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TREAS.
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10
.A13P4
v.289

U.S. DEPARTMENT OF THE TREASURY

PRESS RELEASES

TREASURY NEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
Testimony by
Secretary of the Treasury
Nicholas F. Brady
Before the
Committee on the Budget
U.S. Senate
Wednesday, March 1, 1989
Chairman Sasser, Senator Demenici and members of the
Committee, Z am pleased to be here today to discuss vith you
President Bush's proposed fiscal year 1990 budget. Z know that
you have already heard from the Director of the Office of
Management and Budget, Richard Darman, and the Chairman of the
Council of Economic Advisors, Michael Boskin, so in my testimony
Z vill not repeat a detailed presentation of the Bush budget.
Hovever, Z do wish to devote some time to discussing the
financial aspects of our plan to solve the Savings and Loan
erisis, vhich Z kr>~w to be of interest to members of this
Committee.
The approach to the budget I vieh to take today is from the
perspective of overall economic policy, thus, Z vill discuss the
importance of deficit reduction to the continued vitality and
strength of our national economy and to maintaining and improving
our position in the vorld economy.
We are all avare that ve continue to be in a period of
extraordinary economic expansion, vhich has produced millions of
jobs, vhile reducing inflation. We must equally be avare that to
sustain this expansion ve must reduce the deficit.
As you knov, last veek the Federal Reserve raised the
discount rate one half of a percent to seven percent. I'd like
to say a fev vords about that. First, and foremost, the Bush
Administration and the Federal Reserve share absolutely a firm
commitment to fighting inflation.
It is possible to have
somevhat differing interpretations of the same economic
statistics, to think one set of statistics means more than
another, and still share the same goal of fighting inflation.
The Federal Reserve is using the strongest veapon in its
arsenal to fight inflation to advance the cause of the long-term
strength and vitality of our national economy.
The strongest
veapon ve in the government have to further the cause of our
long-term economic strength is deficit reduction. We must do our
part.
NB-157 Even to delay action costs us — in terms of intereet

2
rates, jobs, the Savings and Loan crisis, the third world debt
problem.
Let us be frank with one another. We are constrained
between revenue levels which are the result of the 1988 election
vhich validated President's Bush's commitment to "No new taxes"
and a Gramm-Rudman-Hollings maximum deficit level of $100 billion
prescribed in law. So, there are not funds to do all that ve
vant.
Stepping back from the roar of the budget discussions for a
minute, one could say, "this is vhere the country vants us to
operate." The key is to have the American people say, "They did
vhat we wanted with what we gave them."
ECONOMIC ASSUMPTIONS
The Bush Administration is absolutely committed to working
vith you to reduce the deficit. But, some have questioned our
economic assumptions.
First, Z vould like to point out that
historically the executive branch's economic assumptions have not
had a consistent bias toward a rosy scenario. Zn fact, in the
last seven years, the Reagan Administration underestimated
growth four times and overestimated it three.
For this year, we believe that the economy vill continue to
grov, but at a slightly slower pace than last year's drought
adjusted rate. We are projecting that GNP vill grov 3.5 percent
next year. But when we exclude the impact of the rebound from
the drought, our forecast is for a moderate 2.8 percent growth
rate.
This is slower than last year's 3.3 percent drought
adjusted growth rate. Our long term forecast for a 3.2 percent
sustainable growth rate is right in line vith our experience over
the past 40 years, during vhich real GNP grovth averaged 3.3
percent.
As one who worked for over 30 years in financial markets,
may Z make a few comments on interest rate assumptions. During
my first year in business, 1954, ten year government bonds
carried an interest rate of 2.4 percent. They reached 14 percent
in 1981. These same ten year government bends vere 12.4 percent
as recently as 1984, but declined to 7.7 percent in 1986. They
nov carry an interest rate of 9.3 percent.
Attached as an exhibit to my testimony is a graph shoving
the decline in rates surrounding the passage of Gramm-RudmanHollings. From three and one-half months prior to the passage of
this all-important fiscal legislation until three and one-half
months after, interest rates declined 300 basis points. Was it
the only cause of this rapid decline in interest rates? No. was
it a principal cause? Yes.

3
This would indicate to me that while there is plenty of
room for honest disagreement about the future level of interest
rates, there is some evidence that fiscal actions have an effect
on interest rates, particularly long-term rates. My conclusion
is that investors and savers all over the vorld are waiting for a
sign from our government that ve are committed to fiscal
prudence, and are willing to do something about it. Delay in
reaching a budget agreement may only maintain the current high
level of interest rates and cost the U.S. and the vorld
unnecessary pain.
Zn sum, do I think our economic assumptions vill prove true
if ve don't reduce the deficit? No. Will they prove accurate if
ve do? I believe so.
PRESIDENT'S BUDGET
Z know that you have heard a great deal about the specific
proposals in our budget from Budget Director Darman. However, Z
vould like to reiterate a fev key points. Within the confines of
meeting the Gramm-Rudman-Hollings target, the President has
proposed budget priorities vhich if adopted vill make a
significant investment in our country's future. Among his key
proposals, he has:
pledged $6 billion to vinning the var against drugs;
kept his promise to emphasize education, not just
through an increase in funding but through programs
which encourage excellence in education:
awards to
successful schools, a recognition program for superior
students, a national science scholars program, and a
plan to foster magnet schools;
addressed environmental issues, particularly that of
acid rain; and
proposed fully funding the McKinney Act and increasing
overall funding to assist the homeless by nearly 30
percent over last year's levels.
Mindful of the growing need for child care, the President
proposes to increase assistance to lov-income families through
changes in the tax code.
He proposes a nev, refundable tax
credit of up to $1,000 for each child under four in lov-income
vorking families. This credit vould be available to very lovincome families, in which at least one parent works, in tax year
1990, and will be expanded to include additional families in
following years. By this tax assistance the President's budget
provides vital support to families vhile permitting families to
make their own choices about child care that best fits their
needs.
The President further proposes to make the existing

4
dependent care credit refundable.
in its current state the
existing credit is of no value to lover income families vho do
not pay tax.
THE SAVINGS AND LOAN SOLUTION
The President's budget also contains the funding required to
resolve the Savings and Loan crisis. Zt has three components.
The first part consists of $50 billion to resolve currently
insolvent institutions which may become insolvent over the next
several years. Secondly, the plan ensures adequate servicing of
the $40 billion in past FSLIC obligations.
And third, and perhaps most important, the plan provides $33
billion in financial resources necessary to put S&L deposit
insurance on a sound financial basis for the future.
At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC), for which the FDZC vill be the primary
manager directed to resolve all S&Ls vhich are nov insolvent or
become so over the next three years.
To provide the $50 billion to the RTC, ve vill create a nev,
separate, privately-owned corporation, the Resolution Funding
Corporation (REFCORP), which vill issue $50 billion in long-term
bonds to raise the needed funds. To pay the principal, industry
funds vill be used to purchase zero-coupon, long-term Treasury
securities which will grow through compound interest to a
maturity value of $50 billion. This assures the repayment of the
principal of the bonds issued by REFCORP.
Funds to purchase
these zero-coupon bonds will come exclusively from private
sources:
The FHLBanks will contribute about $2 billion of their
retained earnings — vhich are currently allocated to,
but not needed by, the existing Financing Corporation
(FICO) — plus approximately 20 percent of their annual
earnings, or $300 million, in 1989, 1990 and 1991;
The S&Ls vill contribute a portion of their insurance
premiums; and
If necessary, proceeds from the sale of FSLZC
receivership assets vill be used.
No Treasury funds or guarantees vill be used to repay any
REFCORP principal.
Interest payments on the REFCORP bonds vill come from a
combination of private and taxpayer sources:

5
The FHLBanks, beginning in 1992, vill contribute $300
million a year;

The RTC will contribute a portion of the proceeds
generated from the sale of receivership assets, and
proceeds from warrants and equity participations taken
in resolutions; and
Treasury funds will make up any shortfall.
All Treasury funds used to service REFCORP interest will be
scored for budget purposes in the year expended.
Funds for the second component of our plan — servicing the
cost of the $40 billion in resolutions already completed by FSLZC
— also will come from a combination of S&L industry and taxpayer
sources:
FICO will issue bonds under its remaining authority and
contribute the proceeds;
The S&Ls will contribute a portion of their insurance
premiums;
FSLIC will contribute the proceeds realized from the
sale of receivership assets taken in already completed
resolutions, as well as miscellaneous income; and
Treasury funds will be used to make up any shortfall.
The final component of the plan is managing future S&L
insolvencies and building the Savings Association Insurance Fund
(SAZF), the nev S&L insurance fund, during the post-RTC period.
The funding vill come from a portion of S&Ls' insurance premiums
and Treasury funds as needed.
These sources provide about $3 billion per year to handle
any insolvencies vhich occur in the 1992-99 period and in
addition contribute at least $1 billion per year to building the
nev Savings Association Insurance Fund.
Overall the plan
contains $33 billion in post-RTC funds from 1992 to 1999 to
manage future insolvencies and contribute to building a healthy
nev S&L insurance fund. Assuming that $24 billion is used for
post-RTC resolutions, by 1999 the SAZF fund vill still contain
just under $9 billion at a minimum to support the healthy S&Ls.
The net impact of the entire plan -- vhich includes paying
for completed S&L resolutions, paying for the S&L resolutions
still to be completed, and providing for fully funded insurance
funds for both commercial banks and thrifts — is $1.9 billion in

6
FY90 and $3 9.9 billion over the next 10 years.

CAPITAL GAINS
The President's budget includes important revenue-related
measures that fall within the jurisdiction of the Treasury
Department.
These measures also directly reflect the
President's commitment to a budget that sustains a strong economy
and builds upon it to enhance our future economic power.
We propose a major tax initiative designed to enhance
America's long-term growth and competitiveness: a reduction and
restructuring of the capital gains tax to encourage long-term
investment.
Our proposal calls for a 45 percent exclusion of
long-term gains or a 15 percent tax rate cap, whichever is more
advantageous to the taxpayer. As an important part of this plan,
ve have targeted the greatest relative benefits to those vith
incomes lower than $20,000, if married, and $10,000 if single.
Such taxpayers would be eligible for a 100 percent exclusion—no
tax at all on long-term capital gains.
The policy of a lower tax rate for capital gains was first
established in the Revenue Act of 1921. This policy remained in
effect for 65 years.
During this time it was endorsed by
Democrats and Republicans alike as an important means of
stimulating investment. The Tax Reform Act of 1986 eliminated
that differential in 1987. In my judgement, the benefits of a
lover capital gains tax merit its reinstatement. Zt is important
for the long-term strength of our economy that our tax lavs
encourage saving and investment in entrepreneurial activities.
Z believe the essential benefit of a reduction in the capital
gains tax goes beyond simply encouraging short-term investment
and grovth. Over the next four years, ve propose to phase in a
three year holding period for capital assets sold to qualify for
the lover capital gains tax rates. Thus ve vant to shift the
focus of investors from the short-term to the long-term, because
ultimately, it is long-term investment vhich vill provide our
economy with its fundamental strength.
Thus ve propose to
restore this long-acknowledged incentive to American enterprise.
Enhancing incentives for long-term investment is not the
only area in which we need to act if the United States is going
to remain a leader in the vorld economy. Zt is equally important
that ve take steps to augment policies and programs vhich
stimulate research and development and vhich foster our long-term
productive capacity.
To this end, the President's budget increases investment in

7
basic research by increasing funding for science and technology
programs by 13 percent over the enacted 1989 funding levels.
Furthermore, we propose to make the tax credit for research and
experimentation permanent. For a number of years, we have had a
temporary tax credit to encourage additional research and
experimentation (R&E) by U.S. industry.
The current credit
expires at the end of 1989. Zt's time ve stopped sending stop
and go signals to the business community on the importance of
research to our economic strength.
Accordingly, the President has proposed to make this eredit
a permanent feature of the landscape so that U.S. corporations
can make their R&E plans with a longer horizon. With this same
purpose in mind, the President has also proposed a permanent and
more beneficial formula for the allocation of R&E expenses
between domestic and foreign income.
INTERNATIONAL CONTEXT
Improving our competitive position in the world economy is
very important to our future international economic position.
Reducing the deficit will not only improve our competitive
position, but is of vital importance to our overall international
economic standing. I wish to take a fev minutes to address the
international implications of our vork on the budget this year.
The new reality is that there are no more international
boundaries when it comes to the flow of dollars—no border
control, no customs officials and no barriers. The influence of
foreign financial markets on our economy is great and deep. Most
of the world's financial transactions settle daily through the
Nev York Federal Reserve Bank.
Before the advent of
instantaneous transfer of information and electronic funds
transfers this settling of accounts vould have taken veeks, nov
it occurs every night. There are tvo "vires" through which the
transactions settle.
The CHIPS wire vhich largely handles
international transactions, and the Fed vire vhich handles
mostly, but not exclusively, domestic transactions. Last month
on average about $735 billion worth of transactions were settled
per day on the CHIPS wire.
And the level of activity is
increasing on average at a rate of 25 percent a year. Zf you
approximate the international transactions settled via the Fed
vire, then there are about $1 trillion of international
transactions settled every day on these vire systems.
This
amounts to $5 trillion a week, in other words greater each veek
than our yearly GNP.
Another statistic which demonstrates the power of
international finance on our economy is that at the end of 1987
the total stock of U.S. assets held by foreigners was almost $400
billion greater than the stock of foreign assets held by
Americans. Ten years ago this difference was $50 billion in our

8
favor. While one can have different vievs of hov to interpret
those numbers, one point is clear — ve cannot ignore the effect
of international markets on our balance of payments vhen
considering the need for deficit reduction.
Both the flow of financial transactions through the Fed vire
and CHIPS and the amount of U.S. assets held by foreigners are
in a sense a measure of foreign confidence in our ability to
maintain a sound economy and reduce our budget deficit.
The
tally of the world's opinion of our progress is registered every
day through the Federal Reserve's wire's. Zt is vital that ve
act decisively to preserve that confidence.
Lest there be any doubt about the extent of the world's
interest and concern about the deficit, let me share vith you
some of the feelings of my G-7 colleagues — vho met here in
Washington, DC the first week in February. We are engaged in a
team effort, the economic policy coordination process, to provide
a growing world economy. I have been pressing them to stimulate
their domestic economies and open their markets to sustain vorld
economic growth. They, in turn, are deeply concerned about our
ability to reduce the deficit.
They worry that ve lack the
strength of purpose to meet the Gramm-Rudman-Hollings target.
They are knowledgeable about the details of our budget process
and are watching very carefully hov ve handle our budget
negotiations. They are concerned that our commitment to abiding
by the current Gramm-Rudman targets is less than firm and
unequivocal, that if meeting the $100 billion target becomes too
onerous that we will move the goal line.
I assured them on
behalf of us all that people in this government—executive and
legislative branches alike—are firmly and absolutely committed
to meeting the deficit reduction target. Z have told them that
ve vill get there one vay or the other.
Z know you share this commitment, z am delighted to be here
today to discuss with you how we can achieve this common goal.

INTEREST RATES* SEPTEMBER 1985 TO APRIL 1986
Daily data, percent

1110- 30-year bond
9-

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8
3-month bill

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7-

V*

65TTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTO

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1985

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1986

M

A

TREASURY.NEWS
Department of the Treasury • Washington, D.c. • Telephone
LI3R;AY.Ru£M5:iO

M a r c h lr

1989

DAVID R. MALPASS L fifofeg) TREASURY 33
DEPASTnLhl v

r!i -r..

:r-

Secretary of the Treasury Nicholas F. Brady announced today that
David R. Malpass, Deputy Assistant Secretary for Developing
Nations, is leaving the Department to become the Minority Staff
Director of the Joint Economic Committee of the U.S. Congress.
The Committee studies domestic and international economic issues
for both the Senate and House of Representatives.
Mr. Malpass has been with the Department for three years.
Since April 1988, he has served as the Deputy Assistant Secretary
for Developing Nations. His responsibilities included economic
and financial relations with developing nations, U.S. policies
within the international financial institutions, and economic
development policies. He also worked closely with Congress,
testifying five times on a range of international issues.
From 1986-1988, Mr. Malpass was Legislative Manager in
Treasury's Office of Legislative Affairs. He worked on budget,
economics and international issues, including tax reform, the
trade bill, and the 1987 budget summit.
From 1984-1986, Mr. Malpass worked for the Senate Budget
Committee as it's international economist and as Senior Analyst
for Taxes and Trade. From 1977-1983, Mr. Malpass held financial
positions in Portland, Oregon.
Mr. Malpass holds a bachelors degree in physics and a
masters degree in business administration. In 1983, he was a
Fellow in Georgetown University's School of Foreign Service. A
native of Michigai>, he now resides in the District of Columbia.
oOo

NB-158

2041

TREASURY NEWS
Department of the Treasury • Washington, o.c. • Telephone 566-2041
' • y-'j: . : .. .. u

REMARKS 3Y
DEPUTY SECRETARY OF THE TREASURY
«. PETER MCPHERSON
BEFORE THE
FIFTH ANNUAL SAN FRANCISCO INSTITUTE
OF THE
NATIONAL CENTER ON FINANCIAL SERVICES
UNIVERSITY OF CALIFORNIA, BERKELEY
MARCH 2, 1989
GLOBAL COMPETITION IN FINANCIAL SERVICES:
A VIEW FROM WASHINGTON
I. Introduction
-- I am pleased to participate in this very timely discussion
of financial services.
— I would like to comment today on the need to look at this
topic from an international point of view. I believe that
policy-makers must examine the competitive position of the
U.S. financial services industry within a global context.
— We are all well aware that the U.S. slice of the global
financial services pie has shrunk markedly.
— For example, among the top 500 banks ranked by assets last
July, the number of U.S. banks fell to 87 from 104 during
1987. Meanwhile the number of Japanese banks increased to
107 from 82 the previous year. Although this is only one
estimate, and there may be several reasons for the U.S.
decline, the trend is clear.
— In fact, between 1972 and 1986 the Federal Reserve Board
found that among the top developed countries, major U.S.
banks experienced the slowest growth in total worldwide
assets measured in U.S. dollars. The growth rate ran 10
percent during that time, while Japanese banks' assets
grew at an average annual rate of 19 percent, followed by
Swiss and German banks at 16 percent and 15 percent
respectively.
— The financial services industry is the lubricant of the
world economy. Its smooth and efficient functioning is
essential to economic growth worldwide. Even though its
participants are private citizens, public policy plays a
role.

NB-159

2
—

The U.S. Treasury is keenly aware of the need to pursue
public policies that are in tune with the problems and
potential opportunities U.S. financial firms encounter in
today's market, both at home and abroad.

— On the domestic front, we are committed to a vigorous U.S.
economy and a healthy financial infrastructure. Shortly
after assuming office, President Bush outlined his budget
program. He is committed to reducing our budget deficit
— a goal considered critical to sustaining a prosperous
domestic economy.
-- Similarly, we are equally committed to ensuring a stable
and sound financial infrastructure. The task of
modernizing our nation's financial services industry
remains an important objective. The Bush Administration
is committed to Glass-Steagall reform. Moreover, we
applaud the Federal Reserve's recent decision to broaden
securities powers for commercial banks. Efforts to
modernize, of course, must be weighed with the need, for
prudential reasons, to ensure an adequate regulatory and
auditing framework.
-- We have many experts here today who can offer a variety of
insights into the multi-faceted subject of financial
services. Other speakers will be exploring the U.S.
domestic angle of financial services in great depth.
— I would like to look at this topic from an international
point of view. Specifically, I would like to focus my
remarks on a critical element of global competition —
that is the treatment U.S. financial firms receive in
foreign markets.
II. The View from Washington
— The issue of how U.S. financial firms are treated in
foreign markets has been of great concern to the previous
Administration and remains paramount within the current
one.
— Moreover, the Omnibus Trade and Competitiveness Act of
1988 now requires the Secretary of the Treasury, in
conjunction with other U.S. Government agencies, to report
on the extent to which foreign countries deny national
treatment to U.S. banking and securities companies. It
also calls for a review of U.S. efforts to eliminate such
discrimination.
— As Congress has made clear, action is needed in instances
where national treatment has been denied to U.S. firms in
other countries.

3
—

This concern motivated the Congress to include a primary
dealer provision in the Trade Act. This provision
essentially prohibits the Federal Reserve from designating
a foreign-owned firm a primary dealer if that foreign
country denies U.S. firms equal access to its government
securities market.
— The growing trend advocating restricted entry to U.S.
financial markets if U.S. firms are denied access to
foreign markets, has lent a sense of urgency to the
question of how the U.S. should respond to perceptions of
unequal global competition.
— The fundamental position of the Executive Branch has not
changed.
— We adamantly support open financial markets at home and
abroad.
— We firmly believe that if U.S. financial firms are able to
compete on a level playing field, they can successfully
compete anywhere in the global market.
— Recent developments in financial services around the world
have created numerous exciting opportunities. International capital markets have grown dramatically this
decade. Despite a temporary lull in 1987, the volume of
borrowing on international financial markets reached an
all-time high last year of approximately $452 billion.
Relatively strong economic growth worldwide combined with
robust investment activity, suggests continued capital
market growth.
— Equally important, many governments have embarked on a
course of domestic market deregulation and liberalization.
While much work remains to be done in many of these
countries, some important steps are under way, for
example, in Great Britain, Japan, Canada, Denmark and
Belgium. And as I mentioned, the U.S. has been engaged in
an ongoing debate about banking reform. Several major
emerging economies such as Korea and Taiwan have also
pursued efforts to modernize and expand their domestic
capital markets.
— As these developments have unfolded, the Administration,
particularly the Treasury, has campaigned relentlessly for
open financial markets — specifically for equality of
competitive opportunity — both at home and abroad.
— Before I continue, I would like to emphasize that open
markets do not benefit just U.S. financial firms. While
foreign banks and securities firms clearly gain by the
greater opportunities that open markets provide, the home
country is the ultimate beneficiary.

4
—

A liberalized, deregulated and more technologically
advanced domestic financial market, particularly in the
developing economies, contributes to a more competitive
and efficient domestic financial services industry. An
efficient financial infrastructure in turn can funnel
capital more effectively into the home economy. As a
result, borrowing costs and spreads should be reduced,
more financial instruments should become available,
capital flight can be deterred and greater foreign capital
inflows can be encouraged. Indeed, failure to take these
steps will mean that the country concerned is left even
further behind as modern technology develops elsewhere.
Ill.Treasury Initiatives
— I would now like to turn to what the Treasury has been
doing to achieve the goal of open financial markets.
National Treatment Study
— Regarding the U.S. market, the Treasury wholeheartedly
supported the International Banking Act of 1978 which
adopted the principle of national treatment for foreign
banks operating in the United States. National treatment
requires that host governments provide foreign institutions the same competitive opportunities that domestic
institutions receive. In fact, we define national
treatment in financial services as equality of competitive
opportunity.
-- At the same time, the International Banking Act mandated
the Administration to report to Congress on the treatment
that U.S. banks receive abroad, and on efforts to
eliminate discrimination against them.
— The original National Treatment Study, was completed in
1979 and, at the request of the Congress, was updated in
1984 and 1986. The 1986 report examined not only the
treatment of U.S. banks abroad but also that of U.S. firms
engaged in securities business.
— The Omnibus Trade and Competitiveness Act of 1988 (Section
3602) has now formalized the reporting process on a
four-year schedule. The Secretary of the Treasury is
required to report to Congress by December 1, 1990, and
every four years thereafter, on the extent to which
foreign countries are denying national treatment to U.S.
banking institutions and securities underwriters. The
report will also describe efforts undertaken by the United
States to eliminate such discrimination. In addition, it
will examine the degree to which foreign financial
services companies have entered into business in the U.S.

5
—

Perhaps as important, the Trade Act (Section 3603)
instructs the President, or his designee, to conduct
bilateral discussions when advantageous to ensure that
U.S. financial services firms have access to foreign
markets and receive national treatment, and that barriers
are reduced.
— The 1990 report to Congress will include the major
traditional markets but will also give added emphasis to
other areas such as financial centers in Latin America,
the Asian economies, and the EC. These regions have
become increasingly important to the financial services
industry.
-- We have serious national treatment concerns in Latin
America. Most of the nations in this region have enjoyed
and benefitted from hard currency trade funds and other
services supplied by foreign banks, including our own.
But at same time, many of these countries have denied
foreign investors the right to establish in the domestic
market.
— Given the dynamic growth of financial activity in the
Pacific Basin, the 1990 report will undoubtedly also place
increased emphasis on the treatment U.S. financial
institutions receive in Korea, Singapore, Thailand, Taiwan
and Philippines.
— The European Community's plan to create a single financial
market by 1992 also warrants special attention in the next
study.
Bilateral Talks
— In addition to monitoring the treatment U.S. financial
firms receive abroad in the course of preparing our
reports to the Congress, the Treasury has undertaken
extensive bilateral discussions with many of our financial
partners. We have achieved significant progress in many
of these talks.
— Perhaps the most notable progress has been in Treasury's
financial discussions with the Japanese. The so-called
Yen/Dollar group — now known as the U.S.-Japan Working
Group on Financial Markets — has met six times since the
fall of 1984. These talks have contributed to greater
access for U.S. firms to Japanese financial markets — to
their stock exchanges, government securities markets, and
to a lesser degree their money markets.

6
—

Financial talks with the Canadians resulted in a financial
services section of the U.S.-Canada Free Trade Agreement
which took effect January 1, 1989. This is a landmark
agreement since it is the first binational agreement by
either of the signatories covering the entire financial
sector.
— It is a balanced agreement that should remove many
discriminatory practices U.S. financial institutions have
encountered. These include restrictions on market share,
asset growth and capital expansion for U.S. bank
subsidiaries operating in Canada.
— The Treasury has also been actively involved in the EC's
efforts to create a single financial market.
— While we have supported the EC goal of economic and
financial liberalization, we are troubled that possible
reciprocity provisions could lead to discrimination and
regulatory chaos — actions which would undoubtedly invite
retaliation.
— We have made some progress. On one important issue, the
EC has finally said that reciprocity will not be applied
retroactively, nor on a "mirror-image" basis. This, of
course, is not enough — but it is a start.
-- In the newly industrializing economies of East Asia, we
have welcomed the Koreans' recent partial interest rate
deregulation, but have urged them to broaden their
liberalization measures to address a variety of U.S.
banks' problems, such as greater ability to open branches
and obtain access to local currency funding.
— The Treasury has also engaged in financial services talks
with Taiwan.
— Among other measures, at a meeting last summer, the Taiwan
authorities announced their intention to move toward
national treatment in the revision of their banking law.
Such a move could enhance U.S. firms' ability to engage
more competitively in a number of new activities, such as
savings and trust operations.
IV. Next Steps
Problem Areas
— Despite the progress I have just outlined, many problems
persist. I would like to enumerate some of these briefly.

7
For example, in Japan, we continue to push for further
financial market liberalization — including the
development of a deep liquid money market and further
interest rate deregulation. Such developments would
permit foreign banks to compete more effectively in the
domestic market.
Moreover, further domestic market liberalization and
deregulation in Japan should contribute to a more level
playing field globally, since the regulatory environment
in Japan has tended to keep down the cost of capital to
Japanese financial institutions. Cost of capital is one
of the most important factors in the global competitive
picture, particularly in our position vis-a-vis Japan.
In South Korea, restrictions must be removed on branching,
local currency funding, and ownership of real property.
The lack of a genuine interbank market for won funding
also affects foreign banks' ability to operate
competitively.
We would also welcome approval of additional branches for
U.S. banks, as well as a more accelerated capital markets
liberalization program.
In Taiwan, we hope to see continued movement toward
national treatment. Entry restrictions for foreign banks
should be relaxed, foreign exchange controls need to be
liberalized further, wholly-owned foreign securities
branches and subsidiaries should be permitted, and onerous
capital requirements for foreign banks should be revised.
Most of our immediate concerns in Canada have been
addressed in the U.S.-Canada Free Trade Agreement. The
agreement establishes a consultative mechanism between the
U.S. Treasury Department and the Canadian Department of
Finance to address any financial services problems in each
other's markets.
While we applaud the EC's basic objectives of economic and
financial liberalization, as I mentioned previously, we
are troubled by its inclination to resort to reciprocity.
More work clearly needs to be done in this area.
We believe that reciprocity would undermine efforts to
liberalize financial markets and mark a fundamental
departure from the principles of national treatment and
non-discrimination which have provided the basis for
progress to date.
One concern is that reciprocity could be used to
discriminate against non-EC based firms.

0

For example, the EC could define reciprocity in a way that
forces the U.S. to permit EC financial institutions to
engage in activities in the U.S. comparable to those
activities American firms are able to undertake in the
Community. European financial firms have expressed
concern about U.S. Glass-Steagall and interstate banking
restrictions.
° If the U.S. is unwilling to grant EC firms special
treatment in the U.S. — i.e., something better than
national treatment — or to change U.S. laws and
regulations to permit all firms to conduct the same
activities here as EC firms do in the EC, then access
could be denied to American firms in the EC.
° In Latin America, we intend to pursue better treatment for
U.S. firms in a broad range of financial services in the
course of bilateral discussions. We would like to see a
more open and hospitable climate for all investors in this
region.
Where Do We Go from Here?
— The larger question is where do we go from here in
addressing problems U.S. financial firms face in meeting
global competition.
— One unknown factor in all this is the role of the Uruguay
Round. Governments have considered the merits of
including financial services among those areas which could
be discussed in a multilateral setting. There are a
number of open questions as to how financial services
might be handled. In any case, national treatment should
be the cornerstone of any multilateral negotiation.
Regardless of the outcome of these deliberations, I
believe we must continue our bilateral consultations.
— From a public policy point of view the most we can do —
and must do — is to ensure that a level playing field
exists on which our firms can compete. We basically have
two roads we can travel to achieve this objective.
— One is to pursue a course of reciprocity and selectively
close our doors to foreigners if U.S. firms encounter
obstacles in foreign markets. The other is to continue to
press in bilateral talks for open markets worldwide.
— I strongly believe that no one benefits in a game of
reciprocity.

9
-- Imagine what kind of financial system the United States
would have if we were to adopt a policy of reciprocity.
Both at the Federal level and in the 50 states, we would
have a matrix of different rules to be applied in
different ways for different institutions from all over
the world. Banks from more than 60 countries are
represented in the U.S. while U.S. banks are located in
over 70 foreign markets. The number of different regimes
which could be applied, and would have to be administered,
is staggering. Reciprocity would clearly be an invitation
to chaos.
— I believe the problems I have discussed can only be dealt
with by an international commitment to a modern version of
national treatment — what we call equality of competitive
opportunity.
— This means providing all domestic and foreign participants, in any given market, the right to compete on a fair
and equal basis. Only if this type of commitment is made
by all parties can we expect markets to remain open around
the world.
V. Conclusion
— To conclude, let me emphasize that, when looking at the
state of the U.S. financial services industry, policymakers must bear in mind the global perspective. We have
an obligation not only to examine this industry within a
U.S. financial market context, but also to look at it
within the context of what is happening in foreign
markets. We must ensure that our firms can compete in
those markets — just as foreign firms can compete in
ours.
— If markets remain open, I am convinced that U.S. firms can
meet global competition.
— Considerable progress has been made over the years in
opening up foreign financial markets. We need to build on
this progress through continued negotiations and other
methods.
— Absent such progress, however, we must live with the
consequences.
— Congress has shown itself to be very sensitive to denials
of national treatment overseas. If foreign financial
markets are perceived to be hopelessly closed to U.S.
firms, then we must be prepared to succumb to a battle
where reciprocity is viewed as the only weapon.
— In the long run we would all lose. Access to markets is
like sound health. It may only be missed when it is no
longer available.

TREASURY NEWS
Department
the Treasury • Washington, D.c. • Telephone 566-2041
'ext as of
Prepared
LI&KA&Y.ROeM 5ilO

!AR

3 8 55 'AH m89

BEPARTMEM 8r-HE "H.ASUSY

Remarks by
The Secretary of the Treasury
Nicholas F. Brady
Before the American Bankers Association
Banking Leadership Conference
Capital Hilton Hotel
Washington, D.C.
March 2, 1989

Good morning and thank you for this opportunity to meet with
the leadership of the American banking community.
I have great
respect for your industry, which helps form the foundation of the
largest and strongest economy in the world.
The American Bankers Association Leadership Conference
provides an important forum for you to establish industry
positions on the major issues facing our nation.
I will concentrate most of my remarks this morning on the
President's reform plan for the savings and loan industry. But
before getting to that, I would like to take just a few minutes
to touch on some of the other important priorities the Bush
Administration will be pursuing.
PROMOTING ECONOMIC GROWTH
Our first and foremost economic priority is fostering a more
competitive, innovative economy which will continue to lead the
world as we move toward the 21st century.
And I am pleased to
say that our economic outlook is very good.
Economic growth
means rising living standards for working Americans and new job
opportunities for those who are out of work.
We must remain vigilant against inflation so that it does
not plague our economy as it did in the late seventies. It is
possible to have somewhat differing interpretations of economic
statistics, to think one set of statistics means more than
NB-160

2
another, but there is no difference between the Administration
and the Federal Reserve Board on the importance of resisting and
preventing inflation in order to help sustain the economic
expansion.
CUTTING THE BUDGET DEFICIT
We must recognize as we pursue our goal of inflation-free
economic growth that the greatest obstacle to success is the
federal budget deficit. And the best way to fight inflation and
encourage economic growth is to cut the deficit.
That is why President Bush has proposed to Congress a budget
that will meet next year's Gramm-Rudman-Hol lings deficit
reduction target of $100 billion without raising taxes. His
budget takes the more than $80 billion in new revenues resulting
from economic growth and allocates them to deficit reduction and
spending priorities.
The President pledged in his budget address to Congress that
he and his team are ready to work with the Congress, "day and
night, if that's what it takes, to meet the budget targets and to
produce a budget on time."
Budget Director Darman, Governor
Sununu and I have begun to negotiate with the Congress to achieve
the budget reduction all of us agree is necessary.
THIRD WORLD DEBT
Perhaps the most difficult of the major issues facing us at
the outset of the Bush Administration is the problem of Third
World debt.
Unlike the federal budget deficit or even the
savings and loan industry crisis, this is not a problem that we
in the U.S. have the power or the resources to solve by
ourselves.
Only about 30 percent of the debt is held in the U.S. and
there are not sufficient resources anywhere in the world to
provide an immediate solution to this seemingly intractable
problem. We have now completed our review of the current debt
strategy and are examining possible changes to that plan. We
will have more to say on that soon.
THE S&L PLAN
Now, let me turn to what has been one of my top priorities
since the day I was sworn in as Secretary of the Treasury: a
sound, responsible solution to the savings and loan crisis.
President Bush is correct. No simple or painless solution
to this problem exists.
Only eighteen days after he was
inaugurated, however, he announced the Administration's plan. In
doing so, President Bush reaffirmed our commitment to fix it now,

3
fix it right, and fix it once and for all.
The Administration's savings and loan industry reform plan
meets these standards.
It serves as a blueprint for
comprehensive reform and sound financing. It is pro-industry—
for S&Ls, for banks and for the industries they serve.
For banks, the plan has a number of positive aspects. First
and foremost, it will quickly resolve the failing savings and
loans and thus reduce deposit costs for banks and healthy S&Ls.
Second, it proposes reforms you have advocated for some time to
require S&Ls to meet safety and soundness standards more like
those required of commercial banks. And finally, it pays for a
very large problem without using any funds at all from the banks.
RESOLVING INSOLVENT S&Ls
Now, let me turn to a few of the most important details: On
February 7, the day after the President announced his plan, the
FSLIC, FDIC, OCC, and the Federal Reserve worked together to
stabilize insolvent institutions.
To date, 34 insolvent S&Ls
have been brought under regulatory control. Within six weeks,
200 of the worst cases should be in the hands of federal
authorities.
That action should begin to reduce the cost of funds — for
banks, as well as for savings and loans. Moreover, this quick
action will give us a head start on implementing the resolutions,
which will be executed as soon as Congress provides the
necessary financing.
THE REFORM PLAN
We have also proposed fundamental reforms in the way the S&L
industry is insured and regulated.
To correct the systemic
problem of having the regulator act both as an industry advocate
and insurer, FSLIC will be separated from the Bank Board and
attached administratively to the FDIC.
The combined resources of FDIC and FSLIC will create an
insurer with independence and sufficient capacity to deal with
this big job.
While a single agency will be created, separate insurance
funds will be maintained for commercial banks and for savings and
loans.
Here is our ironclad pledge:
The separate insurance
funds will not be commingled, and premiums from each industry
will be used only for its own insurance fund.
The Chairman of the FHLBS will continue to be the chartering
authority and the primary federal supervisor of savings and
loans. The current board will be replaced by a single chairman,

4
v

who will be subject to the general direction of the Secretary of
the Treasury in the same manner as the Comptroller of the
Currency.
SAFETY AND SOUNDNESS
The Administration plan will increase safety and soundness
standards for savings and loan institutions by requiring these
institutions to meet standards equivalent to commercial bank
capital and regulatory standards within a two-year period. We
have learned a valuable lesson: Deposit insurance simply will
not work without sufficient private capital at risk and up front.
Incentives for attracting new capital will further increase
the amount of private capital protecting depositors.
For
example, bank holding companies will be permitted to acquire an
insolvent savings and loan without the existing cross-marketing
and tandem restrictions. After two years, bank holding companies
will be able to acquire any savings and loan without these
restrictions. (Of course, non-complying activities would have to
be divested.)
The FDIC will be given enhanced authority to set insurance
standards for all savings and loans, both federal and statechartered.
It will be able to restrict risky activities that
have been authorized by some states in the past. The FDIC also
would have a "fast whistle" to halt unsafe and unsound practices,
while still protecting insured depositors.
All in all, these steps will create a system of checks and
balances for savings and loans that more closely parallels that
of commercial banks. And that ultimately is in the best interest
of the S&Ls, the banks, their customers and all of us as
taxpayers.
SOUNDNESS OF THE DEPOSIT INSURANCE FUNDS
Beyond the regulatory reforms which are designed to insure
that massive insolvencies are never allowed to occur again, there
is a fundamental need to put the federal deposit insurance funds
on a sound financial basis.
This can be accomplished by
reestablishing the basic principle of industry-financed deposit
insurance funds standing between any future industry problems and
the taxpayer.
The cost of the S&L solution underscores the importance of
requiring all federal deposit funds to be adequately capitalized.
The FDIC insurance fund's reserve-to-insured deposit ratio has
fallen to an estimated all-time low of 0.83 percent.
We propose increasing commercial bank premiums to bring the
FDIC fund more in line with its historical reserve-to-deposit

5
ratio to protect depositors and taxpayers. Specifically, we
propose a gradual rise in the deposit insurance premiums paid by
commercial banks, from eight basis points currently to 12 basis
points next year and 15 basis points the following year.
As soon as the fund reaches a 1.25 percent reserve-toinsured deposit ratio, rebates will be granted on premiums.
It is important to point out that this is the first
statutory increase in the FDIC's deposit insurance premium since
1935.
During the intervening years, the amount of deposits
insured per depositor in any one institution has increased from
$2,500 in 1933 to the current level of $100,000,
Let me emphasize, however, that all of the increased premium
revenue paid by commercial banks will go to the FDIC insurance
fund; not one penny from commercial banks will go to any S&L
resolution or to the new Savings Association Insurance Fund.
THE FINANCING PLAN
The financing portion of the Administration's plan has three
components.
The first $50 billion is to resolve currently
insolvent institutions and any other marginally solvent
institutions which may become insolvent over the next several
years. Second, the plan ensures adequate servicing of the $40
billion in past FSLIC obligations. Third, the plan provides $24
billion for any insolvencies that may occur between 1992 and
1999.
At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC) to resolve all S&Ls which are now GAAP
insolvent or become so over the next three years. The creation
of this new corporation will allow the isolation and containment
of all insolvent S&Ls during the three-year resolution process
and will facilitate a full and precise accounting of all the
funds that are used.
To provide the $50 billion to the RTC, we have asked the
Congress to create a separate corporation, the Resolution Funding
Corporation (REFCORP), which will issue $50 billion in longterm bonds to raise the needed funds.
REFCORP will use S&L
industry funds to purchase zero-coupon, long-term Treasury
securities with a maturity value of $50 billion to assure the
repayment of the principal of the bonds issued by REFCORP.
Interest payments on the REFCORP bonds will come from a
combination of private and taxpayer sources. All Treasury funds
used to service REFCORP interest will be scored for budget
purposes in the year expended.
Funds for the second component of our plan — servicing the

6
$40 billion in resolutions already completed by FSLIC — also
will come from a combination of S&L industry and taxpayer
sources.
Funds for the third component of the plan — managing future
S&L insolvencies and building the new S&L insurance fund during
the post-RTC period — will come from a portion of the S&Ls'
insurance premiums and Treasury funds as needed.
CONCLUSION
In conclusion, the Administration's activity of the past few
weeks should illustrate clearly our commitment to a long-lasting
resolution of the S&L crisis. We have presented a structurally
sound plan. We have proposed a balanced financing package that
requires contributions from the S&L industry and also lives
within the government's means.
The plan will create a healthy thrift industry by removing
the insolvents, reducing excess capacity, and requiring those
which remain to have capital and accounting standards equivalent
to banks. The results for the commercial banks will be reduced
cost of funds and competitors operating on a level playing field.
And by requiring that deposit insurance be fully funded and selffunded, the plan will reinforce depositor confidence in the
system.
President Bush deserves a great deal of credit for stepping
forward with a plan that will do the job. And that plan deserves
your outright support. Thank# you
# # very
# # much.

