
Bank in structuring and implementing a swap program.
In negotiating the terms of the World Bank's General Capital
Increase (GCI), the Adminstration has sought to strengthen Bank
policies and programs on a broad range of environmental issues.
In reporting on the recent conclusion of negotiations on a GCI,
the Bank's Board of Directors has called for additional emphasis
on the need for better management of human and natural resources
so that countries can achieve fully sustainable development,
with increased emphasis on environmental work.
I would note at this juncture that World Bank and other
governmental resources must continue to be used judiciously,
and that they are not intended to supplant the resources of
private voluntary institutions. In a similar vein, there

- 4 are no plans for the United States government or World Bank
to engage directly in debt-for-development swaps. Rescheduling
IMF and/or World Bank credits would interfere with the Fund's
monetary role, as well as the World Bank's AAA credit rating
and, thus, its ability to raise funds in the market.
c. A Role for A.I.D.
As Ambassador Wood noted a few minutes ago, A.I.D.'s role
in debt-for-development is primarily catalytic. I believe
that involvement of this type by AID will help create synergy
and pull together the key parties.
For example, AID already has staff working in several of
the heavily indebted countries, including Mexico, Brazil, Bolivia,
Ecuador and Peru. AID can help target areas where swaps will
be fruitful and where host government programs could be
augmented by such swaps. I strongly encourage private voluntary
organizations (PVOs) to use these government resources. AID
has a significant track record in the development field, and
can offer both an infrastructure and guidance to charitable
institutions that do not have the history, experience, staff
and resources to maximize their funds abroad. As we all are
well aware, such resources are too sparse to squander on
ill-conceived programs. It is also the function of the PVO
to preserve the value of, and exercise control over, all
charitable donations from commercial banks.
A Possible Role for Commercial Banks
Treasury has, in many public statements, urged commercial
banks to be creative and flexible in their approach to international debt issues. We have witnessed a number of laudable
innovations in the past few years, including so called "exit
vehicles" that allow banks with smaller exposures to exit from
the new money commitments that are part and parcel of concerted
lending packages. I would encourage the banks to consider
exit vehicles which also advance development, academic, or
environmental objectives.
I would also note that appropriate development support will
help debtor countries get onto a growth path which will, in
turn, provide new markets for U.S. goods and financial services.
While I acknowledge that contributions of developing
country debt paper by commercial banks are likely to be limited,
they may fit well within the charitable interests of individual
banks, while also providing an exit vehicle for banks with
smaller exposure, as I noted earlier. In lieu of donations,
some PVOs may want to purchase debt paper with dollar donations
for such conversions.

- 5 The Role of the PVOs
While the amounts at stake vis-a-vis the external debt of
developing countries is relatively small, debt-for-development
swaps can have a significant positive effect on conservation,
health, educational and other programs, where even small amounts
of money can achieve substantial results. Several of the PVOs
present today have done a remarkable job in formulating and
marketing the debt-for-development swap concept. Their work
is proof of the wealth of ongoing ideas arising from such
initiatives.
Today, we will be hearing from representatives of
Conservation International regarding the debt swap that was
consumated last year whereby $650,000 in debt obligations were
converted into local currency and used for expanding the Beni
Biosphere Reserve, home to 13 species of endangered plants and
animals. We will also be learning about developments in Equador
from the World Wildlife Fund. The country's central bank has
authorized a debt-for-nature swap program totaling $10 million.
We understand that other countries, including Jamaica,
the Philippines, Mexico, Brazil, Peru, Colombia, and the
Dominican Republic are considering starting-up conservation
programs. This is encouraging, and I believe that once the
procedures for such transactions become more standardized,
prospective host governments will become more receptive.
I would like to turn now to some of the more nettlesome
issues facing private voluntary organizations — topics
that will arise in our panel discussions today. One topic
is dealing effectively with host governments. Many developing
countries are reluctant to enter into conversions that would
allow foreigners to direct land use. On the other side of
the issue, conservationists want to ensure the long-term
success of projects that they are funding. Conservation
International was able to bridge diverse viewpoints in Bolivia.
The same is true for the World Wildlife Fund in Costa Rica and
Ecuador, and we are optimistic that these swaps can be replicated
in the future in other countries.
On another point, we have been told several times that
developing countries will not open local currency accounts to
foreigners. This strikes us as an obstacle that can be overcome.
Conclusion
In conclusion, I have observed in my years in the development
arena a progressive melding of viewpoints. An April 25th article
in U.S. News and World Report entitled "The Preservation Paradox"
notes that "the way to get around the apparent conflict between
conservation and economic development ... is to mix the two."

- 6 -

And the political leadership in the developing world is
increasingly responsive to the underlying reality that there
is a direct correlation between wise use of natural resources
and economic growth. Similarly, concerted efforts by^commercial
banks, policy-makers, and private voluntary organizations can
help advance the goal of assisting the developing world achieve
economic growth and a better life for all its citizens.
Thank you very much.

Full text of Press Releases of the United States Department of the Treasury : Volume 285

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