ANNUAL TRADE PROJECTION REPORT TO CONGRESS

Prepared Jointly by the Department of the Treasury
and the Office of the United States Trade Representative

March 1, 1989

Annual Trade Projection Report - 1989
Table of Contents

I.

Introduction

1

II.

Review and Analysis of Recent Developments

2

III.

Projected Developments in 1989 and 1990

10

IV.

Policy Issues

17

V.

Impact of Trade Barriers

20

PART I:

INTRODUCTION

The Omnibus Trade and Competitiveness Act of 1988 (P.L.
100-418) contains numerous reporting requirements, including,
in Section 1641, a requirement for an Annual Trade Projection
Report. The impetus for this report reflected widespread
concern about the emergence of substantial U.S. trade and
current account imbalances and the impact of foreign economic
trends and policies on these imbalances.
The report is to include a review and analysis of key
economic developments in countries and groups of countries that
are major trading partners of the United States, projections
for developments in various macroeconomic variables in the
reporting year and the following year, conclusions and
recommendations for policy changes to improve the outlook, and
the impact on U.S. trade of market barriers and other unfair
practices.
The legislation specifies that the report is to be prepared
jointly by the Treasury Department and the Office of the United
States Trade Representative, in consultation with the Chairman
of the Board of Governors of the Federal Reserve System. The
Report is to be submitted on March 1 of each year to the Senate
Finance Committee and the Ways and Means Committee of the House
of Representatives.
This is the initial report submitted pursuant to P.L.
100-418; Section 1641. Part II provides a review and analysis
of recent macroeconomic developments in countries or groups of
countries that are major trading partners of the United States,
as well as a review of key recent developments in the U.S.
economy. Part III presents projections for key macroeconomic
developments in 1989 and 1990 in the same countries and country
groups. The two main sections are organized as follows:
Section 1 discusses economic growth, fiscal trends and current
and trade account developments in the industrial countries;
Section 2 reviews key developments elsewhere in the world
economy, discussing the non-OPEC member Less Developed
Countries (non-OPEC LDCs), including the Newly Industrializing
Asian Economies (NIEs), as well as the OPEC countries. Part IV
reviews the policy issues raised by these projections, and Part
V discusses the impact on U.S. trade of market barriers and
other unfair practices.
Readers are, in addition, referred to the Treasury
Department's October 1988 Report to Congress on International
Economic and Exchange Rate Policy, which discusses key issues,
including exchange rate developments, in considerable depth and
provides a more detailed review of important recent historical
trends. That report was also completed under requirements in
the Omnibus Trade and Competitiveness Act of 1988
(P.L.100-418) .

-2-

PART II:

REVIEW AND ANALYSIS OF RECENT DEVELOPMENTS

1. Developments in the Industrial Countries
Real economic growth in the industrial countries in 1988
was, for the most part, substantially stronger than had
widely been expected, particularly in view of concerns
raised by the financial market turbulence in the fall of
1987. In fact, average real GNP growth in the OECD group of
industrialized countries strengthened to an estimated 4
percent in 1988, well above the average growth rate during
the previous decade.
A. Key Developments in the United States
Because economic developments in the United States are
such an important determinant of performance elsewhere in
the industrial country group, a brief review of these
developments will help put the subsequent discussion in
context. Real GNP growth in the United States rose from 3.4
percent in 1987 to 3.8 percent in 1988 on an annual average
basis, but slowed from 5.0 percent to 2.7 percent when
measured on a fourth quarter over fourth quarter basis,
i.e., the fourth quarter of 1988 versus the fourth quarter
of 1987. (The latter measurement helps assess the trend
rate of growth during the course of the year — accelerating
or slowing down — though it is also more sensitive to
developments in the starting and ending quarters.)
However, this general picture of slowing growth in the
United States in 1988 is misleading given the substantial
depressing effect of last year's drought. When the GNP data
are adjusted for the drought a rather different picture
emerges: U.S. real GNP growth improved even more strongly
on an annual average basis, to 4.1 percent, and slowed less
substantially on a 4th/4th basis, to 3.3 percent. The
drought adjustment is particularly striking on the 4th/4th
basis because of the greater negative impact of the drought
on GNP during the second half of the year.
The effects of the ongoing reduction of the U.S. trade
and current account deficits are clearly evident in the
national accounts. (Note: There are two basic measurements
of the external side of any economy. The balance of
payments, i.e., the trade and current accounts, measures the
nominal dollar value of international transactions in goods
(trade account) and goods and services (current account).
The national income and product accounts (the NIPA or GNP
accounts) incorporate the external side of the economy by
including exports and imports of goods and services on a
real, i.e., price-adjusted, basis. Thus, by separating the
domestic side of the economy (i.e., private and public

-3-

consumption, and investment) from the external side (exports
and imports), and by presenting both in price-adjusted
terms, the NIPA measurement identifies the relative
contributions of each to the overall real growth
performance.)
Domestic demand growth in the United States was 3.0
percent in 1988, unchanged from its 1987 growth rate. Thus,
GNP growth exceeded domestic demand growth by a substantial
margin in both 1987 and 1988. As explained above, this gap
illustrates the net positive contribution of the external
side to overall U.S. growth since 1986. In 1988 the strong
real improvement in exports of goods and services added a
total of about 0.8 percentage points to real GNP growth;
thus better net exports produced about 20 percent of total
U.S. growth last year even though exports account for only
about 13 percent of overall real GNP. So looked at from the
standpoint of the NIPA, the U.S. external adjustment process
continued, and indeed strengthened, in 1988.
Adjustment is also clearly evident when measured on a
balance of payments basis. As noted in the summary above,
the U.S. trade deficit was reduced by an estimated $35
billion in 1988, and the current account deficit by about
$20 billion. Expressed as a percent of GNP, which
facilitates international comparisons of countries of
different size, the U.S. current account deficit narrowed
from 3.4 percent in 1987 to 2.8 percent in 1988.
The bulk of the improvement in the U.S. trade deficit in
1988 occurred against the industrial countries (about $20
billion), which collectively absorb 64 percent of total U.S.
exports. Within this group, the U.S. deficit vis-a-vis
Western Europe (27 percent of total U.S. exports) was cut by
more than half, from $27 billion to $13 billion: the U.S.
deficit with Germany fell by about $3 billion due entirely
to higher exports; and the U.S. trade balance with the U.K.
improved by nearly $4 billion, to a small surplus. The
balance of U.S. trade with the EC shifted by $12 billion,
from a deficit of $21 billion to a deficit of $9 billion.
The U.S. trade account improvement against Japan (which
accounts for about 12 percent of U.S. exports and 20 percent
of U.S. imports) was about $4 billion.
There was also a considerable decline in the U.S. trade
deficit with the developing countries in 1988. Against this
group, which accounts for 33 percent of U.S. exports (i.e.,
more than Western Europe), the U.S. deficit narrowed by $13
billion, from $59 billion in 1987 to about $46 billion last
year. The U.S. trade deficit with Mexico (the third largest
U.S. export market after Canada and Japan) fell by $3
billion; however this shift was partly offset by a $1
billion increase in the U.S. trade deficit with Brazil.

-4-

Roughly half of the U.S. deficit shift against the LDCs
was accounted for by a $5.5 billion decline in the deficit
with the Newly Industrializing Economies of Asia. (This
group accounts for 11 percent of U.S. exports and 14 percent
of U.S. imports.) The bulk of this improvement came against
Taiwan, with which the U.S. deficit fell from $17 billion to
$13 billion. Against Korea, on the other hand, the U.S.
deficit was virtually unchanged.
Finally, the U.S. deficit with the OPEC countries was
reduced by $4 billion due mainly, and perhaps surprisingly
given the general slowdown in OPEC import growth, to higher
U.S. exports; given oil price developments in 1988 U.S.
imports from OPEC were reduced by about $1 billion.
B. Developments in Other Industrial Countries
The accelerated economic growth in the industrial
countries in 1988 was due to a number of factors. First,
consumer and business sentiment improved dramatically during
the first half of 1988, rebounding from the excessive
pessimism that had prevailed in the wake of the October 1987
financial market events. The effect of this shift was seen
in private consumption spending, which was clearly stronger
than initially expected, and, most importantly, in
substantially higher real investment spending. Second, the
rate of growth of world trade jumped by about 50 percent in
volume terms (from nearly 6 percent in 1987 to an estimated
9 percent in 1988) both reflecting and at the same time
contributing to stronger overall industrial country growth.
Third, some special factors — like a mild winter and extra
work days in Europe — gave growth rates an early boost in
1988.
As noted above, stronger investment activity in 1988
contributed importantly to the general improvement in
domestic demand growth in the industrial countries outside
the United States. In fact, gross investment spending
increased in real terms in each of the six foreign Summit
countries (Japan, Germany, France, U.K., Italy and Canada),
in some cases (Germany and the U.K.) dramatically. In the
12 EC countries as a group investment growth rose from about
4.5 percent in 1987 to an estimated 7.5 percent last year,
an unexpectedly good result that was generally shared by the
other European countries.
Developments in another key domestic demand component,
private consumption, however, were less uniform.
Consumption growth rates picked up in Japan, the U.K. and
the Netherlands, remained essentially unchanged in France,
and generally declined in the rest of the group. For the EC
as a whole, private consumption growth is estimated to have
declined marginally in 1988 but, at about 3.5 percent, still
remained well above average growth rates in the first half

-5-

of the decade. Although it is difficult to generalize,
these declines to some extent reflected the impact on real
earnings of wage restraint and somewhat higher inflation.
Taken together these trends indicate that in addition to
the quantitative improvement in economic growth in our major
industrial trading partners in 1988, there was some further
qualitative improvement as well. Specifically, the gap
between domestic demand growth and overall GNP growth in the
key surplus countries — an important determinant of the
speed of trade and current account adjustment — widened,
particularly in Japan.
In aggregate, average domestic demand growth in the six
foreign Summit countries rose from an annual average of 4.3
percent in 1987 to an estimated 5.5 percent in 1988.
Average GNP growth was 3.4 and 4.4 percent, respectively;
thus the domestic demand versus overall growth gap for this
country group remained at about 1 percent in real terms.
The same general picture applies to the EC group as a whole,
while in the smaller European economies domestic demand
growth is estimated to have exceeded GNP growth by about
half this amount.
Turning to country specifics, Japan was again the Summit
country growth leader in 1988 with its real GNP growth rate
increasing from 4.5 percent in 1987 to an estimated 6.0
percent. Domestic demand (specifically, private consumption
and investment) was again clearly the driving growth force,
expanding by nearly 8 percent in real terms. The picture for
Germany is similar, but less impressive. Overall GNP growth
picked up strongly in 1988 (to about 3.6 percent) after a
disappointing 1.8 percent advance in 1987. Bolstered mainly
by investment, domestic demand growth rose from 3.1 percent
in 1987 to an estimated 3.9 percent in 1988. The gap
between domestic demand and GNP growth in Germany thus
narrowed considerably, from 1.3 percent in 1987 to 0.3
percent in 1988.
Domestic demand growth in the U.K was appreciably
stronger in 1988 (perhaps 5.8 percent), driven in large part
by surging investment. In Canada and Italy domestic demand
growth also led GNP in 1988; in France and Belgium both
advanced by about 3.5 percent, while in the Netherlands
growth rates were a more modest 2.5 percent.
Thus, in the important Summit 6 group as a whole (which,
due entirely to Japan and Germany, is running a substantial
combined current account surplus), the external side of the
economy exerted a net drag on growth in 1988; i.e., net
exports of goods and services declined in real terms. For
both Japan and Germany this was the third consecutive such
annual adjustment. (In the United States, conversely,
improving net exports have been a positive contributor to
GNP growth since 1987.)

-6-

B. Fiscal Balances
The fiscal deficits of industrial country governments
were, in aggregate, generally reduced in 1988 due largely to
the automatic stabilizer effects of the stronger economic
growth described above. Specifically, higher growth and
corporate profits tended to boost tax revenues while, on the
other side of the budget accounts ledger, outlays for public
support programs such as unemployment insurance tended to
grow more slowly or even decline. For the most part,
therefore, the fiscal tightening in 1988 appears to have
been mainly cyclical rather than structural.
Calculations by analysts with the Organization for
Economic Cooperation and Development (OECD) indicate that
underlying fiscal policies in the industrial countries were
mildly contractionary in 1988 after having been mildly
expansionary in 1987. The OECD estimates that the
'cyclically-adjusted' overall fiscal position of the Summit
6 moved toward surplus by about 0.2 percent of GNP in 1988
after having eased by 0.3 percent of GNP in 1987. That is,
when adjusted for the effect of automatic stabilizers
(fiscal drag) plus discrete policy changes, the combined
general government fiscal position (i.e., including all
levels of government) of the six countries swung from slight
stimulus in 1987 (0.3 percent of GNP) to slight contraction
in 1988. Over the two year period, therefore, underlying
fiscal policy in the Summit 6 group was essentially neutral.
The OECD also estimates that the same figures apply to the
European economies in aggregate.
There were, however, some important differences among
countries. In Japan, the effects of a large increase in
public investment and a late-1988 income tax cut were
countered by higher growth-related revenues, resulting in a
slight increase in the small (0.4 percent of GNP) general
government surplus. In Germany, income tax cuts that came
on stream in January 1988 helped boost the general
government deficit somewhat, to an estimated 2.1 percent of
GNP in 1988. However, after several years of contractionary
policies the German deficit, expressed as a percentage of
GNP, still remains well below levels recorded in the early
1980s.
The general government fiscal position continued to
improve in the U.K. in 1988, with the surplus rising to 1.4
percent of GNP; expenditures have remained within fairly
restricitve targets while revenues have benefitted from
strong growth and privatization receipts. Elsewhere, the
general picture is one of continued efforts to restrain
expenditure growth coupled with better than anticipated
revenues, producing deficits in 1988 that were somewhat
reduced relative to GNP.

-7-

C. External Accounts
Although developments in the external accounts of
individual industrial countries in 1988 were typically
divergent, it is clear that in important respects progress
continued to be made toward achieving better international
balance. The U.S. trade and current account deficits were
reduced in both nominal terms and as a percent of GNP. The
counterparts to this U.S. adjustment in 1988 are found in
lower external surpluses in Japan, the EC (and Europe more
broadly), and the Asian NIEs.
Japan's current account surplus declined from $87
billion in 1987 to $79.5 billion in 1988, reflecting both a
decline in the trade surplus and an increase in the
invisibles deficit. The key development on the trade side
was a very strong surge in import volume (about 16 percent)
compared with export volume growth estimated at about 4.5
percent. However, with total exports running at nearly
twice the level of total imports, the trade surplus was
reduced by less than $1 billion in dollar terms (to $96
billion).
Canada's 1988 merchandise trade account netted out to a
surplus of about $7.2 billion, down about $1 billion from
1987, as the real growth rates of both imports and exports
picked up. However, with the traditionally large invisibles
deficit running below its 1987 level, the current account
deficit narrowed to an estimated $7 billion.
The combined current account surplus of the European
Community dropped from about $37 billion in 1987 to an
estimated $15 billion in 1988. However, there were
important differences in the performance of specific member
countries. The most striking development was a nearly
sixfold increase in the current account deficit of the U.K.,
from $4.4 billion in 1987 to an estimated $25 billion in
1988. Lower oil earnings were partly responsible, but the
bulk of the shift was accounted for by a surge in imports of
investment goods.
Germany's trade surplus, on the other hand, reached a
new record in DM terms (equivalent to an estimated $73
billion) due mainly to much stronger investment goods
exports to the other EC countries. As a result, the German
current account surplus rose by about $4 billion to nearly
$49 billion (Germany is running a large and growing
invisibles deficit), though relative to GNP it declined
slightly to 3.9 percent.
Current account patterns within the rest of the EC
remained little changed in 1988. France's deficit rose
slightly to about $4.5 billion but remained quite small as a
share of GNP, as was essentially the case for Italy.

-8-

Elsewhere within the EC, as well as in Europe as a whole,
there were few remarkable developments: the combined deficit
of the Nordic countries remained little changed (about $9
billionTT the combined Benelux surplus rose from $6 billion
to approximately $9 billion; and newly admitted EC member
Spain slipped into deficit.
2. Developments Outside the Industrial Countries
Growth developments in the Less Developed Economies
(LDCs) as a group were broadly satisfactory in 1988, tHough
in contrast to the industrial countries, overall real growth
was somewhat slower than in 1987. Specifically, the GNP
weighted average real growth rate of the 137 non-OPEC LDCs
tracked by Treasury analysts slowed from about 3.7 percent
in 1987 to a provisionally estimated 3.1 percent last year.
As usual, however, there were important differences
among countries and country groups, with the overall average
strongly affected by developments in a few of the largest
economies. Average real growth slowed in Latin America but
remained quite strong in the Newly Industrializing countries
of Asia.
In fact, the overall LDC growth slowdown in 1988 was due
almost entirely to negative developments in a few Latin
American economies. Specifically, Brazil registered zero
real growth in 1988 (after 2.9 percent in 1987) and Mexico's
growth rate slipped from about 1.5 percent in 1987 to an
estimated 0.5 percent in 1988. As a result, in Latin
America as a whole aggregate GNP growth slowed from 2.5
percent in 1987 to 1.4 percent in 1988. Elsewhere, the
non-OPEC LDC real growth performance was about on par with
1987 rates, i.e., just under 4 percent.
The Newly Industrializing Economies of Asia (NIEs;
Taiwan, Korea, Singapore, Hong Kong) were again the clear
growth leaders, recording a weighted average growth rate of
about 10 percent in 1988 after a similar outturn in 1987:
Korea's growth rate remained at roughly 12 percent while
Taiwan's slipped to a still impressive 8 percent.
The aggregate non-OPEC LDC current account balance
registered a small $1 billion deficit in 1988 after a $4
billion surplus in 1987. As with the growth figures
discussed above, however, there were sharp differences among
individual countries and regions.
The combined current account surplus of the Asian NIEs
declined by an estimated $5 billion in 1988, to about $26
billion. This correction was due entirely to a halving of
Taiwan's surplus, from about $18 billion in 1987 to an
estimated $9.6 billion in 1988; however, about $4 billion of
this correction was due to special, and probably one-time,
gold purchases. Korea's surplus, on the other hand, rose
further to approximately $14 billion.

-9-

Other key current account developments within the
non-OPEC LDC group were: a dramatic deterioration in
Mexico's position, which shifted from a $3.4 billion surplus
in 1987 to a $3 billion estimated deficit in 1988; a
substantial opposite move in Brazil's current account, which
shifted from about a $1 billion deficit in 1987 to a
provisional $4.4 billion surplus in 1988.
Despite the important current account shifts within
individual countries, the combined current account position
of Latin America as a whole has actually changed relatively
little in dollar terms in recent years. A $17 billion
deficit in 1986 was reduced to $11 billion in 1987, where it
remained last year.
The four Asian NIEs (Korea, Taiwan, Hong Kong, and
Singapore) have become particularly significant players in
the international trading system. Since 1970, their share
of world exports has more than tripled to 7.4 percent.
Moreover, these economies have in aggregate, accumulated
external surpluses that account for a significant share of
current global imbalances. Taiwan and Korea have recently
been running large current account surpluses — two to four
times those of Japan and Germany as a proportion of GNP.
(It should be noted, however, that Korea ran a current
account deficit as recently as 1986.)
The factors that are responsible for the growth of the
Asian NIEs' external surpluses vary among the individual
countries and generalizations are difficult. Some important
elements are relative advantages in costs of production and
an emphasis on export production at the expense of domestic
consumption and improved living standards. The expansion of
world trade, and of the U.S. economy especially, has of
course benefitted the NIEs, though this applies to the rest
of the world as well. Undervalued exchange rates have also
been a major factor in the cases of Korea and Taiwan.
The 13 member OPEC group collectively experienced a
substantial increase in its current account.deficit in 1988
as earnings from oil and gas exports were reduced
significantly by the roughly 20 percent decline in the
average dollar price of OPEC oil. After the deficit
narrowed from $26 billion in 1986 to under $11 billion in
1987, it about doubled in 1988 to $20 billion. (Although
the OPEC group typically runs a substantial trade surplus,
it has been highly volatile in recent years and is
significantly exceeded by a large deficit on invisibles
transactions.)

-10-

PART III:

PROJECTED DEVELOPMENTS IN 1989 AND 1990

Before reviewing projections for this year and next, it
is important to set forth several key assumptions on which
the analysis is based. First, all projections for
individual countries and groups of countries are based on
current policies. For the United States it is assumed that
the federal budget deficit is reduced along the
Gramm-Rudman-Hollings path. No assumptions are^made as to
how fiscal or monetary policies may be altered during the
forecast period. Secondly, exchange rates are assumed to
remain constant in nominal terms at current levels.
Finally, the Administration's forecasts for the U.S. economy
contained in the budget provide the basis for the U.S.
outlook — itself an important factor in the economic
performance of the major U.S. trading partners.
As a result of these various basic assumptions, the
projections discussed below are not "best guesses" of what
the economic situation will turn out to be in 1989 and 1990.
They are, rather, "best guesses" of what the situation will
be unless policies change.
Latest forecasts and economic data indicate that the
current economic expansion in the industrial countries is
expected to continue through 1989 and 1990, its seventh and
eighth consecutive years. However it is widely expected
that the pace of overall growth will be at a somewhat slower
rate than in 1988. As was the case in 1988, world trade
growth should continue to outstrip real GNP growth
substantially, providing support for the ongoing external
adjustment process as well as a firm foundation and stimulus
to overall growth. Inflation in the industrial world is, on
average, expected to remain moderate through 1990. It is
more difficult to generalize regarding fiscal side
developments: many countries will continue to pursue, with
varying intensity, policies designed to reduce budget
deficits and public borrowing requirements. However, it is
also true that tax reform and the overall reduction of tax
burdens remains a policy objective in numerous other
countries.
1. Projections for the U.S. Economy
The U.S. economy is expected to continue to expand along
a sustainable growth path this year and in 1990. After last
year's partially drought-influenced growth slowdown, GNP
growth (on the 4th/4th basis) is officially forecast to pick
up to about 3-1/2 percent in 1989 and to remain at roughly
this rate in 1990. (Note: This 1989 growth rate tends to
overstate the underlying growth momentum of the economy due
to the negative end-1988 impact of the drought discussed
above.)

-11-

U.S. growth rates on an annual average basis are likely
to be a bit lower, but still in the 3 to 3-1/2 percent range
in both years. Domestic demand growth rates are forecast to
remain in the 2-1/2 to 3 percent range. Thus the external
side will remain a net positive contributor to overall
growth, with real increases in exports expected to exceed
import growth substantially. On the balance of payments
basis, further declines in the U.S. trade and current
account deficits are expected; however, given rising debt
service costs there will not be a full pass-through of the
trade deficit reductions to the current account.
2. Projections for the Other Industrial Countries
A. Economic Growth
Real economic growth in the industrial countries is
expected to slow somewhat this year, to the 3.0-3.5 percent
range, i.e., returning to the rate recorded in 1987.
Largely responsible for this moderate slowdown will be an
anticipated return of investment growth to a more measured
rate in 1989 after its unusual strength in 1988. While 1990
is a bit beyond the normal projection horizon, preliminary
work suggests a further, though more modest, growth slowdown
in the major foreign industrial countries. It is
anticipated that aggregate real growth in the Summit 6
countries will be just under 3 percent on average in 1990.
There is broad agreement among forecasters that German
real GNP growth will fall back somewhat this year from last
year's sharply higher rate, mainly reflecting the dampening
effect of various tax increases on disposable income and
private consumption growth. Japanese growth should also
slow this year, though for different reasons and to a rate
that will still be well above that of the other Summit
economies. Specifically, private consumption growth in
Japan should remain quite robust while investment growth —
an especially dynamic factor in 1988 — cools considerably.
Given Germany's size and the impact of its economic
policies on other EMS countries, it is not surprising that
the aggregate growth performance of the four largest
European economies (Germany, France, U.K., and Italy) will
not diverge much from the German trend. The U.K. is
unlikely to maintain the very strong investment and private
consumption growth rates recorded in 1988 in the face of
recent monetary policy tightening; real GNP growth in the
U.K. is expected to fall back to a more sustainable rate.
France did not experience similarly exceptional developments
in 1988, but both consumption and investment rates
nevertheless appear likely to cool this year.

-12-

Prospects for the rest of Europe, within and outside of
the EC, are broadly similar: slower real GNP and domestic
demand growth due in part to a return of investment to lower
growth rates. Specifically, GNP growth in the non-Summit
European countries is expected to slow by about one half a
percentage point, to 2-3/4 percent.
Domestic demand growth in the six foreign Summit
countries should, in aggregate, continue to outpace that of
overall GNP growth. However, the extent to which domestic
demand growth exceeds GNP growth is likely to narrow
significantly this year. In addition, there are important
differences among the countries. Taken together, domestic
demand growth in the four major European countries (and in
the smaller European countries as well) is expected to be
roughly the same as GNP growth, just under 3 percent.
The disappearance of the domestic demand/GNP growth gap
within the Europe Big 4 this year is expected to be shared
broadly. In Germany, France and the U.K. domestic demand
growth rates will drop substantially, though for the
different reasons mentioned above, pulling overall GNP
growth down with them. From a trade adjustment perspective
the possible elimination of this gap suggests that limited
further progress may be made this year toward adjusting the
aggregate Europe Big 4 trade imbalance. In Japan, in
contrast, domestic demand growth is forecast to continue to
exceed GNP growth though here too the gap is expected to
narrow relative to 1988.
At this early forecasting stage analysis suggests
continued moderate overall GNP growth in the industrial
countries in 1990, which is potentially the eighth
consecutive expansion year. However, while the general
growth picture appears reasonably satisfactory in a
quantitative sense, it is less so in a qualitative one.
Specifically, our projections indicate that the pattern of
domestic versus overall growth is not likely to be much
different from this year's.
For the foreign Summit Six, GNP growth is expected to
slow moderately, to just below 3 percent. Growth rates in
the two largest foreign economies, Japan and Germany, are
both expected to slow somewhat further, though for different
reasons. Despite the enactment of the final stage of a
multi-year tax reform in Germany, tax cuts amounting to
about 0.5 percent of GNP are not expected to boost private
consumption significantly. Consumption growth is likely to
be restrained by an increase in the savings rate, and
investment growth will probably slow after two relatively
strong years. If these views are borne out, German GNP
growth could subside to the bottom end of growth in the
foreign Summit countries.

-13-

In Japan, on the other hand, private consumption growth
is likely to continue at roughly its 1989 pace, but a fairly
substantial slowdown in plant and equipment investment is
expected. Nevertheless, Japan's projected 1990 GNP growth
rate is likely to remain well above the Summit Six average.
Growth rates are also likely to slow a bit further in
Italy and France, the other two major continental European
economies. In the U.K. by contrast, real GNP growth may
well strengthen in 1990 as exports continue to improve and
private consumption rebounds from what is expected to be
weaker growth this year.
At this juncture, it is expected that the rest of Europe
will be on a roughly 2-1/2 percent growth path in 1990.
Spain, Portugal and Turkey are again likely to be the top
growth performers, while real growth in Denmark and Sweden
should remain relatively slow. The aggregate growth rate of
the EC will of course be driven largely by developments in
the "Four major economies, and thus is likely slip to about
2-1/2 percent.
B. Fiscal Balances
If budgetary policies remain as presently anticipated —
as must be assumed — the aggregate fiscal stance of the
OECD as a whole (again, cyclically adjusted) will be broadly
neutral over the 1989-1990 period. Nevertheless, there will
be some significant differences among the individual
countries. Fiscal policy in the United States will be
geared toward meeting statutory requirements for reducing
the federal deficit. In Japan, the fiscal deficit is likely
to rise moderately, reflecting the combination of a variety
of tax changes with a modest rise in government
expenditures. Germany's planned policy over the period
combines an array of tax and social payment increases this
year with further income tax reductions in 1990. The
overall German government budget deficit (as a percent of
GNP) will therefore decline in 1989 and rise in 1990; but
over the 1989-90 period its average will be well below that
of the 1987-88 period.
The U.K. shifted to a budgetary surplus in 19B8, despite
tax cuts, and, relative to GNP, is likely to show moderately
rising surpluses in 1989 and 1990. France has combined
higher outlays on selected domestic programs with reduced
corporate and excise taxes, but little overall change is
expected in its relatively small deficit. On present
policies the general government deficit in Italy will remain
essentially unchanged and relatively high as a percent of
GNP (11.5 percent in 1988). Similarly, little chanq.e is
anticipated in the Canadian budget deficit through < 990.

-14-

The smaller European countries have been steadily
reducing public deficits as a percent of GNP since the early
part of the decade, and this trend is expected to continue.
Specifically, the average deficit is likely to be held below
2 percent this year and next, compared with a 5 percent
level in 1983.
C. External Accounts
Current account projections for the industrial countries
in 1989 and 1990 indicate that the external adjustment
process should continue, albeit with less uniform
improvement than might be desired. World trade flows will,
of course, be driven importantly by the growth trends
discussed above. Thus, with aggregate industrial country
growth expected to slow moderately in 1989 and 1990, so too
should the real expansion (i.e., volume growth) of trade.
Nevertheless, trade volume growth in the OECD countries
should still remain fairly robust and again outstrip GNP
growth by more than a 2:1 margin. Indeed, average trade
volume growth over the 1988-90 period should prove to be
higher than in any three year period since the mid-1970s.
Preliminary projections indicate that the combined
current account surplus of the Summit 6 countries will
decline this year and again in 1990. Specifically, after an
estimated surplus of $88 billion in 1988, the Summit 6 total
surplus is forecast to fall to about $74 billion in 1989 and
$64 billion in 1990. This implies that the group's combined
surplus will have been nearly halved since its record high
of $123 billion in 1986.
The largest shift should be seen in Japan, whose current
account surplus is expected to drop significantly from about
$80 billion last year. Roughly half of this projected
decline is accounted for by a decline in the (dollar value)
trade surplus, with the remainder accounted for by an
increase in the Japanese services and transfers deficit.
Germany, however, presents a different picture. With
export growth having rebounded from a brief slump in 1987
(due in the main to the commodity composition of German
exports and the stronger foreign demand for investment
goods), the German trade surplus is likely to rise
moderately through 1990. Thus, despite an expected increase
in its traditional invisibles deficit, Germany's current
account surplus will probably remain broadly unchanged. On
a regional basis, the key feature of the German trade
account has been a sharp increase in its surplus with other
EC countries, and this is expected to persist.
Elsewhere within the Summit 6, no dramatic chan-ies are
anticipated. Last year's ballooning of the U.K.'s trade
(and current account) deficits is not likely to be reversed

-15-

by 1990. France, Italy and Canada should collectively have
about the same current account deficit in 1990 as they had
in 1988.
The smaller OECD countries should, in aggregate,
experience an increase in their relatively small combined
current account deficit due largely to an expected increase
in Spain's deficit. Among the others, surpluses and
deficits are fairly minor in dollar terms, and no
substantial shifts are anticipated. Thus, current account
trends in the OECD as a whole through 1990 will essentially
track developments in the largest seven economies.
2. Projections for the Non-Industrial Countries
The developing countries should post somewhat higher
aggregate real growth in 1989 and remain on a fairly even
keel in 1990, aided by the expected continued moderate
growth in the industrial countries. Trends in Latin America
will again be dominated by developments in Mexico and
Brazil. In both cases, current trends suggest a modest
growth rebound this year, with somewhat higher real growth
in Argentina as well. Thus for the region as a whole, we
anticipate a return to the 3-1/2 to 4 percent growth range
through 1990.
Growth prospects for the Asian NIEs remain quite good.
Although the two biggest economies, Taiwan and Korea, are
likely to experience a slowdown from their recent
double-digit rates, growth should remain at about 9 and 7
percent, respectively. These projections imply aggregate
NIE growth rates in the 7 to 8 percent range this year and
next. Contributing to this slower growth scenario will be a
reduced rate of export expansion and an increase in the
growth rate of imports. The NIEs traditionally pursue
relatively conservative fiscal policies, which implies
little direct growth stimulus from the public side and
continued fiscal surpluses.
Assessing recent economic growth developments in the
OPEC group, and producing credible projections for the
future, is extremely difficult in view of serious data
problems with two of the largest countries, Iran and Iraq,
and oil price uncertainty. We do not disagree fundamentally
with the latest IMF staff projections, which suggest that
average growth for the group is likely to improve from about
1 percent in 1988 to about 2 percent in 1989. Obviously,
the picture for this year and next will be importantly
affected by oil price developments. If oil prices remain
around current levels (which is but one of several
alternative scenarios), and barring any exceptional
developments, aggregate OPEC growth in 1990 could ?'iain be
be within the 1-1/2 to 2 percent range.

-16-

The aggregate current account deficit of the non-OPEC
LDCs is forecast to expand this year, from an estimated $29
billion in 1988 to about $39 billion. About half of this
shift is expected it be accounted for by a decline in the
combined surplus of the NIEs; the remainder reflects a
projected $2 billion increase in the Latin American deficit
and scattered increases throughout the rest of the non-OPEC
LDC group.
Current account developments in the NIEs will, as usual,
be dominated by Korea and Taiwan. Korea's large surplus is
expected to narrow somewhat this year given the already
emerging trends of slower export and stronger import growth.
In Taiwan, the adjustment that was already underway in 1988
should continue this year, reducing the current account
surplus further. This projection, however, depends
importantly on greater import penetration. In both
countries additional surplus reductions are anticipated in
1990, though they might not be as substantial as this year.
Given these basic projections for the two largest
economies, the combined current account surplus of the NIEs
as a group should show further declines in both 1989 (to $21
billion) and 1990 (to $18 billion). These current account
projections however tend to obscure a somewhat stronger
underlying adjustment process in the trade accounts alone.
Both Korea and Taiwan are running growing surpluses on the
invisibles account (services and transfers) which partially
offsets reductions in merchandise trade surpluses. Thus
while we expect a $8 billion reduction in the combined NIE
current account surplus between 1988 and 1990, the projected
reduction in the merchandise trade deficit is $11 billion.
If our projections are borne out, the overall trade surplus
of the NIEs in 1990 will drop below $10 billion.
Key developments shaping the combined Latin American
current account deficit in 1989 and 1990 are: substantially
reduced surpluses in Brazil relative to 1988; and marginally
lower deficits in Mexico. In aggregate, Latin America's
current account deficit is forecast to widen slightly (to
$13 billion) in 1989 and then narrow slightly (to $11
billion). In light of the projected industrial country
growth and trade trends outlined above, we do not .anticipate
any dramatic developments on the trade side. The Latin
American region's combined trade surplus is expected to
remain little changed, in the $27-28 billion range.
Current account developments in the OPEC countries in
1989/90 will of course turn importantly on the situation in
the world oil market and the extent to which these producers
are able to affect it. With industrial country growth
expected to slow this year and next, and qiven exec's
worldwide production capacity, neither demand nor
supply-side considerations suggest strong price pressure
developing in the near-term. A marginal rise in the OPEC
trade surplus would cut its combined current account deficit
commensurately.

-17-

PART IV:

POLICY ISSUES

The basic near-term policy objectives for the industrial
countries, particularly those with large external
imbalances, will remain what they have been for the past few
years. Together they need to ensure that real growth
continues at a steady, solid pace, that inflationary
pressures are contained, and that the external adjustment
process remains on track in the context of a healthy and
growing international trade and financial system. These
goals apply as well to the non-industrial countries.
There is no controversy about these general objectives.
Indeed, they reflect a clear international consensus and
have been endorsed often and in considerable detail by
participants in the annual Economic Summit meetings, the
regular meetings of the Summit country Finance Ministers and
and Central Bank Governors, and the semi-annual meetings of
the IMF's policy-making Interim Committee.
There are of course inevitable differences of view about
the relative importance of the various objectives, and about
the best means of achieving them. In order to discuss and
help resolve these differences, the summit countries have
developed and strengthened the process of coordinating their
economic policies. International economic policy
cooperation has been a central theme at the past three
Economic Summits (Tokyo in 1986, Venice in 1987, Toronto in
1988) and will again be so at the upcoming 1989 Summit in
Paris. (This process was reviewed in considerable detail in
the October 1988 Treasury Department Report to Congress on
International Economic and Exchange Rate Policy, and readers
are referred to that report for a full discussion.)
The policy coordination process has produced a clear and
solid consensus on the basic elements of achieving the
shared objective of reducing external imbalances while
remaining on a sustainable growth path. At the broadest
level, continued adjustment requires supportive
international macroeconomic developments. The industrial
countries need to remain on a non-inflationary growth path
to stimulate world trade and provide growing markets for
their own exports and the exports of the LDCs that are
striving to meet the objectives of debt management, growth
and development.
The participants are committed to the basic policy
course necessary to translate these objectives into real
progress. The United States, for its part, is committed to
substantial federal budget deficit reductions, improving its
international competitiveness, and bolstering its savings
rate. For the countries with large external surpluses —
particularly Japan and Germany — this means implementing
macroeconomic and structural policies to ensure open,

-18-

growing domestic markets. Essentially, domestic demand
growth in the surplus countries must be strong enough to
compensate for the contractionary effect of declining
surpluses.
There has been a growing recognition, however, that most
economies suffer from structural impediments to growth and
adjustment which diminish the effectiveness of fiscal,
monetary and exchange rate policies. Hence the scope of the
coordination process has been expanded to include, in
addition to the traditional focus on macroeconomic policy,
specific examination of the complementary role that
structural reforms can play. At Toronto each of the
participating countries agreed to specific structural reform
steps including, inter alia: reducing labor market
rigidities that inhibit flexibility and prolong high
unemployment; cutting subsidies that impede the efficient
flow of resources both domestically and across international
borders; reforming tax systems that discourage risk-taking
and innovation and supress demand; liberalizing financial
markets; and, reducing burdensome regulations and excessive
public intervention in private sector activities.
Thus the policy coordination process is an evolving one.
By specifically incorporating macroeconomic and structural
considerations, and by examining the broader consequences of
individual policy choices, it is well suited to producing
medium-term solutions to what are, after all, medium-term
problems.
The need for appropriate macroeconomic and structural
policies is not, however, limited to the industrial
countries. The LDCs also have an essential role to play.
For example, the NIEs need to permit their exchange rates to
move in line with market forces and the underlying strength
of their economies in order to contribute to more balanced
trade flows and further global adjustment. Other policy
changes in the NIEs, including structural reforms to give
greater emphasis to domestic demand as a source of growth
and, in the cases of Korea and Taiwan, measures to
liberalize trade and capital flows are also necessary.
Since mid-1986, the United States has conducted discussions
with the four — most intensively with Korea and Taiwan —
about these issues. In addition, the OECD is exploring ways
to open an informal dialogue with the NIEs, focussing on
mutual responsibilities to promote open markets for trade,
investment and other financial transactions.
As a general matter the LDCs, and especially the heavily
indebted economies, need to ensure that their policies
support domestic growth and capital formation, reduce
inflation, and encourage appropriate financial support from
the commercial banks and the international financial
institutions. Resolving the serious imbalances in these

-19-

economies is a major medium-term challenge that will require
sound policies in both the macroeconomic and structural
areas.
Fiscal deficits and monetary creation must be brought
under control, capital flight must be halted and investment
policies must encourage return of overseas funds to bolster
domestic investment, distortions of relative prices — as
well as interest and exchange rates — must be reduced,
excessive regulation and public sector intervention should
be eliminated, and trade policies should encourage greater
integration with the global trading system.
Fortunately, there is growing evidence that the LDCs
recognize that market-oriented policies hold the greatest
promise for growth, development and global economic
integration. In addition to encouraging this emerging shift
in attitudes, it is essential for the industrial economies
to provide material support by maintaining open and growing
markets, reducing distortions in the global trading system
and providing appropriate support for the international
financial institutions. The policy coordination process is
an integral part of this larger effort.

-20-

PART VI:

IMPACT OF TRADE BARRIERS

The Congress requires the reporting of foreign barriers
to U.S. trade in the National Trade Estimate Report as
revised by Section 1304 of the Omnibus Trade and
Competitiveness Act of 1988. The law also requires
quantification, where feasible, of the estimated effects of
individual barriers to U.S. exports of good and services and
on U.S. foreign direct investment. This report is due and
will be sent to the Congress by April 30, 1989.
Because of the two-month interval between the mandatory
submission dates for the two reports, the National Trade
Estimate Report is only now in preparation as this Annual
Trade Projection Report is being finalized. For a listing
of foreign trade barriers and their impact on U.S. trade and
foreign direct investment, the Congress is, therefore,
referred to the forthcoming National Trade Estimate Report.
Care should be exercised in the interpretation of the
impact of foreign barriers on U.S. trade and investment.
Specific trade barriers can and do have a substantial impact
on exports, imports, production and trade balances for
specific products and, to a lesser extent, for specific U.S.
bilateral trade relationships. However, trade barriers have
relatively little impact on the aggregate imbalance in U.S.
trade.
Summing the estimated trade effects of individual trade
barriers would overestimate the impact on aggregate U.S.
exports of eliminating foreign trade barriers. By
definition, the "partial equilirium" analysis in which trade
barrier effects usually are estimated precludes drawing any
derivative implications of specific trade barriers for the
aggregate trade balance.
Trade barriers are important because they introduce
microeconomic inefficiencies (resource misallocation) at the
national and international levels and impose economic
welfare costs on societies. However, their effect on
aggregate trade balances or the projection of aggregate
balances is limited.

• * •

o

CM
CD
CO

federal financing bank

CO

March 3, 1989

FEDERAL FINANCING BANK ACTIVITY

Charles D. Haworth, Secretary, Federal Financing
Bank (FFB), announced the following activity for the month of
July 1988.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $149.9 billion on July 31, 1988,
posting an increase of $0.1 billion from the level on June 30,
1988. This net change was the result of increases in holdings of
agency debt of $102.7 million, of agency-guaranteed debt of $11.9
million, and a decrease in agency assets of $10.9 million. FFB
made 39 disbursements during July.
Attached to this release are tables presenting FFB July loan
activity and FFB holdings as of July 31, 1988.

NB-161

• *

C\J
CD

tf>c
o
CO IT)
co m

WASHINGTON, DC. 20220

FOR IMMEDIATE RELEASE

GO
CO

Page 2 of 4
FEDERAL FINANCING BANK
JULY 1988 ACTIVITY

BORROWER

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST INTEREST
RATE
RATE
(semi(other than
annual)
semi-annual)

15,330,000.00

10/12/88

6.875%

7/12
7/14
7/14
7/18
7/21
7/25
7/25
7/29
7/31

232,000,000.00
163,000,000.00
229,000,000.00
22,000,000.00
138,000,000.00
239,000,000.00
115,000,000.00
14,000,000.00
108,000,000.00
166,000,000.00
141,000,000.00

7/12/88
7/14/88
7/18/88
7/19/88
7/21/88
7/25/88
7/29/88
8/1/88
8/2/88
8/5/88
8/8/88

6.875%
6.875%
6.935%
7.056%
7.056%
7.051%
7.045%
7.072%
7.072%
7.338%
7.292%

7/12
7/12
7/12
7/15
7/22
7/25
7/26
7/26
7/29

3,965,092.84
75,589,495.78
39,870.53
4,175,369.02
490,997.76
83,404.00
2,066,804.90
788,431.84
220,030.50

9/1/13
8/25/14
9/12/90
8/25/14
9/11/95
8/25/14
9/8/95
9/21/95
8/25/14

9.170%
9.170%
8.403%
9.303%
9.137%
9.313%
9.086%
9.022%
9.377%

DATE

AGENCY DEBT
NATIONAL CREDIT UNION AOCNISTRAnON
Central Liauidity Facility
•Note #468

7/8

$

TENNESSEE VAT J FY AUTHORITY
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance

#915
#916
#917
#918
#919
#920
#921
#922
#923
#924
#925

7/4
7/8

GOVERNMENT - GUARAMIVH) THANS
DEPARTMENT OF DEFENSE
Foreian Military . ^ P - ?
Greece 16
Greece 17
Philippines 11
Greece 17
Portugal 2
Greece 17
Morocco 11
Morocco 12
Greece 17

•rollover

Page 3 of 4

FEDERAL FINANCING BANK
JULY 1988 ACTIVITY

BORROWER

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

7/1/93
8/1/88
10/3/88
8/1/88
8/31/04

8.475%
7.025%
7.118%
7.133%
9.254%

8.655% arm

347,000.00
337,000.00
718,000.00
61,000.00
2 427,000.00
3 ,146,000.00
6 ,642,000.00
302,000.00
650,000.00
1,255,000.00
19 ,000,000.00

12/31/16
12/31/16
7/5/90
12/31/17
7/11/90
1/2/90
1/2/90
12/31/16
12/31/16
9/30/90
12/31/22
10/1/90

8.929%
8.929%
8.110%
8.933%
8.375%
8.179%
8.179%
9.286%
9.286%
8.496%
9.273%
8.464%

8.832%
8.832%
8.029%
8.835%
8.289%
8.097%
8.097%
9.181%
9.181%
8.408%
9.168%
8.376%

683,645,362.76

10/31/88

7.367%

AMOUNT
OF ADVANCE

DATE

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
Community Development
•Niagara Falls, NY
Long Beach, CA
San Juan, PR
Los Angeles, CA
Rochester, NY

VI
7/20
7/22
7/26
7/29

$ 4,223,077.00
642,100.00
1,078,415.00
1,000,000.00
199,000.00

9.468% arm

RURAL ELECTRIFICATION ATimflSTRATION
•Wabash Valley Power #104
•Wabash Valley Power #206
•Wabash Valley Power #206
New Hampshire Elec. Coop. #270
•Wabash Valley Power #206
•Wolverine Power #182A
•Wolverine Power #183A
•Wabash Valley Power #104
•Wabash Valley Power #206
Sho-Me Power Corp. #324
Basin Elec. Power Coop. #232
•Cajun Electric Coop. #197A

7/5
7/5
7/5
7/5
7/11
7/11
7/11
7/14
7/14
7/15
7/18
7/18

7 681,000.00

TENNESSEE V*T.TFV ATmjnRTTY
Seven States Energy Corporation
Note A-88-10 7/29

•maturity extension

qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.

FEDERAL FINANCING BANK HOLDINGS
(in millions)
Julv 31. 1988
Proq£aro
Agency Debt:
$ 11,226.2
95.2
Export-Import Bank
17,054.0
NCUA-Central Liquidity Facility
5,592.2
Tennessee Valley Authority
33,967.6
U.S. Postal Service
sub-total*
59,674.0
Agency Assets:
79.3
96.4
Farmers Home Administration
-0DHHS-Health Maintenance Org.
4,071.2
16.1
DHHS-Medical Facilities
63,936.9
Overseas Private Investment Corp.
Rural Electrification Admin.-CBo
18,556.5
Small Business Administration
4,940.0
sub-total*
50.0
321.0
Government-Guaranteed Lending:
-0DOD-Foreign Military Sales
2,037.0
387.5
DEd.-Student Loan Marketing Assn.
32.6
DOE-Geothermal Loan Guarantees
26.6
949.4
DHUD-Community Dev. Block Grant
1,758.9
DHUD-New Communities
19,206.0
675.5
DHUD-Public Housing Notes +
879.6
General Services Administration +
1,986.1
48.5
DOI-Guam Power Authority
177.0
DOI-Virgin Islands
52,032.1
NASA-Space Communications Co. +
=======«=
DON-Shlp Lease Financing
$ 149,936.6
Rural Electrification Administration
•figures may
not total
due to Cos.
rounding
SBA-Small
Business
Investment
+does
not
include
capitalized
interest
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511
D0T-WMATA
sub-total*
grand total*

June 30. 1988
$

Net Ch anqe
771/88-7/31/88

33,864.9

-0-1.3
104.0
-0102.7

59,674.0
84.0
102.2
-04,071.2
16.4
63,947.8

-0-4.7
-5.9
-0-0-0.3
-10.9

18,539.2
4,940.0
50.0
329.7
-02,037.0
387.5
32.6
26.7
949.4
1,758.9
19,204.1
678.5
884.0
1,976.9
48.5
177.0

17.2
-0-0-8.8
-0-0-0-0-0.1
-0-01.9
-3.1
-4.5
9.2
-0-0-

11,226.2
96.5
16,950.0
5,592.2

$

52,020.2

11.9

asaxsssss

=========
$ 103.8

$ 149,832.9

TREASURY NEWS 1&

Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 12:00 NOON
March 3, 1989

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 $9,000
million of 364-day Treasury bills
to be dated
March 16, 1989,
and to mature March 15, 1990
(CUSIP No. 912794 TV 6 ) . This issue will result in a paydown for
the Treasury of about $ 200
million, as the maturing 52-week bill
is outstanding in the amount of $9,200
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 Standard time, Thursday, March 9, 1989.
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 March 16, 1989.
In addition to the
maturing 52-week bills, there are $14,963 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 $ 2,497 million as agents for foreign
and international monetary authorities, and $7,363 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 $ 330
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
NB-162
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
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.

TREASURY NEWS
Department of the Treasury • Washington,
D.c. • Telephone 566-2041
C O N T A C T : Office of Financing
202/376-4350
FOR IMMEDIATE RELEASE
March 6, 1989
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
Tenders for $7,211 million of 13-week bills and for $7,216 million
of 26-week bills, both to be issued on- March 9, 1989,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

Low
High
Average

13-•week bills
June 8, 1989
maturing
Discount Investment
Rate
Rate 1/
Price
8.65%
8.66%
8.65%

8.97%
8.98%
8.97%

:

97.813
97.811
97.813

:
:

26--week bills
maturing September 7, 1989
Discount Investment
Rate
Price
Rate 1/
8.64%
8.67%
8.66%

9.16%
9.19%
9.18%

95.632
95.617
95.622

Tenders at the high discount rate for the 13-week bills were allotted 5%.
Tenders at the high discount rate for the 26-week bills were allotted 18%.

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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
Received

Accepted

$
55,055
31,867,750
30,455
53,980
76,165
47,685
1,312,140
54,120
10,315
44,360
31,785
1,800,150
479,285

$

$35,863,245

$7,211,380

:

$24,128,450

$7,215,750

$31,846,640
1,423,485
$33,270,125

$3,194,775
1,423,485
$4,618,260

: $19,071,935
:
1,195,205
j $20,267,140

$2,159,235
1,195,205
$3,354,440

2,532,230

2,532,230

:

2,400,000

2,400,000

60,890

60,890

:

1,461,310

1,461,310

$35,863,245

$7,211,380

: $24,128,450

$7,215,750

55,055
6,194,560
30,455
53,505
55,165
47,485
57,140
33,620
10,315
44,360
31,785
118,650
479,285

: $
38,790
. 20,620,675
:
22,195
41,470
::
48,675
:
37,900
:
973,890
:
39,760
9,970
:
;
54,225
;
24,500
1,713,895
:
;
502,505

$
38,790
6,090,375
22,195
41,470
48,675
37,900
96,630
32,120
9,970
54,225
24,500
216,395
502,505

- An additional $9,510 thousand of 13-week bills and an additional $342,490
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield.
NB-163

TREASURY NEWS
•pertinent
Treasury • Washington, D.C. • Telephone 566-2041
Text of
as the
Prepared
Embargoed for Release Upon Deliverv
Expected at 10:30 a.m., E.S.T.
\ -r ,"

Testimony by
Secretary of the Treasury
Nicholas F. Brady
Before the
Committee on Appropriations
U.S. Senate
Tuesday, March 7, 1989

Chairman
Byrd,
Senator
Hatfield
and
members
of
the
Committee, I am pleased to be here today to discuss vith you
President Bush's proposed fiscal year 1990 budget.
I know that
you have already heard from the Director of the Office of
Management and Budget, Richard Darman, so in my testimony I vill
not repeat a detailed presentation of the Bush budget.
The approach to the budget I wish to take today is from the
perspective of overall economic policy, thus, Z vill discuss the
importance of deficit reduction to the continued vitality and
strength of our national economy and to maintaining and improving
our position in the vorld economy.
We are all aware that we continue to be in a period of
extraordinary economic expansion, which has produced millions of
jobs, while reducing inflation, we must equally be avare that to
sustain this expansion ve must reduce the deficit.
As you knov, last veek the Federal Reserve raised the
discount rate one half of a percent to seven percent.
I'd like
to say a fev vords about that.
First, and foremost, the Bush
Administration and the Federal Reserve share absolutely a firm
commitment
to fighting inflation.
It is possible to have
somevhat
differing
interpretations
of
the
same
economic
statistics, to think one set of statistics means more than
another, and still share the same goal of fighting inflation.
The Federal Reserve is using the strongest veapon in its
arsenal to fight inflation to advance the cause of the long-term
strength and vitality of our national economy.
The strongest
veapon ve in the government have to further the cause of our
long-term economic strength is deficit reduction. We must do our
part.
Even to delay action costs us —
in terms of interest
rates, jobs, the Savings and Loan crisis, the third vorld debt
problem.
Let us be frank vith one another. We are constrained
between revenue levels which are the result of the 1988 election

NB-164

2
vhich validated President's Bush's commitment to "No nev taxes'*
and a Gramm-Rudman-Hollings maximum deficit level of $100 billion
prescribed in lav.
so, there are not funds to do all that ve
want.
Stepping back from the roar of the budget discussions for a
minute, one could say, "This is where the country vants us to
operate." The key is to have the American people say, "They did
what ve vanted vith what ve gave them."
ECONOMIC ASSUMPTIONS
The Bush Administration is absolutely committad to working
vith you to reduce the deficit. But, some have questioned our
economic assumptions.
First, I vould like to point out that
historically the executive branch's economic assumptions have not
had a consistent bias toward a rosy scenario. In fact, in the
last seven years, the Reagan Administration underestimated
growth four times and overestimated it three.
For this year, ve believe that the economy vill continue to
grov, but at a slightly slover pace than last year's drought
adjusted rate. We are projecting that GNP vill grow 3.5 percent
next year. But vhen ve exclude the impact of the rebound from
the drought, our forecast is for a moderate 2.8 percent grovth
rate.
This is slover than last year's 3.4 percent drought
adjusted grovth rate. Our long term forecast for a 3.2 percent
sustainable grovth rate is right in line vith our experience over
the past 40 years, during vhich real GNP grovth averaged 3.3
percent.
As one vho vorked for over 30 years in financial markets,
may I make a few comments on interest rate assumptions. During
my first year in business, 1954, ten-year government bonds
carried an interest rate of 2.4 percent. They reached 14 percent
in 1981. These same ten-year government bonds were 12.4 percent
as recently as 1984, but declined to 7.7 percent in 1986. They
nov carry an interest rate of about 9.3 percent.
Attached as an exhibit to my testimony is a graph shoving
the decline in rates surrounding the passage of Gramm-RudmanHollings. From three and one-half months prior to the passage of
this all-important fiscal legislation until three and one-half
months after, interest rates declined 300 basis points. Was it
the only cause of this rapid decline in interest rates? No. Was
it a principal cause? Yes.
This would indicate to me that while there is plenty of
room for honest disagreement about the future level of interest
rates, there is some evidence that fiscal actions have an effect
on interest rates, particularly long-term rates. My conclusion
is that investors and savers all over the world are waiting for a

3
sign from our government that ve are committed to fiscal
prudence, and are villing to do something about it.
Delay in
reaching a budget agreement may only maintain the current high
level of interest rates and cost the U.S. and the vorld
unnecessary pain.
In sum, do I think our economic assumptions vill prove true
if ve don't reduce the deficit? No. will they prove accurate if
we do? I believe so.
I know that you have heard a great deal about the specific
proposals in our budget from Budget Director Darman.
I vould
simply like to reiterate the fundamental point that, vithin the
confines of meeting the Gramm-Rudman-Hol lings target, the
President has proposed budget priorities vhich if adopted vill
make a significant investment in our country's future.
THE SAVINGS AND LOAN SOLUTION
The President's budget contains the funding required to
resolve the Savings and Loan crisis. It has three components.
The first part consists of $50 billion to resolve currently
solvent institutions vhich may become insolvent over the next
several years. Secondly, the plan ensures adequate servicing of
the $40 billion in past FSLIC obligations.
And third, and perhaps most important, the plan provides $33
billion in financial resources necessary to put S&L deposit
insurance on a sound financial basis for the future.
At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC), for vhich the FDIC vill be the primary
manager directed to resolve all S&Ls vhich are nov insolvent or
become so over the next three years.
To provide the $50 billion to the RTC, ve vill create a nev,
separate, privately-owned corporation, the Resolution Funding
Corporation (REFCORP), vhich vill issue $50 billion in long-term
bonds to raise the needed funds. To pay the principal, industry
funds will be used to purchase zero-coupon, long-term Treasury
securities vhich vill grov through compound interest to a
maturity value of $50 billion. This assures the repayment of the
principal of the bonds issued by REFCORP.
Funds to purchase
these zero-coupon bonds vill come exclusively from private
sources:
The FHLBanks vill contribute about $2 billion of their
retained earnings — vhich are currently allocated to,
but not needed by, the existing Financing Corporation
(FICO) — plus approximately 20 percent of their annual
earnings, or $300 million, in 1989, 1990 and 1991;

4
The S&Ls vill contribute a portion of their insurance
premiums; and
If necessary, proceeds from the sale of FSLIC
receivership assets vill be used.
No Treasury funds or guarantees vill be used to repay any
REFCORP principal.
Interest payments on the REFCORP bonds vill come from a
combination of private and taxpayer sources:
The FHLBanks, beginning in 1992, will contribute $300
million a year;
The RTC will contribute a portion of the proceeds
generated from the sale of receivership assets, and
proceeds from warrants and equity participations taken
in resolutions; and
Treasury funds vill make up any shortfall.
All Treasury funds used to service REFCORP interest will be
scored for budget purposes in the year expended.
Funds for the second component of our plan — servicing the
cost of the $40 billion in resolutions already completed by FSLIC
— also vill come from a combination of S&L industry and taxpayer
sources:
FICO vill issue bonds under its remaining authority and
contribute the proceeds;
The S&Ls vill contribute a portion of their insurance
premiums;
FSLIC will contribute the proceeds realized from the
sale of receivership assets taken in already completed
resolutions, as well as miscellaneous income; and
Treasury funds will be used to make up any shortfall.
The final component of the plan is managing future S&L
insolvencies and building the Savings Association Insurance Fund
(SAIF), the new S&L insurance fund, during the post-RTC period.
The funding will come from a portion of S&Ls' insurance premiums
and Treasury funds as needed.
These sources provide about $3 billion per year to handle
any insolvencies which occur in the 1992-99 period and in
addition contribute at least $1 billion per year to building the
nev Savings Association Insurance Fund.
Overall the plan

5
contains $33 billion in post-RTC funds from 1992 to 1999 to
manage future insolvencies and contribute to building a healthy
nev S&L insurance fund. Assuming that $2 4 billion is used for
post-RTC resolutions, by 1999 the SAIF fund vill still contain
just under $9 billion at a minimum to support the healthy S&Ls.
The net impact of the entire plan — vhich includes paying
for completed S&L resolutions, paying for the S&L resolutions
still to be completed, and providing for fully funded insurance
funds for both commercial banks and thrifts — is $1.9 billion in
FY90 and $39.9 billion over the next 10 years.
CAPITAL GAINS
The President's .budget includes important revenue-related
measures that fall vithin the jurisdiction of the Treasury
Department.
These measures also directly reflect the
President's commitment to a budget that sustains a strong economy
and builds upon it to enhance our future economic pover.
We propose a major tax initiative designed to enhance
America's long-term grovth and competitiveness: a reduction and
restructuring of the capital gains tax to encourage long-term
investment.
Our proposal calls for a 45 percent exclusion of
long-term gains or a 15 percent tax rate cap, vhichever is more
advantageous to the taxpayer. As an important part of this plan,
ve have targeted the greatest relative benefits to those vith
incomes lover than $20,000, if married, and $10,000 if single.
Such taxpayers vould be eligible for a 100 percent exclusion—no
tax at all on long-term capital gains.
The policy of a lover tax rate for capital gains vas first
established in the Revenue Act of 1921. This policy remained in
effect for 65 years.
During this time it vas endorsed by
Democrats and Republicans alike as an important means of
stimulating investment.
The Tax Reform Act of 1986 eliminated
that differential in 1987. In my judgement, the benefits of a
lower capital gains tax merit its reinstatement. It is important
for the long-term strength of our economy that our tax lavs
encourage saving and investment in entrepreneurial activities.
I believe the essential benefit of a reduction in the capital
gains tax goes beyond simply encouraging short-term investment
and growth. Over the next four years, ve propose to phase in a
three-year holding period for capital assets sold to qualify for
the lover capital gains tax rates. Thus ve vant to shift the
focus of investors from the short-term to the long-term, because
ultimately, it is long-term investment vhich will provide our
economy with its fundamental strength.
Thus ve propose to
restore this long-acknowledged incentive to American enterprise.
Enhancing incentives for long-term investment is not the

6
only area in vhich ve need to act if the United States is going
to remain a leader in the vorld economy. It is equally important
that ve take steps to augment policies and programs vhich
stimulate research and development and vhich foster our long-term
productive capacity.
To this end, the President's budget increases investment in
basic research by increasing funding for science and technology
programs by 13 percent over the enacted 1989 funding levels.
Furthermore, ve propose to make the tax credit for research and
experimentation permanent. For a number of years, ve have had a
temporary tax credit to encourage additional research and
experimentation (R&E) by U.S. industry.
The current credit
expires at the end of 1989. It's time ve stopped sending stop
and go signals to the business community on the importance of
research to our economic strength.
Accordingly, the President has proposed to make this credit
a permanent feature of the landscape so that U.S. corporations
can make their R&E plans vith a longer horizon. With this same
purpose in mind, the President has also proposed a permanent and
more beneficial formula for the allocation of R&E expenses
between domestic and foreign income.
INTERNATIONAL CONTEXT
Improving our competitive position in the world economy is
very important to our future international economic position.
Reducing the deficit will not only improve our competitive
position, but is of vital importance to our overall international
economic standing. I vish to take a fev minutes to address the
international implications of our vork on the budget this year.
The nev reality is that there are no more international
boundaries vhen it comes to the flov of dollars—no border
control, no customs officials and no barriers. The influence of
foreign financial markets on our economy is great and deep. Most
of the world's dollar financial transactions settle daily through
New York.
Before the advent of instantaneous transfer of
information and electronic funds transfers this settling of
accounts would have taken weeks, now it occurs every night.
There are two "wires" through which the transactions settle. The
CHIPS vire which largely handles international transactions, and
the Fed vire which handles mostly, but not exclusively, domestic
transactions. Last month on average about $735 billion worth of
transactions were settled per day on the CHIPS wire.
And the
level of activity ?s increasing on average at a rate of 25
percent a year.
If you approximate the international
transactions settled via the Fed wire, then there are about $1
trillion of international transactions settled every day on these
vire systems. This amounts to $5 trillion a week, in other words
greater each week than our yearly GNP.

7
Another
statistic which demonstrates the pover of
international finance on our economy is that at the end of 1987
the recorded stock of U.S. assets held by foreigners vas almost
$400 billion greater than the stock of foreign assets held by
Americans. Ten years ago this difference vas $50 billion in our
favor.
While one can have different views of how to interpret
those numbers, one point is clear — ve cannot ignore the effect
of international markets on our balance of payments vhen
considering the need for deficit reduction.
Both the flov of financial transactions through the Fed vire
and CHIPS and the amount of U.S. assets held by foreigners are
in a sense a measure of foreign confidence in our ability to
maintain a sound economy and reduce our budget deficit.
The
tally of the vorld's opinion of our progress is registered every
day through the Federal Reserve's vires.
It is vital that ve
act decisively to preserve that confidence.
Lest there be any doubt about the extent of the vorld's
interest and concern about the deficit, let me share vith you
some of the feelings of my G-7 colleagues — vho met here in
Washington, DC the first veek in February. we are engaged in a
team effort, the economic policy coordination process, to provide
a growing world economy. I have been pressing them to stimulate
their domestic economies and open their markets to sustain vorld
economic grovth. They, in turn, are deeply concerned about our
ability to reduce the deficit.
They worry that ve lack the
strength of purpose to meet the Gramm-Rudman-Hollings target.
They are knowledgeable about the details of our budget process
and are vatching very carefully hov ve handle our budget
negotiations. They are concerned that our commitment to abiding
by the current Gramm-Rudman targets is less than firm and
unequivocal, that if meeting the $100 billion target becomes too
onerous that ve vill move the goal line.
I assured them on
behalf of us all that people in this government—executive and
legislative branches alike—are firmly and absolutely committed
to meeting the deficit reduction targets I have told them that
ve will get there one vay or the other.
I know you share this commitment. I am delighted to be here
today to discuss with you how ve can achieve this common goal.

INTEREST RATES, SEPTEMBER 1985 TO APRIL 1986
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TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
Contact: Peter Hollenbach
(202) 376-4302

FOR RELEASE AT 3:00 PM
March 6, 1989

TREASURY ANNOUNCES ACTIVITY IN
SECURITIES IN THE STRIPS PROGRAM FOR FEBRUARY 1989
The Department of the Treasury announced activity figures for the
month of February, 1989 of securities within the Separate Trading
of Registered Interest and Principal of Securities program,
(STRIPS). The principal outstanding for eligible securities was
$326,960,184,000 with $250,378,914,000 held in unstripped form
and $76,581,270,000 held in stripped form. The amount
reconstituted through February was $18,928,840,000. The attached
table gives a breakdown of STRIPS activity by individual loan
description.
These monthly figures are included in Table VI of the Monthly
Statement of the Public Debt, entitled "Holdings of Treasury
Securities in Stripped Form." These can also be obtained through
a recorded message on (202) 447-9873.
oOo

NB-165

TABLE VI—HOLDINGS OF TREASURY SECURITIES IN STRIPPED FORM, FEBRUARY 28, 1989
(In thousands)

24

Frmcipal Amount Outstanding
Maturity Date

Loan Description

Total

Portion Held in
Unstripped Form'

Portion Held in
Stripped Form '•

Gross Amount
Reconstituted to
Date

S6.658.554

S5.576.954

SI. 081.600

.2/15/95

6.933.861

6.234.821

699.040

948.960

11-1/4% Note B-1995 .

5/15/95

7.127.086

5.434.926

1.692.160

l 124.000

10-1/2% Note C-1995 . .

8/15/95

7.955.901

7.005,101

950.800

628.000

11/15/95.

7.318.550

6.794.550

524,000

913.600

297.600

11/15/94

11-5/8% Note C-1994
11-1/4% Note A-1995

9-1/2% Note 0-1995

8.410.929

8,113.329

20.085.643

19.919.243

166.400 I

20.258.810

19.966.810

292.000

9,921.237

9.776.037

145.200

8/15/97

9.362.836

9.362.836

8-7/8% Note A-1996

...2/15/96

7-3/8% NoteC-1996

5/15/96
11/15/96

7-1/4% Note 0-1996
8-1/2% Note A-1997

..

!

8-5/8% Note B-1997

...5/15/97

. ...

-o- !

S2.334.400

88.000
177.600
86.400

-0-0-

11/15/97.. . .

9.808.329

9,792.329

16.000

73,600

8-1/8% Note A-1998

'

2/15/98

9.159.068

9.159.068

-0-

-0-

9 % Note B-1998

I

5/15/98

9.165.387

9.165.387

-0-

-0-

8/15/98

11,342.646

11.342.646

-0-

-0-

9,902.875

9.902.875

-0-

-0-

9.719.800

9,719,800

-0-

8.301.806

2,716,206

5.585.600

8-7/8% Note C-1997

9-1/4% Note C-1998
8-7/8% Note 0-1998
8-7/8% Note A-1999
11-5/8% Bond 2004

. .11/15/98
2/15/99
. ...11/15/04.

.

-01.167.200

1 2 % Bond 2005

5/15/05

4.260.758

1.725.608

2.535.150

129.400

10-3/4% Bond 2005

8/15/05

9.269.713

6.379.313

2.890.400

1.017.600

4,755.916

4.755,916

6,005,584

1,415,984

4.589.600

1.222.400

12.667,799

2,729.719

9.938.080

425.440

7,149,916

1,946.716

5.203.200

429.760
345.600

9-3/8% Bond 2006
11-3/4% Bond 2009-14

.. .2/15/06
11/15/14.

11-1/4% Bond 2015

2/15/15

10-5/8% Bond 2015

. 8/15/15

..

..

-0-

-0-

9-7/8% Bond 2015

11/15/15

6.899.859

3.258.259

3.641.600

9-1/4% Bond 2016

2/15/16

7,266.854

5.139.654

2.127,200

594.400

7-1/4% Bond 2016

5/15/16

18.823.551

13.369,951

5.453.600

2.756.800

7-1/2% Bond 2016

11/15/16

18.864,448

10.118.368

8.746.080

2.756.640

8-3/4% Bond 2017

5/15/17

18,194.169

8,417,209

9.776,960

1.068.640

8-7/8% Bond 2017

8/15/17

14.016.858

9.580.058

4,436.800

169.600

9-1/8% Bond 2018

5/15/18

8,708.639

5.763.839

2.944.800

410,400

9 % Bond 2018

11/15/18

9.032.870

6,307.070

2.725.800

60,400

8-7/8% Bond 2019

2/15/19

9.609.932

9.488.332

121.600

326.960.184

250.378.914

76,581.270

Total

-018,928.840

'Effective M a y 1, 1987, securities held in stripped form were eligible for reconstitution to their unstripped form. The amounts in this column represent the net affect of stripping and
reconstituting securities.
Note: On the 4th workday of each month a recording of Table VI will be available after 3:00 pm. The telephone number is (202) 447-9873.
The balances in this table are subject to audit and subsequent adjustments.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
r

tier
FOR RELEASE AT 4:00 P.M.
March 7, 19 89

k> ,.

' (XBThCT: Office of Financing
202/376-4350

a

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,400 million, to be issued March 16. 1989.
This offering
will result in a paydown for the Treasury of about $ 575 million, as
the maturing bills are outstanding in the amount of $14,963 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 Standard time, Monday, March 13, 1989.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
December 15, 1988, and to mature
June 15, 1989
(CUSIP No.
912794 SE 5), currently outstanding in the amount of $7,804 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,200 million, to be dated
March 16, 1989,
and to mature September 14, 1989 (CUSIP No.
912794 SX 3).
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 March 16, 1989.
In addition to the maturing
13-week and 26-week bills, there are $9,200 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 $1,921 million of the original 13-week and 26-week
issues. Federal Reserve Banks currently hold $2,251 million as
agents for foreign and international monetary authorities, and $7,363
million for their own account. These amounts represent the combined
holdings of such accounts for the three issues of maturing bills.
NB-166
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
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
10/87
the Public Debt.

TREASURY NEWSl
Department of the Treasury • Washington, D.c. • Telephone 566-2041
' •« •*» nirj

^M 5310

Text as Prepared

Remarks by Thomas J. Berger
Deputy Assistant Secretary of the U.S. Treasury
for
International Monetary Affairs
before
The Conference on the Future
of
Canadian and U.S. Financial Services
in the Global Context
The Centre for Canadian-American Studies
University of Windsor
Windsor, Ontario
March 1, 1989
In Search of Free Trade in Financial Services:
Reflections on the U.S. - Canada Experience
Good afternoon. I am delighted to be here today to discuss
the topic of free trade in financial services and to s hare with
you my reflections on the Financial Services Chapter o f the
U.S.-Canada Free Trade Agreement (FTA). My colleagues and I at
the U.S. Treasury spent over a year negotiating this b ilateral
financial services agreement with our counterparts in the Canadian
Government. Like any endeavor in which one invests su bstantial
time, there are certain lessons learned as a result of the
process. Perhaps the key lesson I took away from the negotiations
was the importance of teamwork. Although I headed the U.S.
negotiating group, every member of my team brought an unique and
in-depth knowledge base about a different sector of th e financial
markets. This "diversity of excellence" and our abili ty to work
together and use this knowledge to our advantage was c rucial to
our success. That being said, I must confess that the re were
times when I felt indispensable and uniquely contribut ory to the
process. Whenever this happened, however, I was quick ly and
politely reminded
by my U.S.
of the followi
ng words
"The graveyards
are colleagues
full of indispensable
men."
uttered by Charles de Gaulle:

NB-16J:

- 2 -

What I would like to do this afternoon is to share with you
some of the other lessons of the U.S.-Canada talks and to comment
on their implications for future negotiations in the financial
services sector. Putting aside the lesson on indispensability
just described, there were three general lessons learned from the
U.S.-Canada financial services negotiations. The first was how to
conduct a negotiation in the highly technical area of financial
services. Put in another way, what are the critical elements that
will allow for a successful and smooth negotiating process?
Secondly, although the FTA was a bilateral agreement, there
definitely were some lessons learned about what might be realistic
to expect in wider, multilateral negotiations on financial
services. Finally, the third lesson has to do with the financial
services industry itself — how it has changed and what this means
for future bilateral or multilateral financial market
negotiations. Let me deal with each of these in turn.
Lesson #1: Negotiating Financial Services Is More Art than
Science^
Certain critical factors allowed the U.S. and Canada to reach
a mutually satisfactory financial services agreement. Future
negotiations about financial market issues will stand a greater
chance of success, in my opinion, if they follow these principles:
(a) Low profile.
— Herb Schmertz of Mobil Corporation wrote a book in
1986 entitled, Good-bye to the Low Profile. While
this may be the correct recipe for trade negotiations,
given the sensitivity of financial markets to changes
affecting them, financial services negotiations need
to be conducted with due regard to confidentiality.
— During the U.S.-Canada process we did not hold press
conferences nor did we negotiate through the press.
This is how it should be done instead of more publicly
as is often the case in trade negotiations.
(b) Dispute settlement mechanisms must be flexible.
— Financial services are different from other services
because of various prudential, regulatory and
supervisory concerns.
— This was implicitly recognized at the Mid-Term
Review of the Uruguay Round in Montreal last December
where language was inserted into the draft services
framework agreement making it possible for discussions
in some sectors to proceed outside the framework
agreement. It was agreed that the framework might
not be suitable for all sectors.

- 3 -

—

In the U.S.-Canada case, the Financial Services
Chapter of the FTA was not covered by the formal
dispute settlement mechanism of the overall Agreement.
Instead, both countries agreed to a more flexible,
consultative process between the Canadian Department
of Finance and the U.S. Treasury should problems
ar ise.
— This type of mechanism should provide the confidentiality, flexibility and regulatory input necessary to
arrive at fair dispute settlements. The lesson for
future financial services negotiations is that heavy,
mechanistic dispute settlement procedures overseen by
non-experts are not appropriate and are hazardous to
the health of financial markets.
Don't get bogged down over definitions and semantics.
— During the FTA talks both sides wanted to liberalize
their financial markets, but despite these good
intentions there were difficulties.
— For example, even though the U.S.-Canada talks only
involved two parties — both of whom adhere to a
variety of OECD codes — we could not agree on a
mutually acceptable definition of national treatment.
— Rather than allowing ourselves to become bogged down
over definitions, we "agreed to disagree." Instead of
further debates, we worked around the issue to fashion
an agreement fair to both sides. And, even though the
agreement never defined national treatment, it
respected the spirit embodied in the concept of
equality of competitive opportunity.
— Francis Bacon described this important principle of
successful negotiations as follows:
" All rising to a great place is by a winding
stair."
Financial not trade experts must do the negotiating.
— Given the complexity and range of financial issues
covered in the FTA, the negotiations would have been
doomed if they had not been conducted by financial
experts who understood the nuts and bolts involved.
— Despite similarities in the U.S. and Canadian
financial markets, the regulatory, supervisory and
prudential differences between our two systems remain
considerable. Financial Ministries and regulators
from different countries often have honest differences

- 4 -

in their approach to problems. This means that
negotiators must respect and work within these basic
differences. Experienced financial market hands
understand and are sensitive to these differences as
well as to discriminatory practices. Hence, they are
more likely to be able to conclude a meaningful
agreement that will remove barriers.
— In addition, because the banking and financial markets
play such an important role in the conduct of monetary
and macroeconomic policy, it's just common sense that
financial market negotiations be conducted directly by
people who have responsibility for these policies.
Lesson #2: Bilateral and Multilateral Negotiations Have More
Differences than Similarities.
No decisions have been reached at this point regarding
which service sectors will be included in the Uruguay Round. If
financial services are included, the negotiations are likely to be
very different in character from those in the FTA. Some of the
key differences that I see are as follows:
(a) Bilateral discussions allow for a sharper focus on
specific issues.
— In a multilateral setting it will be much more
difficult to address the specific, bilateral problems
such as those we dealt with in the FTA. It may be
that success in negotiating financial services in a
multilateral context will be defined as achieving
agreement with respect to only general principles.
(b) Bilateral problems will be magnified and made more
complex in multilateral talks.
— Given U.S. and Canadian inability to reach an
agreement on the definition of national treatment —
even with similar legal, supervisory and regulatory
systems — progress in a multilateral forum is likely
to be even harder.
— With the greater complexity of multilateral negotiations, two aspects of Lesson #1 become even more
important: the need for financial experts to do the
negotiating and the requirement for a dispute
settlement mechanism that is extremely flexible.
— However, there is a silver lining to increased
complexity; it could lay to rest once and for all the
emotional and simplistic appeal of the concept of
reciprocity in financial services. As you are
probably aware, the Commission of the European

- 5 -

Communities has proposed using reciprocity as a
standard for granting third countries access to newly
liberalized sectors in Europe in those areas not
covered by the GATT.
— If we enter into multilateral negotiations on
financial services, the variety of financial
environments around the world and the scale of our
presence in each others' markets should make clear to
all the impossibility of providing reciprocal
treatment for foreign firms without creating huge
regulatory bureaucracies and markets with limited
flexibility.
Lesson #3: Changes That Have Taken Place in the Financial
Services Industry Will Make Future Negotiations Easier.
Prior to joining the Treasury Department in 1986 I spent
a number of years in New York with both Citibank and Merrill
Lynch. During this time the key buzzword in financial circles
was "globalization." Every self-respecting bank wanted to be a
worldwide, full-service "superbank." Securities firms felt the
same way. The name of the game was to be all things to all
customers.
This type of talk, of course, does not facilitate financial
services negotiations. Countries that may be considering
liberalizing their markets view such chatter as concrete evidence
that expansion-hungry financial institutions from, say, the U.S.
or Japan, will come in willy-nilly and swallow the local banks and
securities firms. And, I would be less than frank with you if I
didn't say that there were some concerns of this type in Canada
during the course of the FTA negotiations.
However, in recent years both commercial bankers and
investment bankers have become more realistic and hard-headed.
Most have given up the quest to have a branch in every country
or to dominate every market. Many overseas operations have
not been as profitable as hoped and, of course, Black Monday,
October 19, 1987, brought a new sense of realism to all financial
institutions. In today's environment, the new buzzphrase is
"niche player." Banks and securities firms are more concerned
about doing what they do best rather than expanding for the sake
of expansion.
This new trend should be helpful in promoting financial
liberalization. It should allay the fears of those countries
who envision tidal waves of foreign investment in the financial
services industry the minute a market-opening move is made.

- 6 -

Conclusion
In conclusion, I would like to offer two quotes by one of the
world's most successful, practical and realistic negotiators,
Niccolo Machiavelli (1469-1527). "Old Nick" as he was called by
some issued a warning in his classic book, The Prince, to those
offering advice or holding forth on the lessons of history. He
put it this way:
"Tender your advice with modesty."
I hope that my comments today on the lessons learned from the
U.S.-Canada negotiations have been in harmony with Machiavelli's
wise observation.
Machiavelli also counseled in The Prince that those who seek
to be useful to others follow the following principle:
"Represent things as they are in real truth rather
than as they are imagined."
Again, I hope my remarks this afternoon have been faithful to this
important principle.
Thank you very much for your attention.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
r |"-i CONTACT•: tOf f ice of Financing
202/376-4350

FOR IMMEDIATE RELEASE
March 9, 1989
RESULTS OF TREASURY'S 52-WEEK BILL~ AUCTION
DEr.£R7H»:K-

Tenders for $9,007 million of 52-week bills to be issued
were accepted
March 16, 1989,
and to mature
March 15, 1990,
today. The details are as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS:
Discount
Investment Rate
Rate
(Equivalent Coupon-Issue Yield) Price
Low
8.66%
9.40%
91.244
High
8.68%
9.43%
91.224
Average 8.68%
9.43%
91.224
Tenders at the high discount rate were allotted 86%.
TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
Boston
$
32,430
New York
22,879,325
Philadelphia
20,905
Cleveland
43,915
Richmond
58,645
Atlanta
39,840
1,152,350
Chicago
St. Louis
40,470
21,240
Minneapolis
Kansas City
79,660
32,880
Dallas
1,767,185
San Francisco
250,985
Treasury
$26,419,830
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

NB-168

Accepted
$
32,430
8,116,800
20,905
43,915
58,645
37,700
114,790
33,330
21,240
72,160
27,180
177,185
250,985
$9,007,265

$22,332,710
1,057,120
$23,389,830
2,800,000

$4,920,145
1,057,120
$5,977,265
2,800,000

230,000
$26,419,830

230,000
$9,007,265

TREASURY NEWS
Department
of the Treasury • Washington, D.c. • Telephone 566-2041
EMBARGOED UNTIL DELIVERY
clO

Expected at 1:45 p.m. EST
Friday, March 10, 1989
rp •

Remarks by
The Secretary of the Treasury
Nicholas F. Brady
to the
Brookings Institution and
The Bretton Woods Committee
Conference On Third World Debt
More than 40 years ago, the representatives of 44 nations
met at Bretton Woods, New Hampshire to build a new international
economic and financial system. The lessons learned from a
devastating world depression and global conflict guided their
efforts. At the concluding session, the President of the
conference, Treasury Secretary Henry Morgenthau, described this
lesson in the following manner:
We have come to recognize that the wisest and most effective
way to protect our national interests is through international
cooperation — this is to say, through united effort for the
attainment of common goals. This has been the great lesson
of contemporary life — that the peoples of the earth are
inseparably linked to one another by a deep, underlying
community of purpose.
The enduring legacy provided by the Bretton Woods institutions
is lasting testament to the success of their efforts. This
community of purpose still resides in these institutions today.
We must once again draw on this special sense of purpose as we
renew our efforts to create and foster world growth.
These past seven years we have faced a major challenge in the
international debt problem. This situation is, in fact, a complex
accumulation of a myriad of interwoven problems. It contains
economic, political and social elements. Taken together, they
represent a truly international problem, for which no one set of
actions or circumstances is responsible. And for which no one
nation can provide the solution. Ultimately, resolution depends
on a great cooperative effort by the international community. It
requires the mobilization of the world's resources and the
dedication of its goodwill.
NB-169

- 2 -

Since 1982 the world community has endeavored to come to
terms with international debt. In 1985 we paused and took stock
of. our progress in addressing the problem.
As a result of that
review, together we brought forth a new strategy, centered on
economic growth. This still makes sense. However, it is
appropriate that now, almost four years later, we again take
stock. Thus in recent months we have undertaken to look afresh
at the international debt situation. The purpose was to discover
what progress has been made: to see where we as a community of
nations have succeeded and where we have not. And, where our
success has not met our expectations, to understand why we have
not achieved our goals. We have studied in depth, we have
consulted widely — seeking and taking into account the views of
debtor nations, multilateral institutions, commercial banks and
legislatures. We have also consulted closely with Japan and
other industrial countries in order to begin to lay the basis for
a common approach to the debt problem by the creditor countries.
Let me share with you the results of our reassessment as
part of the ongoing process of international collaboration. I
would hope that the ideas and suggestions I put forth here will
provide a basis for a concerted effort by the international
community to reinvigorate a process that has become debt-weary.
However, we must strengthen the process without stopping it. As
we move ahead with these ideas in the weeks ahead, it is important
to continue working on individual debt problems.
Recent Progress
Our review confirmed that we have accomplished much, but
much remains to be done.
The experience of the past four years demonstrates that the
fundamental principles of the current strategy remain sound:
o Growth is essential to the resolution of debt
problems;
o Debtor nations will not achieve sufficient
levels of growth without reform;
o Debtor nations have a continuing need for
external resources;
o Solutions must be undertaken on a case-by-case basis.
In recent years, we have seen positive growth occur in many
debtor nations. Last year six major debtor nations realized more
than four percent positive growth. This is primarily due to the
debtors' own efforts. The political leadership of many of these

- 3 -

nations has demonstrated their commitment to implement vital
macroeconomic and structural reforms. In many countries this has
been reflected in the privatization of nationalized industries.
In some countries there has also been a move towards opening
their shores to greater foreign trade and investment. Current
account deficits have been sharply reduced, and the portion of
export earnings going to pay interest on external debt has
declined. These are significant achievements. All the more so,
since in parallel progress, a number of debtor nations have
advanced towards more democratic regimes. This has required
great courage and persistence. The people of these countries
have made substantial sacrifices for which they've earned our
admiration. We must work together to transform these sacrifices
into tangible and lasting benefits.
In another positive development, we have avoided a major
disruption to the global payments system. Commercial banks have
strengthened their capital and built reserves, placing them in a
stronger position to contribute to a more rapid resolution of
debt problems. The "menu" approach of the current strategy has
helped to sustain new financial support while also encouraging
debt reduction efforts. The banks have provided loans in support
of debtor country economic programs. The stock of debt in the
major debtor countries has been reduced by some $24 billion in
the past two years through various voluntary debt reduction
techniques.
However, despite the accomplishments to date, we must
acknowledge that serious problems and impediments to a successful
resolution of the debt crisis remain. Clearly, in many of the
major debtor nations, growth has not been sufficient. Nor has
the level of economic policy reform been adequate. Capital
flight has drained resources from debtor nations' economies.
Meanwhile, neither investment nor domestic savings has shown much
improvement. In many cases, inflation has not been brought under
control. Commercial bank lending has not always been timely.
The force of these circumstances has overshadowed the progress
achieved. Despite progress, prosperity remains, but for many,
out of reach.
Other pressures also exist. The multilateral institutions
and the Paris Club have made up a portion of the shortfall in
finance. Commercial bank exposure to the major debtors since
1985 has declined slightly, while the exposure of the international
institutions has increased sharply. If this trend were to
continue, it could lead to a situation in which the debt problem
would be transferred largely to the international institutions,
weakening their financial position.

- 4 -

These are realities that we cannot deny. They are problems
we must address if we are to renew progress on the international
debt crisis.
Let me reiterate that we believe that the fundamental
principles of the current strategy remain valid. However, we
believe that the time has come for all members of the international
community to consider new ways that they may contribute to the
common effort.
In considering next steps, a few key points should be kept
in mind:
o First, obviously financial resources are scarce. Can
they be used more effectively?
o Second, we must recognize that reversing capital flight
offers a major opportunity, since in many cases flight
capital is larger than outstanding debt.
o Third, there is no substitute for sound policies.
o Fourth, we must maintain the important role of the
international financial institutions and preserve their
financial integrity.
o Fifth, we should encourage debt and debt service
reduction on a voluntary basis, while recognizing the
importance of continued new lending. This should
provide an important step back to the free markets,
where funds abound and transactions are enacted in
days not months.
o Finally, we must draw together these elements to provide
debtor countries with greater hope for the future.
Strengthening the Current Strategy
Any new approach must continue to emphasize the importance
of stronger growth in debtor nations, as well as the need for
debtor reforms and adequate financial support to achieve that
growth. We will have success only if our efforts are truly
cooperative. And, to succeed we must have the commitment and
involvement of all parties.
First and foremost, debtor nations must focus particular
attention on the adoption of policies which can better encourage
new investment flows, strengthen domestic savings, and promote
the return of flight capital. This requires sound growth policies

- 5 -

which foster confidence in both domestic and foreign investors.
These are essential ingredients for reducing the future stock of
debt and sustaining strong growth. Specific policy measures in
these areas should be part of any new IMF and World Bank programs.
It is worth noting that total capital flight for most major
debtors is roughly comparable to their total debt.
Second, the creditor community — the commercial banks,
international financial institutions, and creditor governments —
should provide more effective and timely financial support. A
number of steps are needed in this area.
Commercial banks need to work with debtor nations to provide
a broader range of alternatives for financial support, including
greater efforts to achieve both debt and debt service reduction
and to provide new lending. The approach to this problem must be
realistic. The path towards greater creditworthiness and a
return to the markets for many debtor countries needs to involve
debt reduction. Diversified forms of financial support need to
flourish'and constraints should be relaxed. To be specific, the
sharing and negative pledge clauses included in existing loan
agreements are a substantial barrier to debt reduction. In
addition, the banking community's interests have become more
diverse in recent years. This needs to be recognized by both
banks and debtors to take advantage of various preferences.
A key element of this approach, therefore, would be the
negotiation of a general waiver of the sharing and negative
pledge clauses for each performing debtor, to permit an orderly
process whereby banks which wish to do so, negotiate debt or debt
service reduction transactions. Such waivers might have a three
year life, to stimulate activity within a short but measurable
timeframe.
We expect these waivers to accelerate sharply the
pace of debt reduction and pass the benefits directly to the
debtor nations. We would expect debtor nations also to maintain
viable debt/equity swap programs for the duration of this endeavor,
and would encourage them to permit domestic nationals to engage
in such transactions.
Of course, banks will remain interested in providing new
money, especially if creditworthiness improves over the three
year period. They should be encouraged to do so, for new
financing will still be required. In this connection,
consideration could be given in some cases to ways of
differentiating new from old debt.
The international financial institutions will need to continue
to play central roles. The heart of their effort would be to
promote sound policies in the debtor countries through advice
and financial support. With steady performance under IMF and

- 6 -

World Bank programs, these institutions can catalyze new financing.
In addition, to support and encourage debtor and commercial bank
efforts to reduce debt and debt service burdens, the IMF and
World Bank could provide funding, as part of their policy-based
lending programs, for debt or debt service reduction purposes.
This financial support would be available to countries which
elect to undertake a debt reduction program. A portion of their
policy based loans could be used to finance specific debt reduction
plans. These funds could support collateralized debt for bond
exchanges involving a significant discount on outstanding debt.
They could also be used to replenish reserves following a cash
buyback.
Moreover, both institutions could offer new, additional
financial support to collateralize a portion of interest payments
for debt or debt service reduction transactions. By offering
direct financial support for debt and debt service operations,
the IMF and the World Bank could provide new incentives, which
would act simultaneously to strengthen prospects for greater
creditworthiness and to restore voluntary private financing in
the future. This could lead to considerable improvements in the
cash flow positions of the debtor countries.
While the IMF and World Bank will want to set guidelines on
how their funds are used, the negotiation of transactions will
remain in the market place — encouraged and supported but not
managed by the international institutions.
It will be important that the Fund and the Bank both be in a
strong financial position to fulfill effectively their roles in
the strengthened strategy. The Bretton Woods Committee has
provided an important public service in mobilizing capital
resources for these institutions. The capital of the World Bank
has recently been replenished with the implementation of the
recent general capital increase providing approximately $75
billion in new resources to the Bank. With respect to the Fund,
the implementation of these new efforts to strengthen the debt
strategy could help lay the basis for an increase in IMF quotas.
There are, of course, other important issues that have to be
addressed in the quota review, including the IMF arrears problem
and a need for clear vision of the IMF's role in the 1990's. It
is our hope that a consensus can be reached on the quota question
before the end of the year.
Creditor governments should continue to reschedule or
restructure their own exposure through the Paris Club, and to
maintain export credit cover for countries with sound reform
programs. In addition, creditor countries which are in a position
to provide additional financing in support of this effort may
wish to consider doing so. This could contribute significantly

- 7 -

to the overall success of this effort. We believe that creditor
governments should also consider how to reduce regulatory,
accounting, or tax impediments to debt reduction, where these
exist.
The third key element of our thinking involves more timely and
flexible financial support. The current manner in which "financial
gaps" are estimated and filled is cumbersome and rigid. We
should seek to change this mentality and make the process work
better. At the same time, we must maintain the close association
between economic performance and external financial support.
While we believe the IMF should continue to estimate debtor
financing needs, we question whether the international financial
institutions should delay their initial disbursements until firm,
detailed commitments have been provided by all other creditors to
fill the financing "gap." In many instances, this has served to
provide a false sense of security rather than meaningful financial
support. The banks will themselves need to provide diverse,
active, and timely support in order to facilitate servicing of the
commercial debt remaining after debt reduction. Debtor nations
should set goals for both new investment and the repatriation of
flight capital, and to adopt policy measures designed to achieve
those targets. Debtor nations and commercial banks should
determine through negotiations the portion of financing needs to
be met via concerted or voluntary lending, and the contribution
to be made by voluntary debt or debt service reduction.
Finally, sound policies and open, growing markets within the
industrial nations will continue to be an essential foundation
for efforts to make progress on the debt problem.
We cannot
reasonably expect the debtor nations to increase their exports
and strengthen their economies without access to industrial
country markets. The Uruguay Round of trade negotiations provides
an important opportunity to advance an open trading system. We
must all strive to make this a success.
Conclusion
Taken together, the ideas I have discussed today represent a
basis on which we can work to revitalize the current debt
strategy. We believe that through our efforts we can provide
substantial benefits for debtor nations in the form of more
manageable debt service obligations, smaller and more realistic
financing needs, stronger economic growth, and higher standards
of living for their people.

- 8 -

If we work, together, we can make important progress towards
our key objectives:
o to assure that benefits are available to any debtor
nation which demonstrates a commitment to sound policies;
o to minimize the cost or contingent shift in risk to
creditor governments and taxpayers;
o to provide maximum opportunities for voluntary, marketbased transactions rather than mandatory centralization
of debt restructurings;
o and to better tap the potential for alternative sources
of private capital.
In the final analysis, our objective is to rekindle the hope
of the people and leaders of debtor nations that their sacrifices
will lead to greater prosperity in the present and the prospect
of a future unclouded by the burden of debt.

FINANCIAL INSTITUTIONS REFORM,
RECOVERY AND ENFORCEMENT ACT
OF 1989
SECTION-BY-SECTION ANALYSIS

Section 101.

PURPOSES.

of this Act are:

Section 101 provides that the purposes

to promote a safe and stable system of

affordable housing finance through regulatory reform; to improve
supervision by strengthening capital, accounting, and other
supervisory standards; to establish a relationship by the
Treasury Department over the Federal Home Loan Bank System
similar to that of the Office of the Comptroller of the Currency;
to establish an independent insurance agency to provide deposit
insurance for savers; to put the federal deposit insurance system
on a sound financial basis for the future; to create a new
corporation to contain, manage and resolve failed thrift
institutions; to provide the necessary private and public
financing to resolve failed institutions in an expeditious
manner; to provide for improved supervision and enhanced
enforcement powers; to increase criminal and civil money
penalties for crimes of fraud against financial institutions and

- 2 -

depositors; and for other purposes.

TITLE II - FEDERAL DEPOSIT INSURANCE CORPORATION AUTHORITIES AND
RESPONSIBILITIES.

Section 201. FINANCIAL INSTITUTIONS. Section 201 generally
replaces "bank" with "financial institution"—a term that
includes both banks and savings associations (thrifts)—
throughout the Federal Deposit Insurance Act (FDI Act). It also
replaces "Federal Home Loan Bank Board" with "Chairman of the,.
Federal Home Loan Bank System" (FHLBS).

Section 202. DUTIES OF THE FEDERAL DEPOSIT INSURANCE
CORPORATION.

Section 202 authorizes the FDIC to insure savings

associations in addition to banks.

Section 203. FDIC BOARD MEMBERS. Section 203 increases the
membership of the FDIC's Board of Directors from three members to
five.

The Comptroller of the Currency and the Chairman of FHLBS

are ex officio members.

The other three are appointive members,

no more than two of which may be from the same political party.
As under current law, the appointive members have fixed six-year
terms.

The President may designate one appointive member as the

Chairman and one as the Vice Chairman of the FDIC.

Under current

law, Board members may not serve as officer or director of any
insured bank or of a Federal Reserve bank, and
stock in any insured bank.

may not hold

Section 203 provides that, in

- 3 -

addition, Board members may not serve as directors or

officers

of any insured thrifts or of any Federal Home Loan bank,

and may

not invest in any insured thrift, or in any bank holding company
or savings and

loan holding company.

The Board members serving

on the date of enactment are to complete their terms of office,
and the Chairman is to continue to serve as Chairman until his
successor has been appointed and qualified.

Section 204. DEFINITIONS. Section 204 amends some of the
existing definitions in Section 3 of the FDI Act, and also
provides several new definitions.

The term "insured bank" is retained.

Section 3(j) of the FDI Act, which defines "receiver", is .
clarified to provide that "conserving assets" is one of the
functions of a "receiver", and includes "savings associations"
among the institutions for which a receiver may act.

Section 3(1), which defines "deposit", is amended to include
obligations of savings associations, and to specify that foreign
currencies and obligations expressed in foreign currencies, do
not qualify as "deposits."

The Chairman of the FHLBS is added to

the list of bank regulators with which the FDIC Board must
consult in any decision on whether to treat other obligations as
deposits.

- 4 -

Section 3(m), which defines "insured deposit", is amended to
accommodate deposits held by thrifts and makes allowance for any
differences that might currently exist between an "insured
deposit" under the FDI Act and an "insured account" under the
National Housing Act.

Section 204 specifies that any liability

that was an "insured account" under the FSLIC's rules, but that
would not otherwise qualify as an FDIC-insured deposit, will
continue to be insured for six months after the effective date of
the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 (FIRRE Act), or (in the case -of a fixed-maturity time
deposit)

until its earliest maturity date occurring after the

expiration of six months from enactment of the amendments.

Section 3(q), which defines the term "appropriate Federal banking
-agency", adds the Chairman of the FHLBS as the appropriate
Federal banking agency with respect to a savings association or a
savings and loan holding company.

Section 204 adds a new definition for the term "savings
association".

This term includes thrifts that are insured by the

FSLIC on the effective date of the FIRRE Act, any Federal savings
and loan association or

Federal savings bank, and any

State-chartered savings and loan.

"Savings association" also

includes any corporation that the FDIC considers to be operating
substantially in the same manner as a savings and loan
association.

- 5 -

Section 204 also adds definitions for "default" and "danger of
default", which are generally defined to be determinations by a
public authority for appointment of a conservator or receiver.
These concepts are taken from the National Housing Act, and are
used throughout the FDI Act in lieu of current references to
"closed" banks and banks in "danger of closing".

Finally, Section 204 defines various other terms—e.g., "bank,"
"financial institution" (which includes "banks" and "savings
associations"), and "financial institution holding company"
(which includes bank holding companies and savings and loan
holding companies).

Section 205. INSURED SAVINGS ASSOCIATIONS. Section 205 provides
•that all FDIC-insured banks and all FSLIC-insured institutions
continue to be insured by the FDIC without application or
approval.

In addition, this section states that whenever a

financial institution files an application with another Federal
banking agency that would result in granting insurance to the
institution—e.g., an application for a national bank
charter—the other agency must provide the application to the
FDIC for comment (such comment to be made in a reasonable time)
and the agency must take the FDICfs comments into account in
deciding whether to grant the application.

Section 206. APPLICATION PROCESS; INSURANCE FEES. Section 206
requires State savings associations to apply to the FDIC for

- 6 -

deposit insurance.

Federal savings associations may apply to the

FHLBS, but must also submit an application to the FDIC together
with a certificate from the FHLBS.

The FDIC Board must consider

the first five factors specified in Section 6 of the FDI Act when
evaluating the application.

The FDIC Board (which may not

delegate denial authority in the case of such Federal
associations) may, after reviewing the application and the
certificate, decline to insure the applicant and must provide
specific written reasons to the Chairman of FHLBS for any such
denial.

Section 206 provides that any financial institution that

becomes insured must pay any entrance fee prescribed by FDIC
regulations.

The fee is paid into the particular fund, the Bank

Insurance Fund (BIF) or the Savings Association Insurance Fund
(SAIF), depending upon which Fund it joins.
generally apply to conversions.

The same rules

When a bank that is already a

member of the BIF converts into a SAIF member, the bank must pay
an entrance fee to the SAIF.

When a savings association converts

into a BIF member, the savings association must pay an entrance
fee to the BIF.

The fee in each case must be enough to prevent

the dilution of the reserves of the Fund to be joined by the
institution.

FDIC must approve any conversion transaction. There is a
five-year moratorium on such conversions although the FDIC may
permit a conversion during the moratorium with respect to a de
minimis transaction (such as minor branch sales) or in cases
where the FDIC and the Oversight Board of the Resolution Trust

- 7 -

Corporation agree that the conversion transaction is in the best
interests of both BIF and SAIF.

In a conversion transaction, the institution must also pay an
exit fee as determined by the Secretary of the Treasury to be
paid to the Resolution Trust Corporation (RTC) or such agency as
determined by the Secretary.

Finally, Section 206 provides for "cross-guarantees" by insured
financial institutions that are commonly controlled.

Each such

financial institution must reimburse FDIC, as requested, for any
loss the FDIC may incur in connection with the failure of, or
assistance to, another commonly owned insured financial
institution.

However, for the first five years after the

effective date of the FIRRE Act, BIF members do not have to
reimburse the FDIC for losses in connection with SAIF members,
and vice versa.

The cross-guarantees are subordinate in right of payment to
deposits (except those owed to commonly controlled institutions),
to secured obligations, and generally to other liabilities except
as specified.

The cross-guarantees are superior, however, to

obligations owed to other commonly-controlled companies or to
shareholders, to debts and obligations that are subordinated to
depositors and other general creditors, and to contingent claims.

The FDIC may specify how much of the overall loss will be borne

- 8 -

by any given institution, but must consult with the Federal
supervisor of any such institution for the purpose of setting the
procedures and schedules of any program of reimbursement.

The FDIC must promulgate regulations to implement an
administrative review procedure, and to provide a hearing to any
commonly-controlled financial institution that is required to
reimburse the FDIC.

When courts review the FDIC's determinations

regarding the amount of the liability, and regarding procedures
and schedules for reimbursement, the courts must sustain the
FDIC's determinations unless they are found to be arbitrary or
capricious.

The Bank Holding Company Act definitions of "control" and
"company" are adopted for this purpose.

Section 207. INSURABILITY FACTORS. Section 207 adds, as a new
factor for agencies to consider when evaluating applications that
result in deposit insurance, the risk presented to the BIF, to
the SAIF, and to the overall Deposit Insurance Fund as a whole.

Section 208. ASSESSMENTS. Section 208 provides that the FDIC,
after reaching agreement with the other three Federal banking
agencies, may require insured financial institutions to file
additional reports for insurance" purposes.

Section 208 also sets insurance assessment rates for BIF members

- 9 -

(generally banks) on one hand and for the SAIF members (generally
savings associations) on the other.

BIF members must pay the

current rate (1/12 of 1 percent) until the end of the current
year.

For the year 1990, the rate is 12/100 of 1 percent.

1990, the rate remains at 15/100 of 1 percent.

After

SAIF members must

likewise pay their current rate (20.8/100 of 1 percent) until
December 31, 1990.

From January 1, 1991, through December 31,

1993, they pay 23/100 of 1 percent.

Finally, on January 1, 1994,

this rate becomes 18/100 of 1 percent, where it remains.

The FDIC may raise these rates for the BIF Fund or the SAIF fund
if the FDIC makes any of the following findings about the Fund in
question:

—That the Fund has experienced a net loss in any of the prior
three years;

—That the Fund's "reserve ratio"—the ratio of its net worth to
its insurance liabilities—is less than 1.20 percent; or

—That extraordinary circumstances exist that raise a reasonable
risk of serious future losses to the Fund in question.

The FDIC may not raise the rates more than 50 percent over the
prior year's rate, and, in any event, the maximum rate for either
Fund is 35/100 of 1 percent.

- 10 -

The FDIC may also lower the rates below the statutory minimums.
The FDIC may set a lower rate for a Fund if the FDIC determines
that the ratio of the Fund's net worth to its insurance
liabilities exceeds 1.25 percent, and if the FDIC believes that
the ratio is not likely to decrease for the next five years.

Finally, every financial institution must pay a minimum annual
assessment of $500 or such greater amount as is necessary to
cover the direct costs related to assessment and processing.

Section 208 clarifies that amounts of premiums paid to the
Financing Corporation (FICO) and the Resolution Funding
Corporation (REFCORP) under their respective authorities to
assess, are to be subtracted from the amounts assessed under this
section to be paid to SAIF.

This ensures that institutions are

not double or triple assessed.

Section 208 also provides for assessment credits. When the
reserve ratio of a Fund exceeds 1.25 percent (or such higher
level as determined by the FDIC), the FDIC may rebate to the
Fund's members some of the assessments they have paid in the
prior year.

The rebate would be the lesser of the amount

necessary to reduce the Fund's reserve ratio to 1.25 percent (or
to the level determined by the. FDIC) or 60 percent of the net
assessment income the Fund members have paid in during the prior
year.

This section, as all the others dealing with assessments,

is Fund specific.

The FDIC must deduct any amount that an

- 11 -

institution owes the FDIC from any rebate to be credited to that
institution.

Furthermore,

the FDIC may not rebate any amounts

to SAIF members so long as the Financing Corporation is
authorized to assess SAIF members for Financing Corporation
interest obligations.

Finally, Section 208 extends the scope of the Change in Bank
Control Act to reach savings associations as well as banks.
Elsewhere the FIRRE Act repeals Title IV of the National Housing
Act, which contains the provisions of the equivalent law
currently applicable to savings and loan associations.

Section 209. FDIC CORPORATE POWERS. Section 209 makes technical
and conforming amendments to Section 9 of the FDI Act, which
generally sets forth the basic corporate powers of the FDIC.
Section 209 also clarifies the FDIC's authority to define any
terras used in the FDI Act that are not specifically defined, and
to interpret definitions that are defined; provided that the FDIC
definitions are not binding on other Federal banking agencies.

Section 210. ADMINISTRATION OF THE FDIC. Section 210 gives the
FDIC the same authority to examine insured thrifts as it has now
with respect to insured banks.

Section 211. INSURANCE FUNDS; FDIC POWERS AS RECEIVER. Section
211 amends Section 11 of the FDI Act to provide for two separate
insurance funds, which are not to be commingled.

BIF is

- 12 -

essentially a continuation of the FDIC's existing fund, which
until the passage of the FIRRE Act has been known as the
Permanent Insurance Fund.

All the assets, debts,

obligations,

contracts, and other liabilities of the existing FDIC fund are
transferred to the BIF.

All assessments paid by BIF members

(generally banks) are to be paid into this Fund, and

the assets

of the Fund are to be used in connection with BIF members.
other Fund is the SAIF.

The

All assessments paid by SAIF members

(generally thrifts) (which are not otherwise committed to the
Financing Corporation or Resolution Trust Corporation)

are to be

paid into the Fund, and the assets of the Fund are to be used in
connection with SAIF members.

In addition, the Treasury is to

make the following contributions to the SAIF, subject to
available appropriations:

Fiscal Year Dollars (in Billions)

1991 $2.0
1992

3.4

1993

4.6

1994

3.0

1995

4.0

1996

4.0

1997

4.0

1998

4.0

1999

3.0

- 13 -

In the event that case resolution costs run higher than estimated
over the period from 1992 through 1999, then Treasury (subject to
available appropriations) will contribute additional funds to
SAIF that may exceed the levels in the above table so as to cover
resolution costs that do not come from other income sources and
keep the fund at a minimum level. The minimum level of the fund
for each of the years 1992 through 1999 is as follows:

Fiscal Year
Beginning October 1, Dollars (in Billions)

1992 $1.0
1993 n 2.1
1994 3.2
1995 4.3
1996 5.4
1997 6.5
1998 7.6
1999 8.8

Treasury will provide- funds to keep SAIF at the above minimum
levels until the earlier of 1999, or the first fiscal year that
SAIF's reserve ratio is at least 1.25 per centum.

Finally, the FDIC is authorized to borrow from the Federal Home
Loan Banks, with concurrence of the Chairman of the System, such
funds as the FDIC deems necessary for the use of the SAIF,

- 14 -

subject to the cap on borrowing specified in Section 216.

This

borrowing authority was authorized for FSLIC prior to enactment
of this Act.

Any borrowings under this section become a specific

liability of SAIF.

Section 211 defines the FDIC's authorities and duties as receiver
or conservator.

The authorities essentially parallel those

heretofore exercised by the FSLIC and the FDIC, and are designed
to give the FDIC power to take all actions necessary to resolve
the problems posed by a financial institution in default.
Section 211 specifies that the authority includes the power to
conduct business, including taking deposits, and performing all
functions of'the financial institution in its own name; to take
necessary action to put the institution in sound and solvent
condition; to merge the institution with an'other insured
financial institution;

to organize a Federal savings association

to take over assets and liabilities from a failed thrift, or to
organize a bridge bank or a new national bank to take over assets
and liabilities of any insured financial institution; to transfer
assets or liabilities of the financial institution, including
those associated with any trust business carried on by the
institution, without any further approvals; to place the
financial institution in liquidation; to determine claims; and to
exercise all powers and authorities granted by the Act or
incidental thereto.

Section 211 of FIRRE Act establishes a claims procedure, with

- 15 -

specific deadlines both for creditors and for the FDIC, to be
followed in cases where the FDIC has been appointed receiver.
Section 211 enables the FDIC, when acting as receiver, to request
a stay of litigation or other similar proceeding for a period of
up to 90 days after its appointment.

The appointment of a

receiver or conservator can often change the character of
litigation.

The stay gives the FDIC a chance to analyze pending

matters and decide how best to proceed.

Section 211 also codifies the common-law right of a receiver or
conservator to disaffirm or repudiate contracts.

The need to

exercise this right generally occurs when a failed institution
has entered into a long-term lease or long-term service contract
shortly before going into default.

Without the common-law right

of disaffirmance .or repudiation, the lessor or contractor could
reap a windfall for a service or lease that was clearly not
necessary.

(Section 211 provides, however, that a lessor is

entitled to the contractual rent for the period the receiver
occupies the premises.)

In order to repudiate or disaffirm' a contract the FDIC, as
receiver, must determine that the contract would be burdensome to
the estate of the failed institution or that the disaffirmance
would promote the. orderly administration of the financial
institution's affairs.

If the FDIC disaffirms or repudiates the

contract within ninety (90) days from the date the FDIC is
appointed receiver or discovers the existence of the contract or

- 16 -

lease, there will be no resulting damages for the disaffirmance
against either the FDIC or the estate of the financial
institution in default.

Conversely, Section 211 allows the FDIC as receiver to enforce
contractual terms that the FDIC deems necessary for the orderly
execution of its duties as receiver.

Contracts often have a

provision specifying that the contract is automatically in
default on the appointment of a receiver or conservator, or
similar event.

Such provisions are generally held void and

section 211 merely codifies the common-law rule.

Section 211 requires the FDIC to keep and maintain a full
accounting with respect to the affairs of the financial
institution in default and specifies that the accounting shall be
available to the institution's shareholders and other regulatory
agencies.

Section 211 also provides that the FDIC may destroy

records of a Federal financial institution default after five
years from its appointment as receiver.

Section 211 specifies that, when a receiver or conservator is
appointed for an insured Federal financial institution (or for an
insured District bank or District savings and loan association)
for the purpose of liquidating it or winding up its affairs, the
FDIC must be appointed as such receiver or conservator.

Section

211 authorizes, but does not require, the FDIC to accept
appointment as receiver in other circumstances, if appointment is

- 17 -

offered: namely, to serve as conservator for an insured Federal
or District financial institution for the purpose of operating
the institution, or to serve as conservator or receiver for State
institutions either for operating or for liquidation purposes.
When the FDIC serves as conservator or receiver for a State
institution, it has all the rights, powers and privileges granted
to receivers of State financial institutions under State law in
addition to, and not in derogation of, the powers conferred by
the FDI Act.

Section 211 provides that the FDIC as conservator or receiver
shall not be subject to the direction or supervision of any other
agency or Department in the exercise of its duties (except as may
otherwise be provided in the FIRRE Act).

The only exception to

the rule is where the FDIC has been appointed conservator for a
Federal financial institution by that institution's primary
regulator, and the institution continues to operate in
conservatorship.

In such cases, the FDIC shall be subject to the

supervision of that primary regulator.

In addition, Section' 211 gives the FDIC the power currently
available to the FSLIC to appoint itself as sole conservator or
receiver, of an insured State financial institution under certain
conditions.

The FDIC may not exercise this power unless it makes

each of two findings.

First, either (1) that a conservator, receiver or other legal

- 18 -

custodian has been appointed for an insured State financial
institution, that the appointment has been outstanding for at
least 15 consecutive days, and that one or more depositors is
unable to obtain withdrawal of his or her deposit, in whole or in
part, or (2) that a State financial institution has been closed
by or under the laws of any State.
following grounds exist:

Second, that any of the

(1) insolvency in that the assets of

the institution are less than its obligations to its creditors
and others, including depositors; (2) substantial dissipation of
assets or earnings due to any violation or violations of law,
rules, or regulations, or to any unsafe or unsound practice or
practices; (3) an unsafe or unsound condition to transact
business; (4) willful violation of a cease-and-desist order which
has become final; or (5) concealment of books, papers, records,
or assets of the institution or refusal to submit books, papers,
records, or affairs of the institution for inspection to any
examiner or to any lawful agent of the FDIC.

Section 211 specifies that payments made on account of a BIF
member may only be made from the BIF, and that payments on
account of a SAIF member may only be made from the SAIF.

The

FDIC may require proof of claims and may determine claims,
subject to review by the Court of Appeals for the District of
Columbia Circuit or for the circuit where the financial
institution is located.

The court must sustain the FDIC's

determination unless the court finds the determination to be
arbitrary or capricious.

- 19 -

Section 211 provides that, when the FDIC pays insurance to a
depositor, the FDIC is automatically subrogated to the
depositor's claim against the institution. The automatic right
of subrogation now applies only to national banks; Section 211(g)
extends it to all insured financial institutions.

Section 211 allows the FDIC to use its Deposit Insurance National
Bank powers in the case of failed thrifts as well as in the case
of failed banks, but does not otherwise change the role or powers
of Deposit Insurance National Banks.

Section 211 makes technical changes in the bridge bank statute.
The changes clear up some of the statute's ambiguities and
streamline bridge bank operations. For example, Section 211
allows the FDIC to use bridge banks in the case of savings
associations as well as banks. Section 211 also specifies that
while a person who serves in any capacity with respect to a
bridge bank does not thereby become an officer or employee of the
United States for purposes of Title 5 of the United States Code,
a Federal employee who serves in some capacity with respect to a
bridge bank does not thereby lose any such status under Title 5;
but Federal employees may not receive additional compensation
apart from their Federal compensation. In addition, Section 211
provides that a bridge bank may be treated as a financial
institution in default. Treating a bridge bank as being "in
default" makes it clear that the bridge bank is eligible for the
provisions applicable to failed and failing institutions (e.g.,

- 20 -

acquisition by interstate holding companies).

Section 211 also

gives a bridge bank three one-year extensions of corporate life,
not just one such extension as is the case now.

Section 211 clarifies the principle that people with claims
against the estate of a failed financial institution are only
entitled to their share of the institution's estate:

i.e., that

the value of a claim is the amount that claimant would have
received had the FDIC liquidated the estate.

Section 211 makes

it explicit that the value of any such claim is not affected by
the procedure that the FDIC may choose to adopt in dealing with a
failed institution, even if the procedure results in making some
creditors whole (e.g., a purchase-and-assumption transaction in
which all deposits, both insured and uninsured, are transferred
to. an acquiring institution but other- claims are not
transferred).

Section 211 permits the FDIC to make additional

payments to, or for the benefit of, particular creditors or
categories of creditors out of its own resources without becoming
obligated to make similar payments to any other claimant or
category of claimant.

The FDIC may only use the resources of the

Fund to which the failed institution belonged in making any such
payments.

Under this procedure, no creditor ever receives any less than the
fair value of his claim against the estate.

But at the same

time, the FDIC is free to take action that is to the benefit of
the institution and the public without being subject to the

- 21 -

constraint of making all creditors whole if even one creditor is
made whole.

Section 211 also provides that, where the FDIC elects to operate
an institution in default for a period of time before beginning
to wind up its affairs, the FDIC would incur no liability to any
claimant should the estate of the institution be diminished
during such period of operation, absent a finding of bad faith on
the part of the FDIC.

Section 211 authorizes the FDIC to make rules and regulations for
the conduct of conservatorships and receiverships, and enables
the FDIC to adjudicate claims.

The power to adjudicate may be

exercised only if the FDIC has first issued regulations governing
the processing of claims.- Claims determinations made by agency
adjudication are subject to appellate court review, and must be
upheld unless found to be arbitrary or capricious.

In the

absence of FDIC regulations governing claims resolution, the
Federal district courts (or State or local courts) would have
jurisdiction to hear such cases.

Finally, Section 211 bars courts, to the same extent as the Home
Owners' Loan Act does now under existing law, from restraining or
affecting the exercise of the powers or functions of the FDIC as
receiver or conservator, except at the request of the Board of
Directors.

- 22 -

Section 212.

FSLIC RESOLUTION FUND.

FSLIC Resolution Fund.

Section 212 creates the

Consistent with the provisions of

Title IV of this Act, this Fund is the successor to the existing
reserves and assets, debts, obligations, contracts and other
liabilities of the FSLIC, and is required to be held separately
and not commingled with BIF or SAIF.

The FSLIC Resolution Fund is funded from the following sources in
the listed priority:

(1) the income generated on the assets

transferred to it; (2) the proceeds of the resolution of
insolvent thrift institutions which became insolvent prior to
December 31, 1988 (to the extent such funds are not required by
the Resolution Funding Corporation); (3) the proceeds from
borrowings by the Financing Corporation; and (4) until 1992, from
the assessments levied on SAIF members and not required by the
Financing Corporation or the Resolution Trust Corporation.
Section 212 also provides for additional funding by the Secretary
of the Treasury from appropriated funds, if needed.

Any judgment resulting from any civil action or proceeding to
which the FSLIC was a party prior to its dissolution in any
action or which is initiated against the FDIC based upon FSLIC
actions is limited to the assets of the FSLIC Resolution Fund.

The FSLIC Resolution Fund will be dissolved when its debts and
liabilities have been satisfied and all its assets have been
sold, with remaining funds being covered into Treasury because of

- 23 -

Treasury funds having been injected into the FSLIC Resolution
Fund over the years.

Only minimal offices and office supplies

are to be transferred to SAIF.

Section 213. AMENDMENTS TO SECTION 12. This section makes
conforming technical changes to Section 12 of the FDI Act, which
deals with paying insurance to depositors, the appointment of
agents to assist the FDIC in conducting receiverships, and other
matters.

Section 214. AMENDMENTS TO SECTION 13. Section 214 specifies
that the funds held in each of the specific funds administered by
the FDIC must be invested separately, and may not be commingled.
Section 214 allows the FDIC to stay legal proceedings involving
asset purchases for up- to 90 days.
"cost test" for FDIC assistance.

Section 214 also amends the

Under current law, the FDIC may

not provide assistance in excess of that amount which the FDIC
determines to be reasonably necessary to save the cost of
liquidating (unless continued operation is necessary to provide
essential banking services).

Section 214 would additionally

require FDIC to consider the immediate and long-term obligations
of the FDIC with respect to the assistance, and also the Federal
tax revenues foregone by the Government as a result of specific
tax benefits granted to acquirers of financial institutions in
default or in danger of default.

Section 214 provides that transfers of assets or liabilities

- 24 -

associated with any trust business may be effected by FDIC in
connection with any asset purchase transaction without any
further State or Federal approval.

Section 214 eliminates the requirement for approval by the
appropriate State authority and by a court for sales of assets or
pledges of assets to secure loans by conservators, receivers or
liquidators to the FDIC.

Section 214 clarifies the provision invalidating certain secret
agreements against interests of the FDIC.

Section 214 makes it

clear that these provisions apply to assets that the FDIC
acquires as receiver as well as to assets that it acquires in its
corporate capacity.

Section 214 specifies that the Board of Directors of the FDIC
must act by a 75 percent vote (rather than the present unanimous
vote) in order to override State objection to an assisted
interstate acquisition of an insured financial institution in
default having $500,000,000 or more in assets.

Section 214 retains the current rules governing interstate
acquisitions of banks, and keeps them separate from those that
govern thrifts.

It tightens the rules by providing that such

acquisitions would be prohibited if they threaten the safety or
soundness of the acquirer or would not result in the future
viability of the resulting institution.

— ^D —

Section 214 transfers the parallel interstate-acquisition
provisions relating to thrifts, which now appear at section
408(m) of the National Housing Act, to subsection 13(k) of the
FDI Act (with technical and conforming amendments). These rules
continue to apply only to savings institutions and are not
extended to banks. The current law allows an override of the
laws or constitution of any State, or any Federal law, that
constitutes a material impediment to supervisory acquisitions and
provides for consultation with State authorities. In addition,
as amended, in exercising this override authority, the FDIC must
obtain the prior concurrence of the Chairman of the Federal Home
Loan Bank System in all respects other than section 10(e)(3) of
the Home Owners' Loan Act, and the prior concurrence of the
Federal Reserve Board for the override of the Bank Holding
Company Act or Federal Reserve Act.

Section 215. BORROWING AUTHORITY. Section 215 increases the
borrowing authority of FDIC from $3,000,000,000 to
$5,000,000,000, and also specifically states that the Secretary
of the Treasury must approve any use of the credit line.

Section 216. LIMITATION ON BORROWING.

Section 216 clarifies the existing provision specifying that the
only kind of non-Federal tax to which the FDIC, in its corporate
capacity or as receiver, is subject is a tax on real property.

- 26 -

Section 216 further specifies that if an insured institution
fails to pay a tax, the FDIC's only obligation as receiver or
conservator for the institution is to pay the pro-rata claim for
the tax—the FDIC will not be subject to any special penalties or
forfeitures that might otherwise apply (e.g., loss of a secured
interest in the property.)

Finally, Section 216 sets a cap on the notes, debentures, bonds,
and similar obligations, including estimated losses for
guarantees and other liabilities of the BIF and of the SAIF,
respectively.

Each cap is set independently.

In each case, the

Fund may not incur such obligations in an amount exceeding 50
percent of the Fund's adjusted net worth, including reserves for
losses and similar reserves or $10,000,000,000, whichever is
less.

These obligation caps apply to borrowings by. the Funds, .

and do not affect or apply to the FDIC's power to draw upon its
credit line of $5,000,000,000 from the Treasury.

Section 217. REPORTS. Section 217 requires the FDIC to report
to Congress annually on its operations, activities, budget,
receipts and expenditures.

Current law specifies only the FDIC's

operations as subject to reporting requirements.

Section 217

also requires the FDIC to make quarterly reports to the Secretary
of the Treasury and to the Director of the Office of Management
and Budget with respect to the FDIC's financial operating plans
and forecasts (including estimates of actual and future spending,
and estimates of future non-cash obligations) taking into account

- 27 -

the FDIC's financial commitments, guarantees and other contingent
liabilities.

Section 218. REGULATIONS GOVERNING INSURED FINANCIAL
INSTITUTIONS.

Section 218 specifies that FDIC signs displayed by

insured financial institutions shall represent whether an
institution is a BIF member or a SAIF member.

Section 218

subjects all insured financial institutions to the Bank Merger
Act.

The Chairman of FHLBS is the responsible agency with

respect to mergers where the«acquiring, assuming or resulting
institution is to be a savings association.

Section 218 provides

that all insured State financial institutions, other than State
member banks or District banks, would be subject to the
requirement of prior FDIC consent to the reduction of capital.

Section 2i8 sets out new rules governing subsidiaries of insured
savings associations.

Whenever an insured savings association

establishes or acquires control of a company, or elects to
conduct any new activity through a company that the association
controls, the savings association must notify the FDIC and the
Chairman of FHLBS.

The savings association must deduct its

entire investment in and loans to the company from its own
capital for purposes of determining capital adequacy if the
company is engaged in activities not permissible for a national
bank.

In any event, mortgage banking activities need not be

deducted.

- 28 -

The Chairman of FHLBS is given rule-making authority over
subsidiaries' activities.

The Chairman of FHLBS may order a

thrift to divest itself of a subsidiary if the company
constitutes a serious risk to the thrift's financial safety.
Both the FDIC and the Chairman of FHLBS are given the same powers
with respect to a savings association's subsidiary as they have
with respect to the savings association itself pursuant to this
section 218 or section 8 of the FDI Act.

Section 218 states that the FDIC may determine by regulation,
with respect to all State-chartered SAIF members (after
consultation with the Chairman of the FHLBS) that any specific
activity (other than any activity permitted to a Federal savings
and loan association) poses a serious threat to the SAIF, and may
prohibit any such activity.

Once the FDIC issues such a

regulation, it may order that no SAIF member may engage directly
in that activity.

Section 218 further specifies that a SAIF

member may not be held liable indirectly for any obligation
arising out of the activity of the subsidiary unless the
obligation is in writing, is executed by the SAIF member and the
party to whom the obligation is owed, is approved by the SAIF
member's board of directors or an official committee of the
association, and the liability or obligation has been
continuously maintained as an official document of the SAIF
member.

Section 219. NONDISCRIMINATION. This section specifies that the

- 29 -

FDI Act is not intended to discriminate against State nonmember
banks or against State-chartered thrifts.

It also eliminates the

provision requiring nondiscrimination on account of having
capital stock less than the amount required for Federal Reserve
membership.

TITLE III - SAVINGS ASSOCIATION SUPERVISION IMPROVEMENTS

Section 301.

DEFINITIONS.

This section revises the definitional

section of the Home Owners Loan Act of 1933 ("HOLA") to
incorporate the new terms used in the FIRRE Act.

Section 301(1) defines the term "Chairman" as the Chairman of the
Federal Home Loan Bank System created under the FIRRE Act.

Section 301(2) defines the term "System" as the Federal Home Loan
Bank System.

Section 301(3) defines the term "savings association" to include:
(1) all institutions currently supervised by the Federal Savings
and Loan Insurance Corporation; (2) all federally chartered
savings and loan associations and savings banks; (3) all
state-chartered building and loan, savings and loan, and
homestead associations and cooperative banks; and (4) those state
savings banks that will be members of the Savings Association
Insurance Fund.

- 30 -

Section 301(4) defines the term "federal association" to include
all federal savings and loan associations and federal savings
banks chartered pursuant to section 5 of the HOLA.

Section 301(5) defines the term "federal banking agencies" as the
Office of the Comptroller of the Currency, the Board of Governors
of the Federal Reserve System, and the Federal Deposit Insurance
Corporation.

Section 302. SUPERVISION OF SAVINGS ASSOCIATIONS. This section
creates a new section 3 of the HOLA setting forth new provisions
applicable to the Chairman's responsibilities as primary federal
supervisor and regulator of both federally and state-chartered
savings associations.

It also incorporates into the HOLA certain

provisions of the National Housing Act ("NHA")".

Section 302(a) establishes the scope of the Chairman's overall
responsibilities for the supervision and regulation of savings
associations.

It clarifies that the HOLA's purpose of

encouraging credit for housing is coupled with the purpose of
establishing a safe and sound system to provide such credit.

The

Chairman is given the power to examine state associations and is
granted broad rulemaking authority to carry out his responsibilities to supervise and regulate savings associations in
accordance with both the HOLA and all other applicable laws.
rulemaking authority includes the ability to issue rules
governing safety and soundness.

Uniform accounting and

The

- 31 -

disclosure standards are to be prescribed for all savings
associations.

These standards are to be coordinated with capital

standards established by the Chairman.

Savings associations are

to be in full compliance with these uniform accounting standards
by no later than December 31, 1993.

This carries forward the

uniform accounting provisions adopted in the Competitive Equality
Banking Act of 1987.

Those rules, regulations, and policies

established by the Chairman that govern the safe and sound
operation of savings associations are to be no less stringent
than those established by the Office of the Comptroller of the
Currency.

The section also transfers into new section 3(d) of

the HOLA the existing authority to set geographical lending
limits generally within an area one hundred miles from the
location of the savings association's principal office (currently
found in section 403(b) of the NHA).

Section 302(b) preserves, with minor technical changes, former
Section 409 of the NHA by transferring this section to new
Section 3(e) of the HOLA.

As modified, this section provides

that insured savings accounts and share accounts held by
FDIC-insured savings associations are lawful investments and may
be accepted as security for specified public funds of the United
States and funds of corporations organized under United States
laws notwithstanding limitations upon the investment of, or upon
the acceptance of security for the investment or deposit of, such
funds.

- 32 -

Section 302(c) transfers former Section 410 of the NHA pertaining
to participation in lotteries to new section 3(f) of the HOLA
with conforming amendments.

This section prohibits a savings

association from dealing in lottery tickets, dealing in bets used
as a means of participating in a lottery, announcing,
advertising, or publicizing the existence of a lottery or
participant/winner of a lottery, or using its offices for such
prohibited activities.

Savings associations are not prohibited

from accepting funds from, or performing any lawful services for,
a S.tate operating a lottery.

Section 302(d) preserves former section 413 of the NHA relating
to disclosures of beneficiaries with respect to federally related
mortgage loans, by transferring this section to new section 3(g)
of the HOLA with conforming amendments.

Under this provision,

savings associations are prohibited from making a federally
related mortgage loan to any agent, trustee, nominee, or other
person acting in a fiduciary capacity without the prior condition
that the identity of the person receiving the beneficial interest
of the loan shall at all times be revealed to the association.
With respect to such loans, the Chairman of the Federal Home Loan
Bank system may request the identity of such person and the
nature and amount of the loan.

Section 302(e) preserves former section 414 of the NHA by
transferring this section to new section 3(h) of the HOLA and
makes conforming amendments.

This section provides that a

- 33 -

savings association may take, receive, reserve, or charge on any
loan, note, bill of exchange, or other evidence of debt, interest
at the greater of (1) a rate not more than one per centum in
excess of the discount rate on ninety-day commercial paper in the
specified Federal Reserve Bank where the institution is located,
or (2) the rate allowed by the laws of the state where such
institution is located.

If the former rate exceeds the rate that

would be permitted in the absence of this section, such rate may
be employed notwithstanding any state constitution or statute,
which is thus preempted.

This section also prescribes penalties

for knowingly charging a rate in excess of the "greater" rate
permitted in subsection (a) of the provision.

Section 302(f) provides that no savings association may issue
securities which guarantee a definite maturity except with the
specific approval of the Chairman, nor issue any securities the
form of which has not been approved by the Chairman.

This

section is intended to preserve, as section (3)(i) of the HOLA, a
similar provision of former section 403(b) of the NHA.

Section 303. APPLICABILITY. This section applies to all savings
associations those provisions of the HOLA that either authorize
examination by the Chairman of the Federal Home Loan Bank System
or proscribe or limit certain association activities, where such
prohibitions or limitations are equally appropriate for federally
chartered and state-chartered institutions.

Specifically, those

provisions deal with the HOLA territorial application (section

- 34 -

7); the Bank System's general supervisory authority (section 3)
and enforcement authority (section 5(d))—including the authority
to recoup the cost of its examinations (section 9 ) ; set capital
standards for associations (sections 5(s) and (t)); restrict
transactions with affiliates, loans to insiders (section 11),
tying arrangements (section 5(q)), and certain advertising
practices (section 12); supervision of savings association
holding companies (section 10); rules requiring membership by all
savings associations in a Federal Home Loan Bank (section 5(f));
and rules covering conversions from a state to a Federal charter
(section 5(i)), from a state savings bank to a Federal savings
bank (section 5(o))and from a mutual savings association to a
stock savings association (section 5(p)).

This section would apply to Federal savings associations only
those provisions of the HOLA that are relevant to the holders of
Federal charters, such as rules authorizing various types of
accounts (HOLA section 5(b); investment authority (section 5(c));
qualifications for individuals seeking a Federal charter (section
5(e)); subscriptions of preferred stock and full-paid income
shares by the United States (sections 5(g) and (j)); exemption
from state taxation (section 5(h)); trust powers (sections 5(1)
and (n)); out of state branches (section 5(r)) and District of
Columbia savings associations (sections 5(m) and 8 ) . These
Federal-charter only delineations are intended to maintain the
distinctions between Federal and state-chartered associations
that exist under current law.

- 35 -

Section 304.

CONFORMING NAME CHANGES.

This section makes

terminology changes to existing law to conform to the treatment
used in this legislation.

Section 304(1) would replace the terms "association," "Federal
association," or "Federal savings and loan association" in the
HOLA where they refer only to federally chartered associations
with the term "Federal savings association."

By doing so, this

subsection would be merely adopting terminology consistent with
the overall treatment of such associations in this legislation.

Section 304(2) would replace references to "association" in the
HOLA with "savings association" where the term refers to
state-chartered institutions under the supervision of the Feder
Home Loan Bank System.

Thus, this subsection will ensure that

these relevant provisions of the HOLA apply to the latter body
associations, consistent with the overall treatment of such
associations in this legislation.

Section 304(3) would exempt certain sections of the HOLA
from the name change Of section 304(1) and (2). These
exceptions generally deal with situations where the
original HOLA language was somewhat different from
language found in other HOLA provisions or where, as in
the conversion statutes, the distinction is still
relevant.

Moreover, references to the government-sponsored

associations in HOLA sections 5(c)(1)(D) and (F) and "domestic

- 36 -

building and loan associations" in HOLA section 5(r)(l) would
remain unchanged because those terms have meaning independent of
their inclusion in the HOLA.

Section 305. SAFETY AND SOUNDNESS. This section amends section
1464(a) of the HOLA, which sets forth the purpose of that
statute, by adding language emphasizing the importance of the
safe and sound operations of the nation's savings associations to
the statute's purpose of providing credit for home financing.

Section 306. DEPOSITS. This section would amend current
subsection 5(c)(1)(G) of the HOLA to clarify that federal savings
associations may invest in deposits of any type in any financial
institution whose deposits are insured by the Federal Deposit
Insurance Corporation. •

*

Section 307. SUPERVISORY REVISIONS. Section 307(a) would delete
the majority of the enforcement provisions currently in the HOLA
with regard to federally chartered savings associations.

These

provisions are subsumed in the enforcement provisions, of section
8 of the Federal Deposit Insurance Act, as amended, with regard
to all institutions for which the Chairman of the Federal Home
Loan Bank System is the appropriate federal banking agency.

Section 307(b) would preserve without change the existing general
enforcement and related authorities currently contained in
section 5(d)(1) of the HOLA and would redesignate 5(d)(1) as

- 37 -

5(d)(1)(A).

Section 307(c) would transfer the provisions of section 407(m) of
the NHA, with conforming amendments, into section 5(d)(1)(B) of
the HOLA.

Section 407(m) of the NHA provides for routine

examination of institutions supervised by the Chairman of the
Federal Home Loan Bank System and their affiliates.

In addition,

this section preserves the powers of the Chairman in formal
examination procedures including subpoena power and the ability
to take and preserve testimony under oath.

Finally, it

authorizes an administrative law judge to conduct hearings in
enforcement actions.

Section 308. RECEIVERSHIPS. This section amends the current
provisions of the HOLA on the appointment of conservators and
receivers (Section 5(d)(6) redesignated as (d)(2)) to provide for
the Chairman's appointment of the Federal Deposit Insurance
Corporation rather than the Federal Savings and Loan Insurance
Corporation as conservator or receiver for both federally and
state-chartered savings associations.

It incorporates provisions

currently located in section 406 of the NHA setting forth the
procedures to be followed in the case of state savings
associations, without substantive change except with regard to
the time for approval of state officials.

in that regard, it

would cut back from 90 to 30 days the amount of time that must
elapse before the Chairman could act in the event that notice of
grounds for the appointment of a conservator or receiver for a

- 38 -

state savings association has been provided to the appropriate
state official and no response has been received.

Sections 309. TECHNICAL AMENDMENT. This section would renumber
section 5(d)(11) of the HOLA, dealing with the Chairman of the
Federal Home Loan Bank System's ability to issue rules and
regulations on conservatorships and receiverships, as section
5(d)(3).

This renumbering would be necessary because of the

deletion of preceding paragraphs.

The renumbered section would

also be amended by section 304 of the FIRRE Act to apply to all
savings associations.

Sections 310. TECHNICAL AMENDMENT. This section would preserve
and renumber sections 5(d)(12) (B) and (C) of the HOLA, dealing
with penalties that would attach to criminal conduct by employees
or agents of savings associations and failure to comply with
demands of conservators and receivers, as section 5(d)(4).

This

renumbering would be necessary because of the deletion of
preceding paragraphs.

The renumbered section would also be

amended by section 304 of the FIRRE Act to apply to all savings
associations.

Section 311. AMENDMENT TO SECTION 5. This section is a
technical amendment that would renumber section 5(d)(14) of the
HOLA, which provides definitions dealing with the ability of the
Chairman of the Federal Home Loan Bank System to enforce
compliance with applicable law and regulations, as section

- 39 -

5(d)(5).

This renumbering is necessary because of the deletion

of preceding subparts.

This section would also amend that HOLA

provision to state that the enforcement powers of the Chairman of
the Federal Home Loan Bank System would remain in effect against
a savings association even when that association had its insured
status terminated by the Federal Deposit Insurance Corporation,
so long as the association retained deposits insured by the FDIC.

Section 312. TECHNICAL AMENDMENT. This section would renumber
section 5(d)(16) of the HOLA, dealing with compliance with
monetary transaction recordkeeping and report requirements by
savings associations, as section 5(d)(6).

This renumbering would

be necessary because of the deletion of preceding paragraphs.
The renumbered section would also be amended by section 304 of
the FIRREA to apply to all savings associations.

Section 313. CONVERSIONS. This section would expand the
existing provisions of section 5(i) of the HOLA regarding the
authority of the Chairman of FHLBS to oversee and

approve

mutual-to-stock conversions to include state-chartered savings
associations.

This amendment is required due to the proposed

repeal of the NHA and the resulting need to incorporate this
authority with respect to mutual to stock conversions of
state-chartered savings associations into the HOLA.

In addition

it incorporates the grievance procedures for the NHA with regard
to conversion decisions.

- 40 -

Section 314.

CAPITAL STANDARDS.

This section requires the

Chairman of the FHLBS to establish for all savings associations
capital standards that are no less stringent than those applied
to national banks.

Such standards are to be promulgated within

90 days of the enactment of the Act and are to be fully
implemented by June 1, 1991.

The section establishes certain

differences from standards currently applicable to national banks
in the areas of goodwill and the treatment of certain
subsidiaries and provides that the Chairman's standards may have
minor differences from those currently applicable to national
banks so long as the Chairman's standards would not result in
materially lower capital standards.

With respect to goodwill,

capital may include such goodwill existing on the date of
enactment of FIRRE Act, but it must be amortized over a ten-year
period* (or such shorter period as determined by the Chairman of
FHLBS with the concurrence of the Secretary of Treasury).

With

respect to investments in subsidiaries engaged in activities not
permissible for national banks, such investment and loans to the
subsidiary must be deducted from capital (in any event, the
investment in and loan to a subsidiary engaged solely in mortgage
banking activities are not to be deducted).

The Chairman is also

permitted to take into account differences in powers and in asset
and liability composition between savings associations and
national banks, so long as the resulting capital standards are
not materially lower than*the capital standards applicable to
national banks.

The section further provides that the Chairman

may, until June 1, 1991, restrict the asset growth of savings

- 41 -

associations not in compliance with these capital standards.
After that date, asset growth by such associations would be
prohibited. The Chairman could restrict the asset growth of any
savings association, regardless of its capital level, that he
determined was taking excessive risks or paying excessive rates
for deposits.

Section 315. TECHNICAL AMENDMENT. This section would replace
all references to "association" in section 8 of the HOLA, which
deals with District of Columbia savings associations, with
"savings association" and all references to "Federal savings and
loan association" with "Federal savings association." By so
doing, this section would be merely adopting terminology
consistent with the overall treatment of such associations in
this legislation.

Section 316. REPEAL. This section would repeal section 9 of the
HOLA, which deals with accounting principles and other standards
and requirements. These requirements would be covered elsewhere
in the HOLA as amended by this legislation.

Section 317. RECOVERY REGULATIONS REPEALED. This section
repeals section 10 of the HOLA and section 416 of the NHA. Those
sections permitted the Federal Home Loan Bank Board to provide
capital forbearance to certain federal associations and insured
institutions. Section 317 provides that associations and
institutions operating under capital plans previously approved

- 42 -

pursuant to those sections may continue to operate under such
plans so long as they remain in compliance with the terms of such
plans and continue to supply to the Chairman of the System
regular and complete reports on their progress in meeting goals
under the plans.

Section 318. COST OF EXAMINATION AND REPORTS. Section 318 adds
a new section to the HOLA preserving authority from the NHA to
assess the costs of examining savings associations (or
affiliates) upon the savings associations (or affiliates) in
proportion to their assets or resources.

This section also

addresses remedies available to the Chairman when an affiliate
refuses to pay examination costs or refuses to permit examination
or provide required information.

This section addresses the

deposit of funds derived from assessments, the Chairman's
authority to issue regulations governing the computation and
assessment of examination expenses, the authority to'assess for
the examination of an associations fiduciary activities, and

the

obligation of savings associations and affiliates to provide the
Chairman with access to- information and reports regarding
examinations by other public regulatory authorities.

These

provisions are intended to be comparable to those governing the
Office of the Comptroller of the Currency.

Section 319. SAVINGS AND LOAN HOLDING COMPANIES. This section
transfers the provisions of the Savings and Loan Holding Company
Act from the NHA to the HOLA.

In addition, this section deletes

- 43 -

current NHA sections 408(d), (p) and (t), which pertain tc
transactions with affiliates, and replaces those provisions with
a new subsection 10(d) in the Home Owners' Loan Act, which refers
to new section 11 of the HOLA (Section 320 below), which
establishes a uniform approach to regulation of transactions with
affiliates based on sections 23A and 23B and section 22(h) of the
Federal Reserve Act.

This section also deletes current section

408(g) of the NHA, which imposed debt approval requirements on
certain types of savings and loan holding companies.

The debt

control provisions of the Savings and Loan Holding Company Act
have generally been viewed as an obstacle to acquisitions, overly
burdensome to administer, and producing limited supervisory
benefits not commensurate with the burden associated with the
approval requirements involved.

This section also removes

current section 408(m) of the NHA, which is moved to Section
13(k) of the Federal Deposit Insurance Act.

This section also makes changes to the qualified thrift lender
test, currently contained at section 408(o) of the NHA, to
provide new sanctions for failure to satisfy the qualified thrift
lender requirements.

Under the new qualified thrift lender rule,

a thrift that fails to maintain its status as a qualified thrift
lender, must, within 3 years of the date it loses such status,
convert its charter to a bank charter unless it requalifies as a
qualified thrift lender'within the one-year period after losing
such status and maintains its status as a qualified thrift lender
thereafter.

Also under the new rule, three years after losing

- 44 -

qualified thrift lender status, a thrift will be prohibited from
obtaining advances from its Federal Home Loan Bank and engaging
in any activities not permitted either for a national bank or a
bank chartered in the state in which the thrift resides.
Effective immediately upon losing its status as a qualified
thrift lender, the thrift would also be prohibited from expanding
its activities, or opening any additional branch offices.

Any

company that controls a thrift that loses its qualified thrift
lender status shall, beginning three years after the thrift has
lost its status as a qualified thrift lender, be, subject to
restrictions on its activities, regulated as if it were a bank
holding company.

Any bank chartered as a result of these

requirements for failure to maintain qualified thrift lender
status will continue to pay savings association assessments until
December 31, 1993 (or such later date if it loses its status
after that date), and would also be assessed the exit fees and
entrance fees applicable to conversion.

Section 320. TRANSACTIONS WITH AFFILIATES. This section adds
new section 11 to the HOLA, which establishes a uniform approach
to regulation of transactions with affiliates based on Sections
23A, 23B and 22(h) of the Federal Reserve Act.

The Chairman of

the Federal Home Loan Bank System would also retain the right to
determine for reasons of safety and soundness to impose
additional restrictions on transactions with affiliates and
insiders of savings associations.

- 45 -

Section 321. ADVERTISING.

This section provides that no savings

association shall carry on any sale, plan, or practices, or any
advertising, in violation of regulations promulgated by the
Chairman.

This section would preserve a similar provision found

in former Section 403(b) of the NHA.

TITLE IV. DISSOLUTION AND TRANSFER OF FUNCTIONS, PERSONNEL,
AND PROPERTY OF FEDERAL SAVINGS AND LOAN INSURANCE CORPORATION.

Section 401.

DISSOLUTION.

This section provides for the

dissolution of FSLIC within 60 days of enactment of this
legislation.

It also provides for all insurance and receivership

functions of FSLIC to be performed by the FDIC or the RTC after
enactment.

Section 402. CONTINUATION OF RULES. This section provides that
all rules and regulations of the FSLIC or the Board in effect on
the date of enactment which relate to insurance of accounts,
administration of the insurance fund or conduct of
conservatorships or receiverships shall remain in effect and be
enforced by the FDIC or the RTC.

All other rules and regulations

of the FSLIC shall remain effective and enforceable by the FHLBS.
The Chairman of FDIC and the Chairman of FHLBS are required to
identify the rules and regulations referred to in this section
within 60 days of enactment and to publish notice thereof in the
Federal Register.

The FDIC is vested with authority to

- 46 -

promulgate and enforce rules to prevent actions by savings
associations which could pose a serious threat to the Savings
Association Insurance Fund or the Bank Insurance Fund.

Section 403. PERSONNEL. Subsection (a) requires the Chairman of
the FHLBS and the Chairman of the FDIC to identify employees of
FSLIC and the Board whose functions will be transferred to FDIC
under the Act.

Paragraph (a)(1) provides certain rights for employees who elect
to transfer to FDIC.

All employees so identified shall be

offered a position with FDIC.

Employees are to be transferred to

FDIC within 60 days of enactment.

This transfer is deemed a

transfer of function under applicable RIF regulations.

All

.employees transferred will be placed in a competitive area
separate from those already in existence at FDIC.

In placing

transferred employees under RIF procedures, FDIC may assign
excepted service employees to competitive service positions and
may convert transferred positions from the excepted service to
the competitive service.

Any transferred employee placed by FDIC

in a competitive service position shall be given career or
career-conditional status.

Transferred employees shall be given

their RIF notices within 90 days after transfer.

Such employees

will be accorded pay and grade retention under the principles
reflected in applicable OPM regulations.

Paragraph (a)(2) provides certain rights to employees who decline

- 47 -

to transfer.

Such employees will be given severance pay under

applicable regulations.

FHLBS will pay for severance pay.

Such

employees will also be granted placement assistance by OPM for
120 days.

Paragraph (a)(3) also provides certain rights for employees who
transfer to FDIC but then decline an offer of employment.

Such

employees are provided severance pay like that provided to
employees who decline to transfer.

Such employees are also

eligible for early out retirement as long as they do not decline
a reasonable offer of employment.

This paragraph also permits

FDIC to offer early out retirement to employees if it has a
reorganization of the combined workforces within one year after
completion of the transfer.

Paragraph (a)(4) permits all transferred employees to retain any
benefit or membership which the employee had at the date of
enrollment provided the FHLBS continues the benefit or program
for its employees.

The FHLBS will pay any difference between the

cost of such benefits and the cost to FDIC of providing such
benefits.

Section 404. DIVISION OF PROPERTY AND PERSONNEL. This section
provides that the Chairman of FHLBS with the Chairman of FDIC
shall divide all personnel and property of FSLIC between their
organizations within 60 days of enactment.

Any dispute will be

settled by the Office of -Management and Budget.

- 48 -

Section 405.

REPEALS.

This section repeals sections 401, 402,

403, 404, 405, 406, 407, 411, 415, and 416 of the National
Housing Act.

The foregoing does not effect provisions of such

sections that have been transferred to other surviving statutory
provisions.

Section 406. REPORT. This section requires FSLIC, prior to its
dissolution, to provide a written report to Treasury, the Office
of Management and Budget and Congress.

TITLE V - FINANCING FOR THRIFT RESOLUTIONS.

Subtitle A — Resolution Trust Corporation

Sec. 501. RESOLUTION TRUST- CORPORATION ESTABLISHED. Section 501
provides for the establishment of the Resolution Trust
Corporation (the "Corporation") and describes its powers and
authorities.

The Oversight Board of the Corporation and the

Corporation itself are stated to not be "agencies" or "executive
agencies" under Title 5 of the United States Code.

Section 501 provides that the purpose of the Corporation is to
carry out a program, under the direction of the Oversight Board,
to manage and resolve all cases involving institutions, the
accounts of which were insured by the Federal Savings and Loan
Insurance Corporation, prior to enactment of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989, for

- 49 -

which a receiver or liquidating conservator had been appointed
since January 1, 1989, or is appointed within the three-year
period following the date of the enactment of that Act; to manage
the assets of the Federal Asset Disposition Association; and to
perform other authorized functions.

In its resolution

activities, the Resolution Trust Corporation is authorized to
take warrants, voting and nonvoting equity, or other
participation interests in resolved institutions or assets or
properties acquired in connection with resolution.

In carrying

out its obligations, the Corporation is provided with all of the
case resolution and financial assistance rights and powers
provided to the Federal Deposit Insurance Corporation, provided
that in resolving an institution, the Corporation must not
provide assistance in excess of the amount determined to be
reasonably necessary to save the cost of liquidating.

Section 501 further provides that the membership of the Oversight
Board- of the Resolution Trust Corporation shall consist of the
Secretary of the Treasury, the Chairman of the Federal Reserve
Board, and the Attorney General of the United States, or their
respective designees, with th'e Chairman being the Secretary of
the Treasury.

The term of each member of the Oversight Board

will expire when the Corporation is terminated and vacancies on
the Oversight Board will be filled in the same manner as the
vacant position was previously filled.

Members of the Oversight

Board are permitted to receive reasonable allowance for necessary
expenses of travel, lodging, and subsistence incurred in

- 50 -

attending meetings and other activities of the Oversight Board,
consistent with maximum travel expense limitations provided in
Title 5 of the United States Code.

The duty of the Oversight

Board is to review and have overall responsibility over the work,
progress, management and activities of the Corporation and may
disapprove, in its discretion, any and all regulations, policies,
procedures, guidelines, statements, contracts, and other actions
of the Corporation.

It is further required to approve or

disapprove, in its discretion, any and all agreements for the
purchase of assets and assumption of liabilities, any and all
agreements for the acquisition, consolidation or merger, or any
other transaction proposed by the Corporation.

All decisions of

the Board require an affirmative vote of at least a majority of
the members voting.

The Oversight Board is authorized to employ

necessary staff, which shall be subject to the terms and
conditions of employment applicable to the Corporation, provided
that the Oversight Board should utilize to the extent practicable
the personnel of the agencies of the three members of the
Oversight Board, without additional compensation to carry out the
Oversight Board's staff functions.

Finally, the Oversight Board

should adopt necessary rules and keep permanent and accurate
records of its acts and proceedings.

Section 501 also provides that a chief executive officer of the
Corporation must be selected by the Oversight Board to serve at
the pleasure of the Board.

-Bi-

section 501 provides the corporate powers of the Corporation
under the direction of the Oversight Board to be as follows:

to

have a corporate seal; to issue capital certificates; to provide
for officers, employees and agents; subject to the approval of
the Oversight Board, to hire, promote, compensate, and discharge
officers and employees of the Corporation, without regard to
title 5, United States Code, provided that compensation and
benefits of such employees shall be consistent with those of the
Federal Deposit Insurance Corporation; to prescribe by the
Oversight Board its bylaws; with the consent of any executive
department or agency, to use the information, services, staff,
and facilities of such in carrying out this title; to enter into
contracts and make advances, progress, or other payments with
respect to such contracts; to acquire, hold, lease, mortgage, or
dispose of, at public or private sale, real and personal
property, and otherwise exercise all the usual incidents of
ownership of property necessary and convenient to its operations;
to obtain insurance against loss; to modify or consent to the
modification of any contract or agreement to which it is a party
or in which it has an interest under this title; to deposit its
securities an its current funds under the terms and conditions
applicable to the Federal Deposit Insurance Corporation under
Section 13(b) of the Federal Deposit Insurance Act and pay fees
therefor and receive interest thereon as may be agreed; and to
exercise such other powers as set forth in this title, and such
incidental powers as are necessary to carry out its powers,
duties and functions in accordance with this title.

- 52 -

In addition, Section 501 provides that the Resolution Trust
Corporation has special powers as follows:

1. To enter into contracts with the Federal Deposit Insurance
Corporation (which is required to be the primary manager that
will manage assets and institutions unless otherwise specifically
provided by the Oversight Board) and with such other persons or
entities, public and private, as it deems advisable and necessary
in order to manage the institutions for which it is responsible
and their assets.

All contracts with persons or entities other

than the Federal Deposit Insurance Corporation are required to be
subject to a competitive bid process.

2. To set the policy on credit standards to be used by an
institution for which it is responsible.

3. To require a merger or consolidation of an institution for
which it is responsible.

4. To organize one or more Federal mutual savings associations,
which must be chartered by the Federal Home Loan Bank System and
insured by the Federal Deposit Insurance Corporation through the
Savings Association Insurance Fund.

5. To review and analyze all insolvent institution cases
resolved by the Federal Savings and Loan Insurance Corporation
since January 1, 1988, through the date of enactment of this Act,

- 53 -

and to actively review all means by which it can reduce costs
under existing Federal Savings and Loan Insurance Corporation
agreements, including through the exercise of rights to
restructure such agreements, subject only to the monitoring of
the Oversight Board.

The Corporation is required to report to

the Oversight Board the results and conclusions of its
examination, and thereafter the Corporation, as permitted by the
terms of any resolution agreement and upon the express
concurrence of the Oversight Board, may restructure such
agreements where savings would be realized therefrom, the costs
of which restructuring shall be a liability of the Corporation.

6. To exercise all resolution powers and activities authorized
to be exercised by the Federal Deposit Insurance Corporation and
the former Federal Savings, and Loan Insurance Corporation,
including but not limited to the powers and authorities with
respect to receiverships or conservatorships, to engage in
assistance transactions, to collect indebtedness, to enforce
liabilities and obligations, and to exercise relevant incidental
powers.

7. To exercise such other incidental powers that the Corporation
determines to be necessary to carry out its purposes.

With respect to institutions managed by the Corporation (those
organized as federal mutuals by the Corporation) Section 501
provides that they are subject to conditions and limitations

- 54 -

imposed by the Corporation on the following:

growth of assets;

lending activities; asset acquisitions (except as necessary to
serve its existing customer base with residential mortgages or
consumer loans); use of brokered deposits; and payment of deposit
rates.

It is further provided that all such savings associations

are subject to all laws, rules, and regulations otherwise
applicable to them as insured savings associations, and to their
appropriate regulators.

Section 501 requires the Corporation to convert the Federal Asset
Disposition Association ("FADA") to a corporation or other
business entity and sell it, wind it down, or dissolve it, no
late than 180 days after enactment of this law.

If FADA is sold,

no contract rights to manage savings association resolutions
would be transferred.

Section 501 authorizes the Corporation to issue nonvoting capital
certificates to the Resolution Funding Corporation in an amount
equal to the aggregate amount of funds provided to it by the
Resolution Funding Corporation.

The Corporation may not pay •

dividends on is capital certificates.

The Corporation, the

capital, reserves, and surplus thereof, and the income derived
therefrom, are exempt from Federal, State, municipal, and local
taxation except taxes on real estate held by the Corporation,
according to its value as other similar property held by other
persons is taxed.

Finally, the Corporation is required to

terminate five years after this law is enacted.

Simultaneously

- 55 -

with the termination of the Corporation, all its assets and
liabilities must be transferred to the FSLIC Resolution Fund to
be managed by the Federal Deposit Insurance Corporation with the
proceeds of the net assets being provided to the Resolution
Funding Corporation to pay interest costs.

Section 501 provides for jurisdiction of law suits in which the
Corporation is a party.

Section 501 further provides that guarantees issued by the
Federal Savings and Loan Insurance Corporation after January 1,
1989, and before the date of enactment of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989, made
in connection with liquidity advances made to savings
associations by the Federal Reserve Banks and Federal Home Loan
Banks (the "Lenders") and guaranteed by the Federal Savings and
Loan Insurance Corporation during such period, become by
operation of law obligations of the Corporation.

These

obligations under the guarantees to the Lenders are required to
be paid by the Corporation one year after the date of enactment
of this law (to the extent that the loans have not previously •
been paid) using any funds or other assets available to the
Corporation, including resources available to it through
borrowing by the Resolution Funding Corporation.

Section 501 authorizes the Corporation to issue such regulations,
policies, procedures, guidelines, or statements as that

- 56 -

Corporation considers necessary or appropriate to carry out its
functions.

Finally, Section 501 provides the Corporation with an emergency
line of credit from the Treasury, and authorizes and directs the
Secretary of the Treasury to loan to the Corporation on such
terms as may be fixed by the Secretary of the Treasury amounts
not exceeding in the aggregate $5,000,000,000 outstanding at any
one time.

Subtitle B — Resolution Funding Corporation

Section 502.

RESOLUTION FUNDING CORPORATION ESTABLISHED.

Section 50-2 amends the Federal Home Loan Bank Act to add a new
section 21b that establishes a corporation to be known as the
Resolution Funding Corporation (hereinafter referred to as the
"Funding Corporation") to provide funds to the Resolution Trust
Corporation ("RTC") through the issuance of debt obligations to
the public.

New section 21b requires the Federal Home Loan Banks

("FHLBanks" or "Banks") to invest in the newly created Funding
Corporation, which, in turn, will be required to invest in the
RTC.

Under subsection (b) of new section 21b, the Chairman of

the Federal Home Loan Bank System ("Chairman") is required to
charter the Funding Corporation no later than five days after the
enactment of this title V of the Financial Institutions Reform,
Recovery and Enforcement Act of 1989.

- 57 -

Subsection (c) of new section 21b provides for a Directorate that
will manage the Funding Corporation.

The Directorate will be

composed of three members, one of whom will be the Director of
the Office of Finance of the FHLBanks or his successor, and two
of whom will be selected by the Oversight Board of the Resolution
Trust Corporation ("Oversight Board") from among the presidents
of the FHLBanks.

Each of the two FHLBank presidents will serve

for a term of three years.

With respect to the initial terms of

the two presidents, one such president will be appointed for a
term of two years and one will be appointed for a term of three
years, and thereafter, each member will be appointed for a term
of three years.

No president of a FHLBank will be selected to

serve an additional term on the Directorate unless each of the
FHLBank presidents had already served at least as many terms as
the' president being selected to serve the additional term.

The

Oversight Board will select a chairperson of the Directorate from
among the three members.

Paragraph (9) of subsection (c)

provides that members of the Directorate will not receive any
compensation from the Funding Corporation for their service on
the Directorate.

Paragraph (6) of subsection (c) of new section 21b provides that
the Funding Corporation will have no paid employees, and that the
Directorate, with the approval of the Chairman, can authorize the
officers, employees, or agents of the FHLBanks to act for and on
behalf of the Funding Corporation to carry out the functions of
the Funding Corporation.

- 58 -

Paragraph (7) of subsection (c) provides that all administrative
expenses, issuance costs and custodian fees will be paid by the
FHLBanks.

The amount each FHLBank will pay will be determined by

the Oversight Board with each Bank paying a pro rata amount based
upon its required capital stock investment in the Funding
Corporation.

Administrative expenses of the Funding Corporation

do not include the interest on its obligations.

The terms

"issuance costs" and "custodian fees" are defined under
subsection (k) of this new section 21b.

Subsection (d) of new section 21b provides for the corporate
powers of the Funding Corporation.

The Funding Corporation,

subject to the other provisions of this section and to the
regulations, orders and directions as may be prescribed by the
Oversight Board, will have the corporate powers necessary and
appropriate for its operations as a specialized corporate entity.
Such corporate powers include the power to issue nonvoting
capital stock to the FHLBanks; to purchase capital certificates
issued by the RTC; to borrow from the capital markets by issuing
debt, the proceeds of which will be invested in the RTC, or used
to refund obligations whose proceeds were so invested, under
terms and conditions approved by the Oversight Board; and other
powers which are customary and usual for corporations generally.

The Funding Corporation will be owned by the FHLBanks and will be
used as a means of purchasing capital certificates issued by the
RTC.

Paragraph (1) of subsection (e) of new section 21b requires

- 59 -

each FHLBank to invest in the nonvoting capital stock of the
Funding Corporation at such time and in such amounts as
prescribed by the Oversight Board.

The stock issued by the

Funding Corporation to the FHLBanks will have a par value
determined by the Oversight Board and will be transferable only
among the FHLBanks as prescribed by the Oversight Board at not
less than par.

The Banks' investment will be lawful,

notwithstanding limitations found elsewhere in the Federal Home
Loan Bank Act.

Paragraph (3) of subsection (e) of new section 21b limits the
cumulative investment for capitalization of the Funding
Corporation by each FHLBank to the aggregate of its legal
reserves plus "undivided profits" minus amounts the Banks will
have used to invest in the capital stock of the Financing
Corporation.

This limitation will be calculated by adding each

Bank's legal reserves on December 31, 1988, plus "undivided
profits" on such date, minus amounts invested in the Financing
Corporation as of such date, and by adding, for the period
December 31, 1988 through December 31, 1991, or such later date
as necessary to fund the Funding Corporation Principal Fund,
legal reserves plus "undivided profits" minus amounts required to
be used to invest in the Financing Corporation.

For purposes of

the Banks' investment in the Funding Corporation, the language
referring to "legal reserves" and "undivided profits" will
include all retained earnings of the FHLBanks except for those
amounts held in the "dividend stabilization reserve" as of

- 60 -

December 31, 1985, and amounts required to be used by the
FHLBanks to purchase capital stock in the Financing Corporation.

The "dividend stabilization reserve" will be excluded from
investment in the Funding Corporation because it includes funds,
above the legal reserves, that had been determined not to be paid
as dividends in the year earned, so as to create a possible
supplement to future years' dividends.

To ensure that only

amounts held in the "dividend stabilization reserve" as of
December 31, 1985, are excluded from the amounts that may be
invested in the Funding Corporation, the legislation
cross-references the table set forth in section 21(a)(7) of the
Federal Home Loan Bank Act, which table specifically lists the
amounts held by each FHLBank in its "dividend stabilization
reserve" as of December 31, 1985.

For purposes of this section,

"undivided profits" includes retained earnings other than legal
reserves and amounts held in the "dividend stabilization reserve"
as of December 31, 1985.

"Legal reserves" refers to the amount

each FHLBank has and is required to carry to a reserve account
pursuant to the first two sentences of Section 16(a) of the
Federal Home Loan Bank Act.

Under paragraph (4) of subsection (e) of new section 21b, each
FHLBank is required to purchase a specified percentage of the
first $1 billion of stock in the Funding Corporation.

The

percentage of the first $1 billion that each Bank is required to
invest in nonvoting capital stock of the Funding Corporation is

- 61 -

derived from a formula taking into account each Bank's individual
share of total FHLBank System retained earnings (minus their
"dividend stabilization reserves" and amounts used to invest in
the capital stock of the Financing Corporation") and the share of
deposits insured by the Federal Savings and Loan Insurance
Corporation ("FSLIC") immediately prior to the enactment of this
Act held by each Bank's member savings associations.

By taking

into account the shares of such FSLIC-insured deposits held by a
Banks' member savings associations, the formula accommodates
Banks' member savings associations that were insured by the
Federal Deposit Insurance Corporation ("FDIC") immediately prior
to the enactment of this Act.

Under paragraph (5) of subsection (e), allocation of the
remaining stock purchases is based on the percentage of total
assets of members insured by FSLIC immediately prior to the
enactment of this Act represented at each Bank; however, no Bank
is required to exceed the limitation set forth in paragraph (3)
of subsection (e). The aggregate amount of Funding Corporation
stock that must be purchased by all of the FHLBanks is not
reduced because of the limitation in that paragraph.

Therefore,

paragraph (6) of subsection (e), described below, provides for a
reallocation of stock purchases among Banks that have not reached
their limits.

Paragraph (6) of subsection (e) of new section 21b provides that
if a FHLBank cannot purchase the full amount of stock in the

- 62 -

Funding Corporation because that amount exceeded its legal
reserves plus undivided profits minus the amount the Bank used to
invest in the Financing Corporation, the amount that the Bank
cannot purchase will be prorated for investment among the
remaining FHLBanks based on their stock holdings in the Funding
Corporation, as long as the cumulative amount of funds required
to be invested by the remaining Banks did not exceed their legal
reserves plus undivided profits minus the amounts used to invest
in the Financing Corporation.

Any FHLBank that did not purchase the full amount of Funding
Corporation capital stock as required under the formula in
paragraph (5) will be required to purchase, annually at the
issuance price, from those Banks to which such stock was
reallocated, the stock originally allocated to it under such
paragraph.

The amount of such stock repurchases will be

determined by the Oversight Board by prorating among the
FHLBanks, based upon the amount reallocated to and purchased and
held by such Banks, the amount available for such purchases.

The

"amount available" includes all retained earnings of the Bank on
whose behalf an investment has been made under subparagraph
(A)(i), less certain amounts.

The "amount available" does not

include the Bank's special dividend stabilization reserve (as of
December 31, 1985), nor an amount of retained earnings equal to
the amount of Funding Corporation and Financing Corporation
capital stock already purchased by the Bank.

Until the

restricted Bank has fulfilled this repurchase obligation, it is

- 63 -

prohibited from paying dividends in excess of one-quarter of its
net earnings available for dividends.

Such funds not paid out in

dividends are to be placed in a reserve account required by the
Oversight Board and will not be available for dividends.

Paragraph (7) of subsection (e) of new section 21b provides for
additional sources of funds for the Funding Corporation Principal
Fund in the event that each FHLBank has exhausted the investment
amount applicable with respect to such Bank under paragraph (3)
(and paragraph (9), described below), as calculated under
paragraphs (4), (5) and (6) of subsection (e). Subparagraph (A)
of paragraph (7) provides that, first, the Funding Corporation,
with the approval of the Board of Directors of the FDIC, will
assess each Savings Association Insurance Fund member an
assessment as if such assessment was assessed by the FDIC with
respect to Savings Association Insurance Fund members pursuant to
section 7 of the Federal Deposit Insurance Act, as amended.

The

maximum amount of the aggregate amount assessed, however, will be
the amount of additional funds necessary to fund the Funding
Corporation Principal Fund; provided that the amount assessed
under this subparagraph (A) and the amount assessed by the
Financing Corporation under section 21 of the Federal Home Loan
Bank Act will not exceed the amount authorized to be assessed
pursuant to section 7 noted above.

The Financing Corporation

will have first priority to make such assessments.

All such

amounts assessed under this subparagraph (A) will be subtracted
from the amounts authorized to be assessed by the FDIC pursuant

- 64 -

to section 7 noted above.

To the extent funds available pursuant to subparagraph (A) are
insufficient to capitalize the Funding Corporation so as to
provide funds for the Funding Corporation Principal Fund, then
the FDIC will transfer to the Funding Corporation from the
receivership proceeds of the FSLIC Resolution Fund the remaining
amount of funds necessary for such purpose.

Paragraph (9) of subsection (e) of new section 21b provides that
notwithstanding any other limiting provisions in sections 21, 21a
and 21b of the Federal Home Loan Bank Act, the aggregate annual
amount that will be contributed by the FHLBanks from their annual
earnings under subsections (e)(3)(B) and (f)(2)(B) of this
section (foir the period from the- date of enactment of this Act,
until such time as the Funding Corporation has no more
liabilities) for Funding Corporation principal and interest
payments and Financing Corporation principal payments under
section 21 of the Federal Home Loan Bank Act, for any given year,
will be $300,000,000; provided, however, that such aggregate
annual amount will be such lesser number equal to all the amounts
needed for the purposes of subsection (e), as determined by the
Oversight Board, if such total amounts will be less than
$300,000,000.

This amount will be in addition to the

approximately $2,000,000,000 by the FHLBanks to be contributed
from their retained earnings as of December 31, 1988/ which are
not needed by the existing Financing Corporation.

- 65 -

Paragraph (1) of subsection (f) of new section 21b authorizes the
Funding Corporation, subject to the direction of the RTC, to
issue up to $50,000,000,000 in debt obligations. Paragraph (2)
of subsection (f) provides for the payment of interest on such
obligations. The Funding Corporation will pay the interest due
on (and any redemption premium with respect to) Funding
Corporation obligations from funds obtained for such interest
payments from certain specified sources described below.

Subparagraph (A) requires the RTC to pay to the Funding
Corporation the net proceeds received by the RTC from the
liquidation of institutions under its management, pursuant to new
section 21a of the Federal Home Loan Bank Act, to the extent they
are determined by the Oversight Board to be in excess of funds
necessary for resolution costs in the near future, and any
proceeds from warrants and participations of the RTC.

Subparagraph (B) provides that to the extent the funds available
from the RTC pursuant to subparagraph (A) are insufficient to
cover the amount of interest payments on the obligations, then
the FHLBanks will pay to the Funding Corporation the aggregate
annual amount of $300,000,000, minus the amounts needed by the
Financing Corporation pursuant to section 21 of the Federal Home
Loan Bank Act and for the purchase of Funding Corporation capital
certificates, with each Bank's individual share to be determined
pursuant to the formulation and limitations of paragraphs (3)
through (6) of subsection (e).

- 66 -

Subparagraph (C) provides that the proceeds of all net assets of
the RTC, upon its dissolution, will be transferred to the Funding
Corporation to be used for interest payments before any Treasury
funds are used.

Finally, subparagraph (D) provides that, to the extent that the
Directorate determines after consultation with and approval of
the Secretary of the Treasury that the Funding Corporation is
unable to pay the interest on any obligation issued under this
subsection from the sources of funds under (A), (B), and (C), the
Secretary of the Treasury will pay to the Funding Corporation the
additional amount due which will be used by the Funding
Corporation to pay such interest.

In each case where the

Secretary of the Treasury is required to make a payment under
this paragraph to the Funding Corporation, the amount of the
payment will become a liability of the Funding Corporation that
will be repaid to the Secretary of the Treasury upon dissolution
of the Funding Corporation to the extent that the Funding
Corporation may have any remaining assets.

There is authorized

to be appropriated to the Secretary of the Treasury, for fiscal
year 1989 and each fiscal year thereafter, such sums as may be
necessary to carry out this paragraph.

Paragraph (3) of subsection (f) provides that on maturity of an
obligation issued by the Funding Corporation under this
subsection, the obligation will be repaid by the Funding
Corporation from the liquidation of noninterest bearing

- 67 -

instruments held in the Funding Corporation Principal Fund.

The

Funding Corporation will obtain funds for such Principal Fund
from the sources of funds obtained pursuant to subsection (e).
All of such funds will be invested in noninterest bearing
instruments which are described in paragraph (1) of subsection
(g) of this new section 21b.

Paragraph (4) of subsection (f) provides that, subject to the
terms and conditions as approved by the Oversight Board, the
gross, proceeds of any obligation issued by the Funding
Corporation will be used to purchase capital certificates issued
by the RTC or to refund any previously issued obligation the
proceeds of which were invested in the capital certificates of
the RTC.

Under paragraph (5) of subsection (f) of new section 21b,
obligations of the Funding Corporation with the approval of the
Oversight Board, like FHLBank obligations, will be lawful
investments and may be accepted as security for all fiduciary,
trust, and public funds, the investment or deposit of which will
be under the authority or control of the United States or any
officer thereof.

Under paragraph (6) of subsection (f) of new section 21b,
obligations of the Funding Corporation will be treated in the
same manner as FHLBank obligations for purposes of investment,
sale, underwriting, purchase, use as collateral, and dealing by

- 68 -

financial institutions such as banks, thrifts, and credit unions.

Under paragraph (7) of subsection (f) of new section 21b,
obligations issued by the Funding Corporation will have the same
tax status as obligations of the FHLBanks.

Thus, interest earned

on those obligations will be taxable as income at the Federal,
but not the State level.

Under paragraph (8) of subsection (f) of new section 21b,
obligations issued by the Funding Corporation will be' exempt
securities under the provisions of the Federal securities laws
administered by the Securities and Exchange Commission.

Paragraph (9) of subsection (f) of new section 21b, requires the
Oversight Board and the Directorate to ensure that minority owned
or controlled commercial banks, investment banking firms,
underwriters, and bond counsels throughout the United States have
an opportunity to participate to a significant degree in any
public offering of obligations issued by the Funding Corporation
under this section.

Under paragraph (10) of subsection (f) of new section 21b, the
Funding Corporation's obligations will not be obligations of or
guaranteed as to principal by the Chairman of the Federal. Home
Loan Bank System, the FHLBanks, the United States, or the RTC.
The Secretary of the Treasury will pay interest on such
obligations as required by subsection (f) of this section.

- 69 -

Subsection (g) of new section 21b sets forth the use and
disposition of assets of the Funding Corporation not required to
be invested in the RTC, not required for current interest
payments, and not required for the Funding Corporation Principal
Fund.

Paragraph (1) provides that, subject to the regulations,

restrictions, an limitations prescribed by the Oversight Board,
such assets will be invested in the instruments described in
subparagraphs (A), (B), (C) and (D), which are the same
instruments FHLBanks are permitted to invest their resources
under section 16 of the Federal Home Loan Bank Act.

Paragraph (2) of subsection (g) requires the Funding Corporation
to invest in and hold in a segregated account, zero coupon
instruments, Treasury STRIPS or other noninterest bearing
instruments, as described in paragraph (1) of that subsection,•of
which the total principal payable at maturity will approximately
be equal to the aggregate amount of principal on the Funding
Corporation's obligations.

The purpose of this segregated

account is to assure the repayment of principal on the Funding
Corporation's obligations.

Under paragraph (1) of subsection (h) of new section 21b, the
Funding Corporation will have the same tax status as the
FHLBanks.

In addition under paragraph (1), the Secretary of the

Treasury is authorized to prepare the necessary forms of stock,
debentures, and bonds, as approved by the Oversight Board,
pursuant to section 23 of the Federal Home Loan Bank Act, for

- 70 -

obligations of the Funding Corporation, as the Secretary of the
Treasury is also so authorized for obligations of the FHLBanks.

Paragraph (2) of subsection (h) of new section 21b provides that
the Federal Reserve banks are authorized to act as depositaries
for or fiscal agents or custodians of the Funding Corporation.

Paragraph (3) of subsection (h) of new section 21b accords the
Funding Corporation, although the Corporation will have no
Government capital invested in it, the same coverage under the
Government Corporations Control Act as the FHLBanks are accorded
under that Act pursuant to section 11(j) of the Federal Home Loan
Bank Act (12 U.S.C. 1431 (j).

Thus, audits of the Funding

Corporation will be conducted by the General Accounting Office.
In addition, the Secretary of the Treasury, a Federal Reserve
Bank, or a bank designated as a depository or fiscal agent of the
United States Government has the authority to keep funding
Corporation accounts (although the Secretary of the Treasury can
waive the provision regarding accounts).

Furthermore, before the

Funding Corporation can issue obligations and offer them to the
public, the Secretary of the Treasury will prescribe the various
conditions to which the obligations will be subject (including
the form, denomination, maturity, and interest rate), the way and
time the obligations will be issued, and the price for which the
obligations will be sold.

This procedure is currently in place

for the issuers who are subject to Section 9108(a) of title 31,
United States Code (part of the Government Corporations Control

- 71 -

Act) and in practice the Treasury generally approves terms and
conditions on obligations as proposed by these issuers.

Finally,

before the Funding Corporation could buy or sell a direct
obligation of the United States Government, or an obligation on
which the principal, interest, or both, is guaranteed, of more
than $100,000, the Secretary of Treasury will have to approve the
purchase or sale, although the Secretary can waive this
requirement.

All of these authorities also pertain to the

FHLBanks' issuance of debt.

Paragraph (4) of subsection (h) of new section 21b provides that
any civil action, suit or proceeding to which the Funding
Corporation is a party, will be deemed to arise under the laws of
the United States, and the U.S. District Court for the District
of Columbia will have original jurisdiction over any such action,
suit or proceeding.

The Funding Corporation is authorized,

without bond or security, to remove any such action, suit or
proceeding from a State court to the U.S. District Court for the
District of Columbia.

Subsection (i) of new section 21b provides for the termination of
the Funding Corporation.

The Funding Corporation will be

dissolved, as soon as practicable, after the date by which all
the RTC capital certificates purchased by the Funding Corporation
have been retired.

On the effective date of the Funding

Corporation's dissolution, the Oversight Board will be authorized
to exercise any power of the Funding Corporation in order to

- 72 -

conclude its affairs.

Upon termination, the remaining funds will

be transferred to the Treasury to the extent of funds provided to
the Funding Corporation over the years and interest thereon, with
any remainder to the FHLBanks in retiring the capital stock.

Subsection (j) of new section 21b provides that the Oversight
Board will be authorized to prescribe such regulations as may be
necessary to carry out the provisions of new section 21b
including issuing regulations to define the terms used in the
section.

Subsection (k) of new section 21b defines certain terms that are
used in the section. Paragraph (1) defines "insured savings
association" to mean a savings association as such term is
defined by section 3(u) of the Federal Deposit Insurance Act and
which was insured by FSLIC immediately prior to the date of
enactment of this Act. Paragraph (2) defines the "Oversight
Board" to mean the Oversight Board of the RTC, and after
termination of the RTC to mean the Secretary of the Treasury, the
Chairman of the Federal Reserve Board and the Attorney General of
the United States. Paragraph (4) defines "issuance costs" to
mean issuance fees and commissions incurred by the Funding
Corporation in connection with the issuance or servicing of any
of the Funding Corporation's obligations, and includes legal and
accounting expenses, trustee and fiscal paying agent charges,
costs incurred in connection with preparing and printing offering
materials, and advertising expenses to the extent these costs is

- 73 -

incurred in connection with issuing any obligation.

Paragraph

(5) defines "custodian fees" to mean any fee incurred by the
Funding Corporation in connection with the transfer of or
maintenance of any security in the segregated account established
under subsection (g), and any other expense incurred in
connection with the establishment and maintenance of the
segregated account.

Section 503. FINANCING CORPORATION. This section amends section
21 of the Federal Home Loan Bank Act which established the
Financing Corporation.

Subsections (1), (2), (3) and (4) of this

section 503 provide for technical amendments to section 21.
These amendments essentially provide that after the enactment of
this Act the Financing Corporation, if necessary, will purchase
capital certificates or capital stock issued by the FSLIC .
Resolution Fund, which will be the successor to the Federal
Savings and Loan Insurance Corporation ("FSLIC").

These

certificates and stock will not pay dividends, and any payment on
them to the Financing Corporation upon termination of the FSLIC
Resolution Fund will be subordinate to any liability to Treasury
for the monies it has provided to that Fund.

Section 503 also replaces, with a new provision, the existing
subsection (f) of section 21 which authorized the Financing
Corporation to assess FSLIC insured institutions for amounts
necessary to obtain interest payments for Financing Corporation
obligations.

The new provisions identify the sources of funds

- 74 -

for interest payments to be as follows:

Paragraph (1) includes the Financing Corporation assessments
which were assessed on insured institutions pursuant to
subsection (f) of this section prior to the enactment of this
Act.

Paragraph (2) provides that the Financing Corporation, with the
approval of the Board of Directors of the Federal Deposit
Insurance Corporation, will assess on each insured Savings
Association Insurance Fund member an assessment as if such
assessment was assessed by the Federal Deposit Insurance
Corporation with respect to Savings Association Insurance Fund
members pursuant to section 7 of the Federal Deposit Insurance
Act.

The amount assessed hereunder, however, and the amount

assessed by the Funding Corporation under section 21b of the
Federal Home Loan Bank Act will not exceed the amount authorized
to be assessed under section 7 of the Federal Deposit Insurance
Act, and that the Financing Corporation will have first priority
to make such assessments.

In addition, all assessments made by

the Financing Corporation under section (2) and the Funding
Corporation under section 21b of the Federal Home Loan Bank Act
will be subtracted from the amounts authorized to be assessed by
the Federal Deposit Insurance Corporation under section 7 of the
Federal Deposit Insurance Act.

Paragraph (3) provides that to the extent the funds available

- 75 -

pursuant to paragraphs (1) and (2) are insufficient to cover the
amount of interest payments on the obligations, then the Federal
Deposit Insurance Corporation will transfer to the Financing
Corporation from the proceeds of the FSLIC Resolution Fund the
remaining amount of funds necessary for the Financing Corporation
to make interest payments only to the extent the funds are not
required by the Resolution Funding Corporation for the Funding
Corporation Principal Fund under section 21b of the Federal Home
Loan Bank Act.

Section 503 also defines "insured savings association" to mean a
savings association as such term is defined by section 3(U) of
the Federal Deposit Insurance Act and which was insured by the
Federal Savings and Loan Insurance Corporation immediately prior
to the date of enactment of this Act.

Section 504. Section 504 is a technical amendment to add the
Funding Corporation to the list of "mixed ownership" government
corporations under the Government Corporations Control Act.
Although there will be no government capital invested in the
Funding Corporation, this category of "mixed ownership" has been
accorded to the Funding Corporation to provide it with parallel
legal status to that of the FHLBanks.

TITLE VI - THRIFT ACQUISITION ENHANCEMENT PROVISIONS

- 76 -

Section 601.

ACQUISITION OF THRIFTS BY BANK HOLDING COMPANIES.

Section 601 amends the Bank Holding Company Act effective two
years after the date of enactment, to specifically permit the
Federal Reserve Board to allow bank holding companies to acquire
any savings association, not only failed or failing ones as the
Board currently permits.

The section also specifies that

effective immediately the Board shall not impose restrictions on
transactions between the savings association and its holding
company affiliates other than those imposed generally by the
affiliate transactions statutes at sections 23A and 23B of the
Federal Reserve Act or other applicable statutes.

This section

is intended to direct the Board not to impose its so-called
"tandem operations" restrictions on bank holding companies that
acquire thrift institutions.

Section 602. INVESTMENTS BY SAVINGS AND LOAN HOLDING COMPANIES
IN UNAFFILIATED THRIFT INSTITUTIONS.

Section 602 amends the

provisions governing savings and loan holding companies (section
408 of the National Housing Act, 12 U.S.C. 1730a, in current law;
to be transferred into the Home Owners' Loan Act) to allow a
savings and loan holding company to hold up to 5 percent of the
voting shares of an unaffiliated savings association or savings
and loan holding company.

This provision also permits multiple

savings and loan holding companies to acquire up to 5 percent of
the voting shares of any company.

Current law prohibits any such

ownership in savings associations other than a controlling
ownership.

This revised treatment is intended to mirror the

- 77 -

ability of bank holding companies to acquire up to 5 percent of
the voting shares of unaffiliated banks.

Section 603. TECHNICAL AMENDMENT TO THE BANK HOLDING COMPANY
ACT. Section 603 amends the Bank Holding Company Act (12 U.S.C.
1841) to define the terms "insured institution" and "savings
association." The definition used incorporates the definition in
the Home Owners' Loan Act, as amended.

TITLE VII - FEDERAL HOME LOAN BANK SYSTEM REFORMS

Subtitle A. —Federal Home Loan Bank Act Amendments

Section 701. DEFINITIONS. Section 701(a) would add a definition
for "savings association" to the Federal Home Loan Bank Act. The
definition conforms to the definition of that term in the
amendments of the Home Owner's Loan Act found in Title III of
this Act.

Section 701(b) creates a new paragraph (11) to Section 2 of the
Federal Home Loan Bank Act (12 U.S.C. 1422) to state that the
term "Chairman" used in-the Federal Home Loan Bank Act, as
amended, refers to the Chairman of the Federal Home Loan Bank
System.

Section 701(c) is a technical amendment to the Federal Home Loan

- 78 -

Bank Act, the Home Owner's Loan Act, as well as any other Federal
law in which a term thereof names the Federal Home Loan Bank
Board. This section makes clear that the Chairman of the Federal
Home Loan Bank System succeeds to all Federal statutory
provisions affecting the Federal Home Loan Bank Board, including
all prerogatives granted it by such laws except those expressly
repealed or amended by this Act. Although this Act expressly
amends selected references in several Federal statutes to the
Federal Home Loan Bank Board to read, Chairman of the Federal
Home Loan Bank System, this section is intended to amend all
other existing references to the Federal Home Loan Bank Board to
read Chairman of the Federal Home Loan Bank System.

SECTION 702. FEDERAL HOME LOAN BANK SYSTEM CHAIRMAN. This
section amends Section 17 of the Federal Home Loan Bank Act (12
U.S.C. 1437) as follows:

Subsection (a) is amended by abolishing the Federal Home Loan
Bank Board and vesting the powers and duties of the Federal Home
Loan Bank Board and of its Chairman in the Chairman of the
Federal Home Loan Bank System, who will continue to supervise and
regulate the Federal Home Loan Banks. The Chairman of the
Federal Home Loan Bank System will be subject to the general
directions of the Secretary of the Treasury. This latter
provision is similar to one for the Comptroller of the Currency
and is intended to provide the Secretary with the same oversight
authority over the Chairman of FHLBS as he currently has with

- 79 -

respect to the Comptroller.

The Chairman of the System will

implement the Federal Home Loan Bank Act, the Home Owners Loan
Act and other laws. The Chairman of the System will have
rulemaking authority to implement those laws.

Subsection (b) is amended to provide that the Chairman of the
System must be a citizen of the United States. He would be
appointed by the President for a five year term with the consent
of the Senate. The President would be able to remove the
Chairman. The President would be required to communicate the
reasons for removal to the appropriate committee of the Senate.
The Chairman would continue to serve until a successor is
appointed.

Subsection (c), provides that subject to the approval of the
Secretary of the Treasury, the Chairman of the System is
empowered to employ and fix the salaries of such employees,
attorneys, and agents. The Chairman would have the authority to
appoint agents as necessary to carry out his duties. The Chairma
would be authorized to designate who will act in the Chairman's
absence. The Chairman would have the authority to continue or
establish collective offices or administrative units of the
Federal Home Loan Banks and to appoint the heads of such entitie
after consulting the Federal Home Loan Banks. The Chairman woul
be authorized to delegate to an agent any power (except
rulemaking).

- 80 -

Subsection (d) provides that the Chairman of the System has the
authority to suspend or remove any director, officer, employee,
or agent of any Federal Home Loan Bank or any joint office or
administrative unit of such bank, and is revised only to require
that the fact of suspension or removal be communicated to that
person.

Subsection (e) provides that the salaries of the Chairman and
other agents and employees will be paid from assessments levied
on the Federal Home Loan Banks and that such assessments, like
those imposed by the Comptroller of the Currency on national
banks under 12 U.S.C. 481, shall not be construed as Government
funds or appropriated monies.

Compensation, other than that of

the Chairman would be paid (as in the Comptroller's Office)
without regard to other laws applicable to officers or employees
of the United States.

Subsection (f) provides that the Chairman shall not have a
financial interest in a member of a Federal Home Loan Bank.

Subsection (g) restates existing provisions of Section 17 to
preserve authority exercised by the Board when it was a
constituent agency of the Housing and Home Finance Agency.

Subsection (h) is amended to provide that the Chairman will make
an annual report to Congress.

- 81 -

Section 703.

ELECTION OF BANK DIRECTORS.

This section would

change the law by changing the manner of the selection of the
directors of the Federal Home Loan Banks. It would establish
three classes of directors, with three directors chosen for each
class. The Class A directors would represent the stockholding
members of the bank and be chosen by the stockholding members.
Class C directors would represent the public and would be chosen
by the Chairman of the Federal Home Loan Bank System. The
Class B directors would be chosen by the Class A directors and
the Class C directors to represent the housing industry and the
financial services industry. The Chairman of the Federal Home
Loan Bank System would appoint one of the Class C directors as
the chairman of the board of directors of each Federal Home Loan
Bank and one Class C Director as deputy chairman, who would serve
in the absence of the chairman. The third Class C director would
serve in the absence of the chairman and deputy chairman.

The provisions regarding the election of directors are, in large
part, based on similar provisions governing the directors of
Federal Reserve banks.

Section 704. FEDERAL HOME LOAN BANK LENDING. Section 704
authorizes the Federal Home Loan Banks to make loans to the
Federal Deposit Insurance Corporation, subject to the concurrence
of the Chairman of the Federal Home Loan Bank System, for the use
of the Savings Association Insurance Fund and provides that such
loans to the Corporation shall be a direct liability on that

- 82 -

insurance fund.

This provision is substituted for the current

law provision, under which the Federal Home Loan Banks are
authorized to make such loans to the Federal Savings and Loan
Insurance Corporation.

Section 705. CHIEF SUPERVISORY OFFICER. Section 705(a) requires
the senior supervisory employee of each Federal Home Loan Bank to
report to the chief supervisory official of the Chairman of the
Federal Home Loan Bank System.

This section authorizes the

Chairman of the Federal Home Loan Bank System to remove the
senior supervisory employee of each Bank for cause.

This section

retains the title, established by the Federal Home Loan Bank
Board through regulation, of Principal Supervisory Agent for the
senior supervisory employee of each Bank.

It is the intent of

this section that the President of the district bank will no
longer be responsible for the supervisory role of the district
bank.

Section 705(b) amends the heading of section 19 of the Federal
Home Loan Bank Act to reflect the substantive changes made in
that section.

Section 706. THRIFT ADVISORY COUNCIL. Section 706 (1) amends
section 8a of the Federal Home Loan Bank Act to change the name
of the Federal Savings and Loan Advisory Council to the Thrift
Advisory Council.

- 83 -

Section 706 (2) and (3) amend section 8a of the Federal Home Loan
Bank Act to delete obsolete references to the Board of Trustees
of the Federal Savings and Loan Insurance Corporation and to the
Corporation itself.

Section 707. FEDERAL SAVINGS AND LOAN INSURANCE CORPORATION
INDUSTRY ADVISORY COMMITTEE.

This section abolishes the Federal

Savings and Loan Insurance Corporation Industry Advisory
Committee.

Section 708. RATE OF INTEREST. This section repeals section 5b
of the Federal Home Loan sank Act as that provision is obsolete.

Section 709. LIQUIDITY REQUIREMENTS. Section 709 (1) makes a
technical change to section 5A of the Federal Home Loan Bank Act.

Section 709 (2) amends Section 5A by substituting at subsection
(d) the Federal Deposit Insurance Corporation for the Federal
Savings and Loan Insurance Corporation which would allow a
penalty assessment for deficiency in compliance with the
section's liquidity requirements made against a savings
association to be paid to the Federal Deposit Insurance
Corporation if the offending savings association is not a member
of a Federal Home Loan Bank.

It is intended that any penalty

paid to the Federal Deposit Insurance Corporation under authority
of section 5A of the Federal Home Loan Bank Act, as amended, will
be for the use of the Savings Association Insurance Fund.

- 84 -

Section 709(3) makes a technical amendment to subsection (f) of
section 5A of the Federal Home Loan Bank Act.

Section 709(4) would allow the Chairman of the Federal Home Loan
Bank System to classify, by regulation, as a liquid asset such
other assets as the Chairman of the System may determine comports
with the purposes of subsection (a) of Section 5a, as amended.

Section 710. ADVANCES. Section 710(a) substitutes "savings
association" for "insured institution" at subsection (e) of
section 10 of the Federal Home Loan Bank Act.

Section 710(b) substitutes "Section 1467a" for "Section
1730a(a)(1)(A)" at paragraph (3)(A) of subsection (e) of section
10 of the Federal Home Loan Bank Act.

Section 710(c) substitutes "Section 1467a" for "Section 1730a (o)
in paragraph (3)(B) of subsection (e) of section 10 of the
Federal Home Loan Bank Act.

Section 710(d) substitutes "Section 1467a" for "Section
1730a(o)(5)(A) in paragraph (3)(C) of subsection (e) of section
10 or the Federal Home Loan Bank Act.

Section 711. CONFORMING FEDERAL HOME LOAN BANK ACT AMENDMENTS.
Section 711(a) deletes a portion of section 1438(c)(5) of Title
12, United States Code, regarding the receipts from the sale of

- 85 -

the Board's old building and receipts from a special assessment
to build the current Board building.

Section 711(b) deletes a portion of section 1438(c)(6) of Title
12, United States Code, regarding the submission of a budget for
the current Board building.

Section 711(c) repeals section 1438a of Title 12, United States
Code as obsolete. It will no longer be necessary to
differentiate between administrative and nonadministrative
expenses of the Chairman of the Federal Home Loan Bank System.

Section 711(d) deletes the last sentence of section 1439 of Title
12, United States Code which refers to obsolete reference to
nonadministrative expenses.

Section 711(e) deletes a portion of section 101 of Title I of the
Act of June 16, 1943 (12 U.S.C. 1439a) which refers to a
provision repealed by section 713 of this Act to conform with
section 713 of this Act.

Section 711(f) amends section 111 of Title I of Public Law No.
93-495 to delete the term "the Federal Home Loan Bank Board."

Subtitle B. — Conforming Amendments

Section 712. FEDERAL HOME LOAN MORTGAGE CORPORATION ACT

- 86 -

AMENDMENTS.

Section 712 (1) changes the composition of the three

member board of directors of the Federal Home Loan Mortgage
Corporation to include, ex officio, the Chairman of the Federal
Home Loan Bank System, who shall be chairman of the board of
directors, the Secretary of the Treasury (or his designee), and
the Secretary of Housing and Urban Development (or his designee),
and provides that the board of directors may elect a
Vice-chairman.

Section 712 (2) substitutes the Resolution Trust Corporation for
the Federal Savings and Loan Insurance Corporation in section 305
of the Federal Home Loan Mortgage Corporation Act, and also
substitutes the term "Chairman" for the term "Board" in the last
sentence of subsection (a)(2) of said section 305.

Section 713. REPEAL OF LIMITATION OF OBLIGATION FOR
ADMINISTRATIVE EXPENSES.

This section amends subsection (b) of

section 7 of the First Deficiency Appropriation Act of 1936 to
delete the terms "Federal Home Loan Bank Board", "Home Owner's
Loan Corporation", and "Federal Savings and Loan Insurance
Corporation."

The reference to the Home Owner's Loan Corporation is deleted
because that instrumentality, once a component of the Federal
Home Loan Bank Board, was dissolved in 1951.

Section 714.

AMENDMENT OF ADDITIONAL POWERS OF CHAIRMAN.

- 87 -

Section 714(A) makes a technical amendment to subsection (c) of
section 502 of the Housing Act of 1948, as amended, to strike out
obsolete terms and substitute therefor the term, "Chairman of the
Federal Home Loan Bank System."

Section 714(B) amends subsection (1) of subsection (c) of said
section 502 by inserting the term "Federal" between the terms "of
any" and "State or".

This amendment will authorize the Chairman

of the Federal Home Loan Bank System to accept or contract for
services with another Federal agency.

Section 715. AMENDMENT OF TITLE 5, UNITED STATES CODE.
Section 715(A) makes a technical amendment to Section 5314 of
Title 5, United States Code regarding the salary of the Chairman
of the Federal Home Loan Bank System.

Section 715(B) adds a reference to sections 17a of the Federal
Home Loan Bank Act (12 U.S.C. 1437) and section 19 of the Federal
Home Loan Bank Act (12 U.S.C. 1439) to section 5373 of Title 5,
United States Code in order to make that provision consistent
with the mandate of section 702 of this Act that decisions
regarding the salaries and administration of staff personnel
employed by the Chairman of the Federal Home Loan Bank System are
made by the Chairman, subject to approval by the Secretary of
Treasury, without regard to any other laws regarding employees of
the Federal Government.

- 88 -

Section 716.

AMENDMENTS OF TITLE 31, UNITED STATES CODE.

Section 716(A) creates a new section 307a of Title 31, United
States Code to reflect the fact that the Chairman of the Federal
Home Loan Bank System is subject to the general direction of the
Secretary of the Treasury.

Section 716(B) adds a new paragraph (3) to subsection (c) of
Section 321, Title 31, United States Code in order to clarify the
relationship between the Chairman of the Federal Home Loan Bank
System and the Secretary of the Treasury.

Section 716(C) adds the term "Office of the Chairman of the
Federal Home Loan Bank System" to subsection (a) of section 714,
Title 31, United States Code, in order to authorize audits by the
Comptroller General.

Section 716(D) deletes a reference to the Federal Savings and
Loan Insurance Corporation.

Section 717. AMENDMENT OF BALANCED BUDGET AND EMERGENCY DEFICIT
CONTROL ACT PROVISIONS.

Section 717(A) makes technical changes

to subsection (1)(A) of subsection (g) of section 255 of the
Balanced Budget and Emergency Deficit Control Act of 1985 to
substitute the Chairman of the Federal Home Loan Bank System and
Resolution Trust Corporation for the Federal Home Loan Bank Board
and Federal Savings and Loan Insurance Corporation.

- 89 -

Section 717(B)(1) makes technical changes to subsection (4) of
subsection (b) of said section 256 to substitute the Chairman of
the Federal Home Loan Bank System and Resolution Trust
Corporation for the Federal Home Loan Bank Board.

Section 717(B)(2) deletes a reference to the Federal Savings and
Loan Insurance Corporation in said provision.

Section 718. AMENDMENT OF TITLE 18, UNITED STATE CODE.
Section 718(A) repeals sections 1008 and 1009 of Title 5, United
States Code as obsolete.

Section 718(B)(1) strikes a reference in said section to the
Federal Home Loan Bank Board and Home Owner's Loan Corporation
and adds a reference to a Federal savings bank.

Section 718(B)(2 ) &(3 ) make technical changes in said section to
reflect amendments made by this Act.

Section 718(B)(4) strikes a reference to the Federal Savings and
Loan Insurance Corporation.

TITLE VIII - BANK CONSERVATION ACT AMENDMENTS

Section 801. DEFINITIONS. Section 801 amends section 202 of the
Act of March 9, 1933, title II of which is the Bank Conservation

- 90 -

Act ("Act").

The amendment defines the term "bank" to include

federally-chartered financial institutions, other than national
banks, that are supervised by the Comptroller (hereinafter
referred to as "bank").

This added provision would permit the

Comptroller to place into conservatorship institutions such as
federal branches of foreign banks.

Section 802. APPOINTMENT OF CONSERVATOR. Section 802 amends
section 203 of the Act to give the Comptroller exclusive
authority to appoint either the FDIC or another person as
conservator for a bank and sets out a number of conditions under
which the Comptroller may make such an appointment.

These

conditions are similar to the grounds for appointment of a
conservator or receiver for federal savings and loan associations
under current law.

See" 12 U.S.C. 1464(d)(6)(A).

These

circumstances generally exist in foundering banks, i.e., banks
that are in an unstable condition as a result of mismanagement,
insider abuse, or a downturn in the segment of the economy in
which the bank is most involved.

Existing section 203 does not

establish explicit standards for appointing a conservator.

To

provide a measure of the flexibility that exists currently, the
amendment would authorize the Comptroller to identify other
circumstances in which the appointment of a conservator is
justified.

The Comptroller could use a conservator to return an

unstable bank to stability or, at a minimum, maintain the status
quo to provide a more saleable bank.

- 91 -

The current provisions regarding the appointment of a conservator
do not address judicial review.

The proposed bill, in -accord

with other statutes authorizing the appointment of a conservator
by federal financial regulatory agencies, would permit an
affected bank to bring an action within 10 days of the
appointment.

The action would be in the nature of an injunction

to terminate the Comptroller's decision to appoint a conservator.
This process would permit an expeditious resolution of the
Comptroller's decision to appoint a conservator.

Any other

judicial action pending against the bank would be stayed until
the conservatorship matter is resolved.

Judicial review would

not be available in cases where the bank has consented to the
imposition of a conservator or where its insurance has been
terminated (an action that already provides adequate
administrative and judicial review).

Section 803. EXAMINATIONS. Section 803 amends section 204 of
the Act by deleting the existing provision authorizing the
Comptroller to conduct such examinations as are necessary to
inform him of the condition of the bank.
longer necessary.

This provision is no

Because a bank under conservatorship remains a

national bank, the Comptroller may continue to conduct such
examinations pursuant to the general examination authority.
12 U.S.C. 481.

See

New section 803 requires the Comptroller to

consult with the FDIC when examining and supervising an ongoing
bank for which the FDIC has been appointed conservator.

- 92 -

Section 804.

TERMINATION OF CONSERVATORSHIP.

Section 804

amends section 205 of the Act regarding the termination of
the conservatorship. Under the proposed amendment, the
conservatorship may be terminated as the result of a sale, merger
or consolidation of the bank, or by the bank being placed in
receivership by a declaration of insolvency, or by the bank being
permitted to resume its business in the same form as previously,
although most likely under new management or directorate. When
the FDIC has been appointed conservator, the Comptroller must
seek the approval of the FDIC to terminate the conservatorship.
The FDIC would wind up the affairs of such a conservatorship. If
the bank is sold, provision is made for an interpleader action
whereby shareholders and nondepositor claimants may request that
the district court equitably distribute the net proceeds of such
sale. This provision is included as a protection for the
shareholders and nondepositor claimants because they are
otherwise precluded from suing the conservator for actions taken
(except where gross negligence can be shown). See proposed 12
U.S.C. 203(b)(3) and 209.

Section 805. CONSERVATOR; POWERS AND DUTIES. Section 805
replaces the existing provisions of section 206 of the Act
with provisions that specify, in general terms, the powers and
responsibilities of the conservator. The current Act does not
establish with sufficient clarity that the conservator has the
full range of powers possessed by bank management. Proposed
section 206 resolves this situation by stating that the

- 93 -

conservator will be given the authority and responsibility of the
shareholders, officers and board of directors. It is anticipated
that regulations will be written regarding the specific powers
and duties of the conservator. Proposed section 206 also
provides that the conservator, except to the extent waived or
modified by the Comptroller, shall be subject to the laws
applicable to officers, directors and employees of a national
bank. The provisions of this section are intended to establish
that the conservator has sufficient flexibility and authority to
operate the bank in an attempt to restore it to a stable and/or
profitable operation and to give the conservator the authority to
sell the bank.

In addition, proposed section 206 authorizes the Comptroller to
pay the conservator at rates in excess of rates paid to federal
employees performing similar work in certain situations. This
provision will enable the Comptroller to recruit competent
personnel from outside the agency to act as conservators as the
need arises by allowing the Comptroller to compensate such
individuals in a manner commensurate with similar positions in
private industry.

Section 806. LIABILITY PROTECTION. Section 806 replaces the
existing provisions of section 209 of the Act with new language.
The current section makes the conservator subject to the
provision of, and to the penalties prescribed by, specific
criminal and banking statutes. A specific listing is no longer

- 94 -

required since proposed section 206 subjects the conservator to
all the laws, including those enumerated in current section 209,
applicable to national bank officers, directors and employees.

Under proposed section 209, the conservator would be protected
from personal liability for actions taken by him as a conservator
except for those actions which are grossly negligent. Because
the conservator would be making difficult decisions regarding a
troubled bank, proof of "gross negligence" would require that the
conservators' decision was an extreme and obvious departure from
prudent banking practices resulting in significant damage to the
bank.

In addition, section 209(b) adds a provision that will allow the
Comptroller to indemnify the conservator out of available funds,
other than those specified in 31 U.S.C. 1304.

Section 807. RULES AND REGULATIONS. Section 807 amends section
211 of the Act. Section 211 currently provides that the
Comptroller may promulgate rules and regulations to carry out the
conservatorship statutes. Proposed section 211 would maintain
the Comptrollers' rulemaking authority.

Section 808. REPEALS. Section 808 repeals section 207
(reorganization; consent of depositors and creditors) and section
208 (provisions as to segregation of deposits inapplicable after
termination of conservatorship, notice of termination) of the

- 95 -

Act.

These provisions are no longer necessary under the proposed

conservatorship legislation. In addition, the existing
provisions of sections 206 and 208 that require segregated
deposits are considered a major impediment in the current
conservatorship statute.

Section 809. CONFORMING AMENDMENT. Section 809 would add
conservators appointed under 12 U.S.C. 203 to the list of persons
that may be appointed by the Comptroller of the Currency without
regard to the otherwise applicable limitation contained in 5
U.S.C. 5373 (which generally prohibits an agency head from fixing
the compensation of a position or employee at no more than the
maximum rate for GS-18).

TITLE IX - ENFORCEMENT POWERS IMPROVEMENT ACT OF 1989

OVERVIEW

Title IX approaches the concept of enforcement both from a civil
and criminal perspective. The goal of this title is to assure
that both regulators and prosecutors have a full arsenal of
weapons available to take swift corrective measures and to
facilitate both punishment and restitution, wherever appropriate.
The provisions recognize that unsafe or unsound practices and
fraud and other financial crimes have both victims and societal
costs and must be dealt with accordingly.

- 96 -

SUBTITLE A - REGULATION OF FINANCIAL INSTITUTIONS

This subtitle improves the enforcement powers of the financial
institution regulatory agencies such as by adding additional
civil penalty provisions and by greatly augmenting the existing
penalty provisions to a maximum of $1,000,000 a day, in some
cases.

Variations of many of the provisions in Subtitle A are

contained in H.R.32 and were passed by the Senate during the last
session of Congress as part of S.1886.

Section 902. SECTION 8 OF THE FEDERAL DEPOSIT INSURANCE ACT.
Section 902(a) makes amendments to section 8 of the Federal
Deposit Insurance Act (12 U.S.C. 1818).

These enforcement powers

will now apply equally with respect to savings associations and
to the Chairman of the Federal Home Loan Bank System (FHLBS) byoperation of the definitional change from "insured bank" to
"insured financial institution" throughout this Act.
Accordingly, many of these authorities that previously were set
forth for the Federal Home Loan Bank Board in section 5(d) of the
Home Owners' Loan Act (12 U.S.C. 1464(d)) are repealed in section
307, as discussed above.

Section 902(a)(1) replaces terms such as "director, officer,
employee, agent, or other person participating in the conduct of
the affairs" of financial institutions throughout section 8 of
the Federal Deposit Insurance Act with the new term
"institution-related" party.

This change must be read in

- 97 -

conjunction with the new definitions of "institution-related
party" and "controlling shareholder" in section (a)(17).
Institution-related party includes not only directors, officers,
employees and agents of a financial institution, but also
controlling shareholders, independent contractors, and other
persons participating in the conduct of the affairs of an insured
financial institution or a subsidiary thereof (e.g., a service
corporation subsidiary of a savings association) or a person
required to file a change-in-control notice.

Under appropriate

circumstances, an attorney, accountant or appraiser could be an
independent contractor or person participating in the affairs of
an institution.

Section 902(a)(2) amends the insurance termination procedures in
section 8(a) of the Federal Deposit Insurance Act (12 U.S.C.
1818(a)) in three respects:

First, in section (a)(2)(A), the

current maximum statutory notice the FDIC gives to primary
regulators of intention to terminate insurance is reduced from
not more than 120 to not more than 60 days.

Second, in section

(a)(2)(B) the Federal Deposit Insurance Corporation (FDIC) is
given the discretion to shorten the current two-year period that
all deposits are insured after termination of insurance to a
minimum period of six months.

Third, in section 902(a)(2)(C), a new temporary order of
termination of insurance authority is introduced for extreme
situations where an institution is found to be virtually without

- 98 -

capital.

This procedure could be invoked by the FDIC after

consultation with the primary regulator for the institution.

The

termination would go into effect ten days after issuance unless
enjoined by the financial institution through an action in
Federal district court.

After the effective date of the order,

deposits will continue to be insured for not less than six months
or more than two years, at the discretion of the FDIC, and the
institution can proceed with the regular administrative hearing
process on the termination issue provided in the normal
termination process.

Decisions by the Board of Directors to issue a notice of
intention to terminate insurance or to issue temporary or final
orders terminating insurance under section 8(a) may not be
delegated, as discussed with reference to section.(a)(18 ) , below.

Section (a)(3) clarifies that cease and desist authority to order
affirmative action to correct violations or practices in section
8(b) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b))
includes the authority to order "reimbursement, restitution,
indemnification, recision, the disposal of loans or assets,
prohibitions or restrictions on growth, guarantees against loss,
or other appropriate action".

The authority to order restitution

was put in question by the decision in the case of Larimore v.
Conover, 789 F.2d 1244 (7th Cir. 1986).

In that case, the court

held that the cease and desist authority of section 8 did not
authorize the Comptroller of the Currency to order a director of

- 99 -

a national bank to make restitution for losses resulting from
violating lending limit provisions of the National Bank Act.

The

court held that the Comptroller would have to seek reimbursement
in a district court action under 12 U.S.C. 93.

Under the

proposal in this bill, restitution could be ordered without
respect to whether the practice or violation giving rise to the
restitution involved unjust enrichment or reckless disregard for
the law.

This amendment also specifies that the cease and desist authority
extends to placement of limitations on the activities or
functions of not only the financial institution, but any
institution-related party necessary to correct conditions that
exist because of an unsafe or unsound practice or violation of
law.

The amendments in section (a)(4) and (5) are necessary to reflect
that the Chairman of the Federal Home Loan Bank System may
exercise cease and desist authority with respect to savings and
loan holding companies, all service corporations and all
subsidiaries of service corporations under section 8(b) (12
U.S.C. 1818(b)).

Current law does not permit Federal Home Loan Bank Board (FHLBB)
enforcement actions against other than "affiliate" service
corporations which has the result that service corporations owned
by many savings associations can escape enforcement actions.

A

- 100 -

recent example was the FHLBB's inability to issue enforcement
orders against SISCORP, a state-wide service corporation in
Oklahoma that is now insolvent.

This service corporation made

bad real estate loans that produced serious losses to its parent
savings associations.

Section (a)(4) is necessary to specify that the Chairman of the
FHLBS may take action with respect to a savings and loan holding
company even if it is also a bank holding company.

Sections 902(a)(6) and (7) amend the temporary cease and desist
authority of section 8(c) of the Federal Deposit Insurance Act
(12 U.S.C. 1818(c)).

Sections (a)(6) and (7) would eliminate the

need for the appropriate banking agency to determine as a
condition to issuance of a temporary cease and desist order that
a violation or unsafe or unsound practice would be likely to
cause "substantial" dissipation of assets or will "seriously"
weaken the condition of the financial institution.

It will be

enough to determine that there would be a likely dissipation or
weakening.

In addition section (a)(6) will allow a temporary

cease and desist order to place limitations on the activities or
functions of the financial institution or restrictions on its
growth.

Section (a)(3)(7) provides that the temporary cease and desist
order authority may be used when a financial institution's
records are so "incomplete or inaccurate" that the appropriate

- 101 -

banking agency cannot determine the financial condition of the
institution or can only determine the condition with great
difficulty.

The temporary cease and desist order may include a

direction to take affirmative action to restore the records to a
complete and accurate state.

In recent years, the need for this authority has been
demonstrated to be acute.

Although somewhat extreme, examples of

the need for this power that the FDIC has recently encountered
include the following situations:

(1) an FDIC-insured

institution maintaining all its books and records in plastic
garbage bags, and (2) an FDIC-insured institution operating
without an employee capable of making postings on the banks'
ledgers, thereby making it impossible for the institution to
determine its own- financial condition.

Another example of the

need for this authority is the case of Empire Savings and Loan
Association, Mesquite, Texas.

Sections 902(a)(8), (9), and (10) set forth amendments to the
provisions dealing with the grounds and procedures for removal or
prohibition from participation in the affairs of a financial
institution by institution-related parties.

At present, the

statute provides for a three-part test, the second part of which
requires either a showing of "substantial" financial loss or that
the interests of depositors are "seriously" jeopardized.

The

appropriate banking agency will no longer have to reach the
conclusion prior to removal that the institution has or will

- 102 -

suffer substantial financial loss or the interest of the
depositors could be seriously jeopardized by the continued
actions of the party. It will be enough to determine there will
be probable loss or jeopardy to the interests of depositors.

Section 902(a) (10) for the first time establishes that a person
removed, suspended or prohibited from participating in the
affairs of an insured financial institution will be under an
industry-wide bar. This means unless the person has received
prior written approval from the appropriate regulatory agency, he
will not be able to participate in the conduct of the affairs of
any other insured financial institution, Edge corporation, bank
or savings and loan holding company, any service corporation or
other savings association subsidiary, any federally insured
credit union or institution chartered under the Farm Credit Act.

Participation would include acting as an officer, director,
employee, agent, controlling shareholder (other than a holding
company), independent contractor or, under appropriate
circumstances, acting as an attorney, accountant or appraiser.

Section (a)(16), discussed below, addresses the separate, but
related, criminal penalty for participation in an insured
institution following certain criminal convictions.

Section 902(a)(ll) is a technical amendment to section 8(f) (12
U.S.C. 1818(f)), the provision dealing with judicial stays of

- 103 -

suspension and removal orders.

This amendment is necessary

because of the changes to section 8(e), described above.

Section 902(a)(12) clarifies that all enforcement actions under
section 8 of the Federal Deposit Insurance Act (12 U.S.C. 1818),
including industry-wide removal orders, may be brought against
former institution-related parties after termination, resignation
or other separation.

An institution-related party cannot

frustrate an administrative action against him and take up
employment with another financial institution by merely resigning
before an action is taken, nor will the closing of an institution
affect the agency's jurisdiction.

The need for this amendment

was highlighted by the recent decision of the Court of Appeals
for the District of Columbia in the case of Stoddard v. Board of
Governors of the Federal Reserve System (No. 88-1148, March 3,
1989) .

Sections 902(a)(13) and (14) amend the civil penalty authority
provisions of section (8)(i) (12 U.S.C. 1818(i)).

In section

(a)(13), the current maximum $1,000 per day penalty for
violations of cease and desist orders or orders relating to Bank
Secrecy Act compliance procedures is raised to a maximum of
$25,000 per day for each day during which violations continue.
In addition, if an order is violated with reckless disregard for
the safety and soundness of a financial institution, a maximum
penalty of $1,000,000 per day may be applied.

- 104 -

Section (a)(14) makes a significant enforcement authority
improvement. New section 8(i)(4) (12 U.S.C. 1818(i)(4)) provides
the appropriate federal banking agency with general civil penalty
authority against any institution or institution-related party
who has violated any law or regulation relating to financial
institutions or any condition imposed in writing by a regulatory
agency. It also allows a civil money penalty to be issued
against an institution-related party who has breached a fiduciary
duty or engaged in an unsafe or unsound practice resulting in
loss to the institution or gain to the individual. This
authority would be available where no other civil penalty
authority currently exists and even, under certain circumstances,
where it does. For instance, if there was a criminal conviction
for a crime such as misapplication (18 U.S.C. 656 or 657) and for
whatever reason the Justice Department did not impose a civil
penalty under the new authority set forth in section 915 of this
bill, the appropriate federal banking agency could proceed to
assess a penalty under section 8(i)(4). However, pursuant to
section 8(i)(4)(c), a civil money penalty could not be assessed
twice against the same party for the same violation. For
instance, the appropriate federal banking agency could not assess
an additional penalty under this section after the Department of
Treasury assessed a civil penalty under the Bank Secrecy Act (31
U.S.C. 5321) based on the same violations.

It is anticipated generally that use of this authority by a
federal banking agency would not be appropriate if there was a

- 105 -

civil penalty authority under a more specific civil penalty
statute such as 31 U.S.C. 5321.

Again, civil penalty amounts are set at a maximum of $25,000 for
day for each day the violation continues or a maximum of
$1,000,000 for violations made with reckless disregard.

Section (a)(15) merely clarifies that banking agencies have the
authority to define by regulation terms not otherwise defined in
section 8 (12 U.S.C. 1818).

Section 902(a)(16) raises the criminal penalty in section 8(j)
(12 U.S.C. 1818(j)) for institution-related parties who
participate in the conduct of the affairs of any insured
financial institution despite a removal, suspension or
non-participation order by an appropriate federal regulatory
agency.

The criminal fine is raised from a maximum of $5,000 to

a maximum of $1,000,000 and the violation is raised from a
misdemeanor to a felony, carrying a maximum sentence of five
years.

Section (a)(17) revises the definitions section, section 8(k) (12
U.S.C. 1818(k)).

The main change is the addition of a definition

of "institution-related party" and "controlling shareholder" as
that term is used in the definition of institution-related party.
This change is discussed above with reference to section (a)(1)
of this Act.

- 106 -

Section 902(a)(18) adds five new subsections to section 8 of the
Federal Deposit Insurance Act (12 U.S.C. 1818).

First, new

subsection 8(t) (12 U.S.C. 1818(t)) gives appropriate federal
banking agencies the authority to pay informants awards to
financial institution employees and other persons who provide
original information that leads to recovery of a criminal fine or
victim restitution, or forfeiture relating to enumerated criminal
offenses, or of a civil penalty under section 8.

This is similar

to the authority of the Internal Revenue Service and other law
enforcement agencies, such as the United States Customs Service.
This authority only would apply to recoveries over $50,000 and
would be limited to 25% of the recovery or $100,000, whichever is
less.

Payment of awards would be totally discretionary. A decision to
pay or not to pay a reward would not be reviewable by any court
or be subject to any administrative review other than any that
may be afforded to claimants by the appropriate federal banking
agency.

An appropriate federal banking agency would notify and seek the
concurrence of the Attorney General before paying or promising to
pay a reward under this section to assure against adversely
affecting ongoing investigations or prosecutions.

Second, new subsection 8(u) (12 U.S.C. 1818(u)) provides
protection to an employee of an insured financial institution who

- 107 -

gives information to a regulatory agency regarding a possible
violation of law or regulation or to the Department of Justice
relating to a possible violation of a criminal law.

The employee

would have a civil cause of action in Federal district court if
he is discharged or discriminated against because of his
assistance to the government.

Similar to other employee

protection statutes covering reporting of information on to
health and safety violations, such as 42 U.S.C. 5851 (relating to
nuclear safety), recovery would be limited to reinstatement with
compensatory damages, such as back pay and lost employment
benefits.

Third, a new subsection 8(v) (12 U.S.C. 1818(v)) allows the Board
of Directors of the Federal Deposit Insurance Corporation to
request the Chairman of the Federal Home Loan Bank System to take
any enforcement action authorized by section 8 with respect to a
savings association.

If the FHLBS does not take the recommended

action within 60 days of receipt of the formal recommendation
from the FDIC, the Board of Directors may order the FDIC to take
the action itself.

In "exigent circumstances" the sixty-day

period may be waived by the FDIC.

The definition of exigent

circumstances will be the subject of a memorandum of
understanding between the Chairman of the FHLBS and the Board of
Directors of the FDIC.

Fourth, a new subsection (8)(w) (12 U.S.C. 1818(w)) makes clear
that the enforcement authority granted in section 8 of the

- 108 -

Federal Deposit Insurance Act is in addition to, and not limited
by, any other statutory grant of authority, as provided by either
Federal or State law.

Thus, it modifies, in part, the Larimore

decision with respect to the use of district court proceedings in
lieu of administrative action under section 8.

Finally, a subsection 8(x) (12 U.S.C. 1818(x)) is added to set
forth the only four actions under section 8 that cannot be
delegated by the Board of Directors of the FDIC.

Three relate to

termination of insurance under section 8(a), and the fourth to
the authority in new subsection 8(v) to initiate an enforcement
action against a savings association.

Section 902(b) raises the criminal penalty of section 19 of the
Federal Deposit Insurance Act (12 U.S.C. 1829) for financial
institutions that allow participation in the conduct of the
affairs of a financial institution or service as an
institution-related party by a person who has been convicted of a
criminal offense involving dishonesty or breach of trust, without
prior approval from the FDIC.

The penalty also applies to the

person who acts as an institution-related party or participates
in the affairs of a financial institution after such a
conviction, without prior approval.

In the same section, the standard is changed from "willful" to
"knowing."

The penalty is raised from a maximum $100 a day for

each day the prohibition is violated, to a maximum of $1,000,000

- 109 -

for each day the prohibition is violated.

The penalty is also

raised from a misdemeanor to a felony, carrying a maximum prison
term of five years.

Currently, the FDIC may recover penalties

collected under this provision "for its own use."

Because of the

great increase in the dollar amount of the penalty, the FDIC only
will be able to recover the costs of penalty assessment and
collection.

Section 903. PARALLEL INCREASES IN CIVIL PENALTY PROVISIONS.
This section amends several other civil penalty provisions in all
cases to increase the current maximum daily penalty amounts to
$25,000 for each day a violation continues, and in cases of
violations made with reckless disregard for the safety or
soundness of an institution, to a maximum of $1,000,000 for each
day a violation continues.

Section 903(a) similarly raises the civil penalty in section
29(a) of the Federal Reserve Act (12 U.S.C. 504(a)) for a number
of violations of the Federal Reserve Act.

The current maximum

penalty is $1,000 per day.

Section 903(b)(1) raises the criminal penalty in section 8 of the
Bank Holding Company Act of 1956 (12 U.S.C. 1847(a)) for
violations of the Bank Holding Company Act.

The criminal fine

for willful violations is raised from a maximum of $10,000 per
day to a maximum of $1,000,000 per day and the violation is
raised from a misdemeanor to a felony, with a maximum term of

- 110 -

imprisonment of five years.

The current criminal penalty in section 1847(a) (for false
entries in the books of a holding company) has been eliminated
from that section and incorporated into 18 U.S.C. 1005.

See

section 915(e) below.

Section 903(b)(2) raises the civil penalty for violations under
section 8 of the Bank Holding Company Act (12 U.S.C. 1847(b)(1))
from the current maximum of $1,000 per day.

It also is clarified

that civil and criminal penalties for violations of the Bank
Holding Company Act are cumulative.

Section 903(c) raises the civil penalty for violations of the
prohibition against tying arrangements in section 106(b)(2)(F)(i)
of the Bank Holding Company Act Amendments of 1970 (12 U.S.C.
1972(2)(F)(i)).

The current penalty is a maximum of $1000 per

day for each day the violation continues.

Section 903(d) raises the general civil penalty authority of the
Comptroller of the Currency in section 5239 of the Revised
Statutes (12 U.S.C. 93) and section 902(e) raises the civil
penalty in section 5240 of the Revised Statutes (12 U.S.C. 481)
for refusal to permit examination of a national bank or
affiliate.

The current maximum penalties under those provisions

are $1,000 per day.

- Ill -

Section 904.

PENALTY FOR VIOLATION OF "CHANGE IN BANK CONTROL

ACT." Section 904 makes several improvements to the penalty
provision of the Change in Bank Control Act, section 7(j)(16) of
the Federal Deposit Insurance Act (12 U.S.C. 1817(j ) (16 ) ) .
First, the current scienter standard of "willful" is eliminated
and the penalty amount for violations is raised from a maximum
$10,000 per day to a maximum of $25,000 for each day during which
the violation continues. For violations made with reckless
disregard for the safety or soundness of a financial institution,
the penalty is raised to a maximum of $1,000,000 for each day
during which the violation continues.

Also, the.penalty procedures for assessment and collections are
made comparable to those for other federal banking agencies civil
penalties, with penalty assessments reviewed through
administrative hearings and appeal to the Court of Appeals.
Currently, Change in Bank Control Act penalties are subject to a
trial de novo in Federal district court.

The deletion of the "willful" standard will afford the regulatory
agencies the opportunity to move more easily against individuals
who take control of a financial institution, without ever having
filed a change in bank control application, and force the
institution to buy worthless or near-worthless assets from them.

These amendments will apply equally to changes in savings
association control pursuant to section 7 of this Act.

- 112 -

Section 905.

REPORTS.

Section 905(a) eliminates a provision in

the Bank Protection Act requiring insured financial institutions
to submit reports with respect to security devices and
procedures. Section (b) eliminates an obsolete requirement
relating to reports to the Comptroller of the Currency.

Sections (c),(d),(e) and (f) make parallel improvements to four
civil penalty provisions relating to call report violations for
national banks, State nonmember banks, and federal reserve member
banks, and bank to reporting violations for holding companies,
respectively. The provisions make clear that not only failure to
submit and late submissions are subject to penalty, but also
false, misleading and incomplete submissions or publications.
The maximum penalty is raised to $25,000 for each day a report is
not submitted or a false, misleading or incomplete report is not
corrected. In the case of violations made with reckless
disregard for the safety and soundness of an institution, the
maximum penalty is raised to $1,000,000 per day. The current
penalty under all four penalty provisions is a maximum daily
penalty of $1,000.

One of the first and foremost indicators of the financial
condition of an institution is the call report, the report on
condition and income that must be regularly filed with
appropriate federal banking agencies. If, in its call report, an
institution deliberately has failed to charge off loans
classified loss, or failed to provide for a loan loss reserve, it

- 113 -

has inflated its overall condition, thereby lulling the
depositors and shareholders into a false sense of security by
implying that the institution is in a stronger financial
condition than it actually is. The increased civil money penalty
for submission of false or misleading call reports provided in
the bill will provide a much needed incentive to encourage
financial institution to file accurate call reports, and prevent
distortion of an institution's financial condition.

Experience has shown„that the current penalties are inadequate to
encourage compliance. For instance, on March 21, 1988, the FDIC
issued a bank letter requesting that all FDIC-insured banks
submit their call reports on time. Despite this Bank Letter,
which was by no means the first request for timely submissions,
thousands of banks failed to submit their reports on time.
The increased civil money penalty proposed in this bill will
encourage compliance. The higher penalties are meant to be
directed at chronic late-filers or those who deliberately delay
in order to postpone the release of adverse financial
information.

SUBTITLE B — REGULATION BY THE CHAIRMAN OF THE FEDERAL HOME LOAN
BANK SYSTEM

Section 906. EXAMINATION AUTHORITY. This section is being
eliminated in technical corrections "to this Act, as these
provisions are repeated in sections 307 and 311, above.

- 114 -

Section 907.

REPORTS OF CONDITION AND PENALTIES.

This section

adds a new subsection (u) to the Home Owners' Loan Act of 1933
(12 U.S.C. 1464(u)) providing for submission of call reports by
savings associations and a new penalty for failure to report or
for submitting or publishing false, misleading or incomplete
information.

This is comparable to the existing requirement for

such reports for federally insured banks.

The penalty provisions

also are parallel to those discussed above in section 905 for
banks and holding companies.

Section 908. SAVINGS AND LOAN HOLDING COMPANIES. Section 908(a)
increases the civil and criminal penalties for violations of the
Savings and Loan Holding Company Act to conform with the penalty
for Bank Holding Company Act violations in section 903(b).
Criminal and civil penalties are cumulative.

Section (b) adds a new civil penalty for reporting violations by
savings and loan holding companies parallel to the reporting
provision and penalty for bank holding companies.

See section

905(f) .

Section 909. CONTINUITY OF AUTHORITY FOR ONGOING LITIGATION.
Section 909 affirms that ongoing, litigation in the name of the
FHLBB or the FSLIC will be continued, as appropriate, under this
Act.

Section 910.

TEMPORARY EXTENSION OF AUTHORITY.

Section 910

- 115 -

states that any action initiated or taken by the FHLBB or FSLIC
under one of the enforcement authorities in section 5 of the Home
Owners' Loan Act or under section 407 of the National Housing
Act, repealed by this Act, may be carried on by the Chairman of
the FHLBS as if those provisions were still in effect.

SUBTITLE C — CREDIT UNIONS

Sections 911, 912, and 913. AMENDMENTS TO 206, 205 AND 202. The
amendments made in this section to the enforcement powers in the
Federal Credit Union Act (12 U.S.C. 1782, 1785, 1786) conform to
the improved enforcement authorities and increased penalties of
other federal financial institution regulatory agencies under
this Act. Parallel amendments are found in Subtitle A for almost
every provision in Subtitle C. The explanation for the
comparable provisions in Subtitle A should be consulted.

SUBTITLE D — RIGHT TO FINANCIAL PRIVACY ACT

Section 914. AMENDMENTS TO THE RIGHT TO FINANCIAL PRIVACY ACT.
There are a number of exceptions to the general requirement of
the Right to Financial Privacy Act of 1978 ("RFPA"), (Title XI of
Pub. L. 95-630, 12 U.S.C. 3401 e_t seq. ) that there be notice to a
financial institution customer prior to disclosure of his records
to a federal authority. One exception made to facilitate smooth
functioning of the examination process is the exception in
section 1113(b) (12 U.S.C. 3913(b)) which provides that the RFPA

- 116 -

does not apply to supervisory agencies in the exercise of their
supervisory, regulatory or monetary functions.

The amendment in section 914(a) and (b)(1) merely makes explicit
that this exception from the RFPA for supervisory agencies with
respect to financial institutions, extends to both bank and
savings and loan holding companies and subsidiaries of financial
institutions or holding companies, as well as to officers,
directors, employees, agents and other persons participating in
the affairs of a financial institution, holding company or
subsidiary. The amendment in (b)(1) also specifies that this
exemption applies to a supervisory agency in the exercise of its
conservatorship or receivership functions.

Section 914(b)(2) adds two new exceptions to section 1113(b) of
the RFPA (12 U.S.C. 3413(b)). First, a new subsection 1113(m)
makes explicit that the RFPA does not apply to examination or
disclosures by the Federal Reserve System in the exercise of its
authority to extend credit to depository institutions and others.

Second, a new subsection 1113(n) is added to cover disclosures to
the Resolution Trust Corporation.

In section (c) a new provision is added to section 1120 of the
RFPA (12 U.S.C. 3420) to prohibit financial institutions from
notifying customers or other persons of the existence of a grand
jury subpoena relating to violations of certain enumerated major

- 117 -

crimes in title 18, United State Code, against financial
institutions or regulatory agencies —

section 215 (financial

institution bribery), sections 656 and 657 (financial institution
misapplication and embezzlement), sections 1005 and 1006 (false
entries), sections 1007 and 1008, (fraud against deposit
insurer), section 1014 (false statement or overvaluation), and
section 1344 (financial institution fraud).

With respect to restricting notice of grand jury subpoenas
involving grand jury investigations of other crimes, the
Department of Justice still would have to seek an ex parte court
order pursuant to section 1109 (12 U.S.C. 3409), as provided in
section 1113(i) (12 U.S.C. 3413(D).

In criminal investigations involving serious financial
institution crimes, there is a compelling need that financial
institution insiders and those acting in concert with them are
not advised prematurely of the existence of criminal
investigations or the parameters of the investigations.
Notification could cause serious damage to investigations and
could lead to possible flight, destruction of evidence, and
removal of assets.

This prohibition should be automatic and not

depend on the existing delayed notice procedures.

Congress recently recognized the need for special treatment under
the RFPA for those involved in crimes against financial
institutions and supervisory agencies.

In section 6186(c) of the

- 118 -

Anti-Drug Abuse Act of 1988, Pub. L. 100-690 (Nov. 18, 1988), a
new exception from the customer notice provisions was added to
allow a financial institution to provide records of a financial
institution insider if there is reason to believe the records are
relevant to a possible crime against the institution or
supervisory agency by an insider. This amendment prohibiting
notification of grand jury subpoenas enhances the effectiveness
of section 6186(c) by assuring that its purpose is not
frustrated.

A related change is made in section 916(h), below, to provide a
new criminal obstruction of justice penalty against a financial
institution officer, director, or employee who notifies a
customer or other party despite this RFPA prohibition.

SUBTITLE E — CRIMINAL ENHANCEMENTS

Section 915. INCREASED CRIMINAL PENALTIES AND CIVIL PENALTIES
FOR CERTAIN FINANCIAL INSTITUTION OFFENSES. Section 915
increases the criminal sanctions for several major financial
institution crimes in title 18, United States Code, under which
those who jeopardize the safety or soundness of insured financial
institutions, either from the inside or from without, are
prosecuted. The crimes covered are: section 215 (financial
institution bribery), sections 656 and 657 (financial institution
misapplication and embezzlement), sections 1-005 and 1006 (false
entries on the books of financial institutions), sections 1007

- 119 -

and 1008, now consolidated as section 1007, (fraud on deposit
insurer), section 1014 (false statement or overvaluation), and
section 1344 (financial institution fraud). The penalties
proposed are purposely the most stringent for any white collar
crime. The severity of the penalty can be compared to the
penalties for money laundering under 18 U.S.C. 1956 and 1957.

The criminal sanctions are raised generally to a maximum criminal
fine of $1,000,000 for each day the violation continues or
$5,000,000, or twice the amount authorized by section 3571(d) of
title 18, whichever is greater. This means that, depending on
which is greater, a maximum daily fine of $1,000,000 can be
imposed, or if a violation does not lend itself to a daily
penalty or occurs on only a few days, the $5,000,000 maximum
would be available. As a third alternative, if the result would
be an even higher fine, a court could use the measure of twice
the fine set forth in section 3571(d). Twice the amount of the
criminal fine in section 3571(d) would be four times the amount
of pecuniary gain to the defendant or loss to the affected
financial institution, whichever is greater.

In addition, in section 915, for the first time, the Civil
Division of the Justice Department and the U.S. Attorney's
Offices are given civil penalty authority for violations of these
sections. All criminal and civil sanctions are cumulative. This
means that Justice may elect whether to proceed civilly or
criminally upon a referral from a bank regulatory agency or may

- 120 -

develop cases civilly or criminally without a referral, for
instance on the basis of an informant's information. It may also
proceed with a civil penalty at the conclusion of a criminal case
or impose a civil penalty in conjunction with a criminal plea
arrangement. Nevertheless, it is intended that the Department of
Justice continue to work closely with the regulatory agencies on
these matters. This authority is intended to provide an
additional means of assessing penalties and is not intended to
limit or restrict those penalties that may otherwise be assessed
by the regulatory agencies pursuant to their authority.

The major difference between the civil and criminal violation
will be the lower standard of proof in civil cases and the method
of developing the basis for the violation. If, following
assessment of a civil penalty, payment is not made, the Attorney
General may recover the penalty through an action in Federal
district court. The standard of proof for a civil penalty case
will be a preponderance of the evidence. The civil case will be
developed through a new civil summons authority comparable to the
civil summons authority of numerous other agencies with civil
penalty authority. See, e.g., 31 U.S.C. 5318(a) (summons
authority of the Secretary of the Treasury under the Bank Secrecy
Act). Standard summons enforcement provisions, including
contempt authority, is included.

The civil penalties, like the criminal penalties, will be the
largest civil money penalties available under any civil penalty

- 121 -

authority.

Generally, the maximum penalty is $1,000,000 for each

day the violation continues, the amount of the pecuniary gain to
the individual attributable to the violation, or $5,000,000,
whichever is greater.

In addition to increased penalties and civil penalty authority in
section 915, the following changes are made in sections (a)
through (i):

In section (a)(2), the references to "bank" insured by the FDIC
are changed to "an institution" and the reference to institutions
insured by the FSLIC is deleted.

The amendment in (d)(1) sets forth that section 1005 (false
entries) applies to officers, directors, agents and employees of
bank and savings and loan holding companies. The current mirror
image criminal provisions in the Bank Holding Company and Savings
and Loan Holding Company Acts are eliminated. This is discussed
in reference to section 903(b), above.

In section (d)(2), a "participation" offense is added to section
1005 (false entry on the books of a bank) which is comparable to
the participation offense currently in section 1006 (credit union
and savings and loan false entries).

The amendments in sections (f) and (g) consolidate current
sections 1007 (fraud on the FDIC) and section 1008 (fraud on

- 122 -

FSLIC) into a new section 1007.

Section (j) adds a new statute of limitations provision, section
3293 of title 18, United States Code, which extends the statute
of limitations for the crimes discussed in section 915 (sections
215, 656, 657, 1003, 1006, 1007, 1008, 1014, and 1344 of title
18) to ten years. Currently, the general five-year statute of
limitations for all crimes listed in 18 U.S.C. 3282 applies.
This extension to ten years recognizes both the complexity of
many of the investigations under these provisions and the volume
of such investigations pending and anticipated in the near
future. The limitations period is comparable to that for certain
national security violations under 18 U.S.C. 792.

The increased period shall apply to any offense committed before
the effective date of this Act as long as the five year statute
has not run as of this date. It is well established that the
application of a new statute of limitations to violations for
which the old statute has not run does not violate the
constitutional prohibition on ex post facto laws. See, e.g.,
United States v. Richardson, 512 F.2d 105 (3rd Cir. 1975).

Since October 1987, in accordance with sentencing reform
provisions of the Comprehensive Crime Authority Control Act of
1984, federal judges must sentence in accordance with guidelines
promulgated by the United States Sentencing Commission. A
statutory increase in a maximum imprisonment terms such as those

- 123 -

made in section (a) through (i) of this section will probably,
but not necessarily, cause the Sentencing Commission to readjust
upward the recommended penalty for such a violation when it next
submits guideline amendments to Congress.

Section (k) is a

direction to the Commission to increase the sentencing guideline
for violations of the financial institution crimes treated in
section 915 where the violation "substantially" jeopardizes the
safety and soundness of a financial institution.

This section directs an increase in the guideline level to at
least level "24" in such situations.

This will mean, in effect,

that there will be a mandatory minimum sentence for such
violations by first offenders of at least fifty-one months of
imprisonment.

It is anticipated that courts will rely on the

judgment of federal financial institution regulatory agencies in
determining whether there has been substantial jeopardy to the
safety and soundness of an institution.

Section 916. MISCELLANEOUS REVISIONS TO TITLE 18. This section
916(a) merely replaces the term "Federal Home Loan Bank Board"
with the term "Federal Home Loan Bank System" in title 18,
consistent with this Act.

Section 915(b) and (c) amends sections 212 and 213 of title 18
(relating to gratuities and loans to bank examiners) to specify
that these provisions apply to examiners of the FHLBS and changes
the reference to "banks" insured by the FDIC to "institutions,"

- 124 -

consistent with this Act.

Section (d) repeals 18 U.S.C. 1009, an obsolete and unused
provision making it a crime to circulate rumors about the FSLIC.

Sections 915(e), (f), (g) and (i) merely make technical revisions
to four criminal provisions to make changes necessitated by the
Act, such as removing references to FSLIC.

Section (h) adds a new provision in the obstruction of justice
statute, 18 U.S.C. 1510, making it a crime for a financial
institution, officer, director, partner, or employee to notify a
customer or any other party, including another financial
institution insider, of the existence or contents of a grand jury
subpoena relating to one of the financial institution crimes
discussed in section 915, (sections 215, 656, 657, 1007, 1008,
1014, or 1344 of title 18). A related RFPA amendment is
discussed in section 914(c), above.

Section (j) adds sections 656 and 657, financial institution
misapplication and embezzlement, and 1344, financial institution
fraud, to the predicates for violations of the RICO (Racketeer
Influenced and Corrupt Organizations) statute, 18 U.S.C.
1961-1968.

This will, in effect, provide prosecutors with

another tool against those who steal from financial institutions
from within and without and seek to profit further from their
crimes through investment in other businesses.

- 125 -

Section 917.

CIVIL AND CRIMINAL FORFEITURE SECTION.

Again in

section 917, weapons have been borrowed from the Administration's
war against drugs and money laundering by adding civil (new
section 983) and criminal (new section 984) forfeiture authority
in connection with violations of the financial provisions
discussed in section 915. Similar forfeiture authority was added
for money laundering and domestic Bank Secrecy Act violations in
1986, as sections 981 and 982 of title 18.

Civil forfeiture will allow the Department of Justice to move
immediately against the property which is the proceeds of the
violation or against property traceable to that property as soon
as it has probable cause for the violation. As in money
laundering cases, time will often be of the essence because
.perpetrators of these offenses attempt to move and conceal their
assets as investigations develop.

Because of the nature of the crimes and the victims, forfeited
amounts will be applied, after deduction for the costs of
forfeiture, differently than amounts forfeited under other
provisions of law. Under section 983(e)(3), in the case of
insolvent institutions, proceeds will be applied to the Treasury
General Fund, and, in the case of ongoing institutions to the
General Fund, or at the option of the appropriate federal
financial institution regulatory agency, may be made available as
restitution to the institution.

- 126 -

As with other victim restitution, under 18 U.S.C. 3523, the
amount received from the forfeiture would be deducted from other
amounts received as restitution in other civil actions or through
cease and desist orders.

Criminal forfeiture would apply following a conviction. The
court would be required to order forfeiture, unlike orders for
victim restitution, which are discretionary. The proceeds of a
criminal forfeiture would be applied in the same way as civil
forfeiture proceeds.

Section 918. GRAND JURY AMENDMENT.

SECTION 918: GRAND JURY AMENDMENTS: Section 918(a) amends Rule
6(e) of the Federal Rules of Criminal Procedure to overcome
impediments to the government's civil enforcement efforts caused
by two decisions of the United States Supreme Court. On June 30,
1983, the Court ruled in United States v. Sells Engineering,
Inc., 463 U.S. 418 (1983), that Department of Justice attorneys
handling civil cases are not "attorneys for the government" for
the purposes of Rule 6(e). Therefore they may not obtain grand
jury materials that pertain to their civil cases without a court
order, and such an order may be granted only upon a showing of
"particularized need." The Court stated that the "particularized
need" standard of Rule 6(e) was not satisfied only by a showing
that non-disclosure would cause lengthy delays in litigation or
would require substantial duplication of effort.

- 127 -

In a companion case, United States v. Baggot, 463 U.S. 476
(1983), the Court further limited federal law enforcement
abilities by narrowly defining the purpose for which disclosures
may be made. It held that agency proceedings such as civil tax
audits are not "preliminary to a judicial proceeding," and thus,
no court order may be secured in such cases, no matter how
compelling the need.

Civil enforcement initiatives have been frustrated by the
inability to share grand jury materials with Department of
Justice (DOJ) civil attorneys or with agencies, such as federal
financial institution regulatory agencies, that contemplate using
those materials in administrative or regulatory proceedings such
as cease or desist or removal proceedings or civil penalty
assessments. The prosecutor is limited in his ability to advise
civil attorneys or agency authorities of activities that may also
violate civil laws which should be investigated, sometimes
preventing timely pursuit of meritorious civil cases. Then, if
the civil attorneys or agencies do learn of the grand jury
investigation, they must duplicate virtually the entire criminal
investigation — an effort which may not be feasible or, at best,
will cause substantial delays and require needless expenditure of
effort, time and money.

The amendments will (1) permit prosecutors to make automatic
disclosure of grand jury materials to Department of Justice civil
attorneys for civil purposes without a court order; (2) expand

- 128 -

the types of proceedings for which other executive departments
and agencies may gain court-authorized disclosure to include not
only "judicial proceedings," but also other matters within their
jurisdiction, such as adjudicative and administrative
proceedings; and (3) reduce the "particularized need" standard
for court-authorized disclosure to a lesser standard of
"substantial need" in certain circumstances. The amendments also
codify a legal issue unanswered by Sells, but recently resolved
affirmatively by the Supreme Court in United States v. John Doe,
Inc. I, 481 U.S. 102 (1987): whether the same criminal
prosecutor who conducted the grand jury investigation is
authorized to present the companion civil case.

In 6(e)(3)(A)(i), disclosure may be made to any government
attorney, i.e., Department of Justice attorney, "to enforce
federal civil law." This term is to be read broadly; it includes
civil enforcement in all non-criminal actions in which the United
States is a party, such as admiralty, immigration, customs and
damage suits. In the terms of this Act, it would include
disclosure to Department of Justice civil attorneys for the
purpose of assessment of new civil penalties discussed in section •
915. Disclosure is not limited by the term "judicial
proceeding," but can be made for the sole purpose of an initial
review of potential civil liability or to facilitate global
dispositions of cases, thus eliminating the barrier to
settlements caused by the inability to provide sufficient
information for the DOJ civil attorney to evaluate the merits of

- 129 -

proposed settlements.

This amendment covers disclosure only to attorneys and their
support staff such as secretaries and paralegals.

If further

disclosures to non-attorney personnel such as examiners, auditors
or agents are necessary to assist in the civil case, a court
order must be sought.

The addition of the words "civil law" in (6)(e)(3)(B) will permit
personnel to whom disclosure has been made for criminal purposes
pursuant to subparagraph (A)(ii), to utilize that material to
assist any attorney for the government in enforcing civil law.
It will allow DOJ civil attorneys to discuss the evidence not
only with the criminal prosecutor, but also with the agents,
auditors or examiners who worked on the grand jury investigation
without court order.

The proposal recognizes that the primary purpose of a grand jury
is, and must remain, to enforce federal criminal laws and in no
way alters that well-founded policy.

It is therefore the intent

of the Department of Justice to issue policy guidelines that
restate existing practices and the current case law that a grand
jury may not be improperly used to gather evidence for civil
purposes.

To make the criminal priority explicit, the guidelines

will state that the criminal prosecutor has the discretion to
decide whether and when to disclose materials to civil attorneys,
and further, to decide what materials should be disclosed.

- 130 -

Disclosures will be limited to only those materials relevant to
the civil case.

Section 6(e)(3) (i) is amended by the addition of the words
"particularized need" to reflect the existing standard for
court-authorized disclosures made preliminary to or in connection
with a judicial proceeding.

While not changing current law, the

addition of the term "particularized need" is intended to
demonstrate the contrast between this higher standard and the
lesser standard of "substantial need" that is required in new
section (C)(v), applicable when government agencies seek
disclosure with the concurrence of the Department of Justice.
This provision will provide the only available method of
disclosure for private parties.

It can also be used by

government agencies with independent litigating authority when
the Justice Department exercises its discretion and declines to
request disclosure under new section (C)(v).

Section 6(e)(3)(C)(v) is the entirely new section authorizing
prosecutors to seek court approval to release grand jury
information to government agencies for use in matters within that
jurisdiction.

This is intended to cure the Baggot problem by

eliminating the requirement that court-authorized disclosure must
be for use in a "judicial proceeding," and also to overrule Sells
by reducing the "particularized need" standard to a "substantial
need" standard.

- 131 -

Under the substantial need standard, a court could consider a
number of factors, including but not limited to, any of the
following:

(1) the public interest —

particularly the

protection of the public health or safety or the safety or
soundness of a federally insured financial institution —

served

by disclosure; (2) the burden or cost of duplicating the grand
jury investigation; (3) the potential unavailability of
witnesses; (4) the fact that the department or agency already has
a legitimate independent right to the materials; (5) the
avcridance of unnecessary inefficiency or waste of resources;
(6) the need to prevent ongoing violations of law; and (7) the
expiration of an applicable statute of limitations.

In weighing

these considerations, consistent with the Supreme Court's
decision in John Doe, Inc. I, a court would not be able to deny
disclosure merely because the agency for whom disclosure is
sought may have alternative discovery tools available to it.

On the other hand, the "substantial need" test does not
contemplate that a court would become simply a "rubber stamp" for
the government's request for disclosure.

Review under this

standard should require a Justice Department attorney to make
more than a showing of mere convenience or simple relevance to
matters within the jurisdiction of the agency.

The words "for use in a matter within the jurisdiction of an
agency" makes clear that an agency's administrative, enforcement
and other non-judicial proceedings are included.

Since the

- 132 -

phrase "matters within the jurisdiction of an agency" has already
been broadly interpreted in cases involving 18 U.S.C. S1001, it
was selected to avoid listing every conceivable agency
proceeding. In the context of financial institution
administrative and enforcement actions, it could include use in
licensing, examination, corporate application involving change in
control or ownership, removal actions, cease and desist orders,
termination of insurance, receivership actions, or penalty
assessments.

Effective control would be exercised by the court in permitting
disclosure only when the agency had a substantial need, and by
delineating in its order the specific purposes for which
disclosure is authorized. Disclosures will not be sought by
Department of Justice attorneys without careful consideration of
all factors and a determination that there is a strong public
interest for each disclosure. Agency personnel who receive
court-authorized disclosures of grand jury materials under this
subparagraph will be authorized to use the material only for the
purpose for which the court order was granted.

Section 918(b) amends the Fair Credit Reporting Act to permit
access to consumer credit report records pursuant to a subpoena
issued by a grand jury. Presently, 15 U.S.C. 1681b forbids a
credit reporting agency from furnishing such records except in a
few restricted instances. One of these is "in response to the
order of a court." Although some district courts have held that

- 133 -

a Federal grand jury subpoena is such an order, the predominant
judicial view is that a grand jury subpoena does not qualify.
See, e.g., Matter of Application to Quash Grand Jury Subpoena,
526 F. Supp. 1253 (D. Md. 1981).

Consumer credit report records are useful in pursuing many kinds
of fraud, including fraud involving financial institutions. The
current requirement for a court order poses a burdensome hurdle
to the effective investigation of fraud by Federal grand juries.
Although the privacy interests sought to be protected under the
Act warrant placing restrictions on access, a Federal grand jury
subpoena carries with it significant safeguards under Rule 6(e)
of the Federal Rules of Criminal Procedure. In a comparable
context, disclosure of customer records of financial institutions
themselves are protected by the Right to Financial Privacy Act
("RFPA") (12 U.S.C. 3401 et seq.). Nevertheless, section 1113(i)
of the RFPA (12 U.S.C. 3413(D) contains an express exception for
any subpoena issued in connection with proceedings before a grand
jury." This leads to the anomalous result that records in the
possession of a financial institution may be disclosed pursuant
to a grand jury subpoena, but the very same records in the
possession of a consumer reporting agency may not be able to be
disclosed.

Section 919. LITIGATION AUTHORITY. This section merely affirms
that the changes made to this Act to the responsibilities of
financial institution regulatory and insurance agencies may not

- 134 -

be construed as impairing or diminishing the authority of the
Attorney General under section 18 U.S.C. 516, to conduct and
coordinate litigation on behalf of the United States Government.

Section 920. DEPARTMENT OF JUSTICE APPROPRIATION. This section
provides authorization of appropriations of $50 million annually,
for fiscal years 1989 through 1991, to investigate and prosecute
financial institution crimes.

It is critical that additional

resources be made available to identify, investigate and bring to
justice those who undermine the safety and soundness of financial
institutions.

This independent authorization is intended to supplement that
included in the annual Department of Justice appropriations
authorizations for this purpose.

Beginning with fiscal year

1992, the need for authorization of continuing appropriations for
this purpose will be addressed within the context of the annual
appropriations authorizations request.

This additional funding is authorized to be appropriated to the
Attorney General.

It is intended that these funds may supplement

any appropriations under the control of the Attorney General.
The Attorney General would have the flexibility to adjust the
funding among the organizations involved in investigating and
prosecuting financial institution fraud, such as the Federal
Bureau of Investigation, the U.S. Attorneys, and the Criminal and
Tax Divisions, to achieve the objectives of this authorization.

- 135 -

TITLE X
STUDY OF FEDERAL DEPOSIT INSURANCE
AND BANKING REGULATION

Section 1001.

STUDY.

Section 1001 requires the Secretary of the

Treasury, in consultation with the bank and thrift Federal
regulators and the Director of the Office of Management and
Budget to conduct a study of the Federal deposit insurance,
system, including an appropriate structure for the offering of
competitive products and services to consumers consistent with
standards of safety and soundness.

Section 1002. TOPICS. Section 1002 lists the topics, to be
included in the above study as follows:

Risk and rate structure for deposit insurance; incentives
for market discipline; the scope of deposit insurance
coverage and its impact on the liability of the insurance
fund; the feasibility of market value accounting,
assessments on foreign deposits, limitations on brokered
deposits, the addition of collateralized borrowings to the
deposit insurance base, and multiple insured accounts;
policies to be followed with respect to the recapitalization
or closure of insured depositories whose capital is depleted
to or near the point of, insolvency; and the efficiency of
housing subsidies through the Federal Home Loan Bank System.

- 136 -

Section 1003.

FINAL REPORT.

Section 1003 requires the Secretary

to submit to Congress within eighteen months from the date of
enactment of this Act, a final report which shall contain a
detailed statement of findings and conclusions, including
recommendations for advisable administrative and legislative
action.

Title XI - MISCELLANEOUS PROVISIONS

Section 1101.

AMENDMENTS TO SECTION 202 OF THE FEDERAL CREDIT

UNION ACT. Section 202 of the Federal Credit Union Act (FCU Act)
establishes the method by which federally-insured credit unions
provide funding to the National Credit Union Share Insurance
Fund. Currently, each federally-insured credit union maintains a
capitalization deposit of 1 percent of its insured shares. This
amendment would phase out the capitalization deposit over eight
years and revert to a premium method of funding.

The NCUA Board would be authorized to issue regulations necessary
to implement this change, including the authority to assess
insurance premiums during the phase out period if necessary to
maintain the equity level of the insurance fund.

Section 1102. AMENDMENT TO SECTION 203 OF THE FEDERAL CREDIT
UNION ACT. This is a conforming amendment to Section 203 of the
FCU Act, removing a reference to the capitalization deposit.

- 137 -

Section 1103.

AMENDMENT TO SECTION 5240 OF THE REVISED STATUTES.

Section 1103 amends Section 5240 of the Revised Statutes. As
amended, the section authorizes the Comptroller of the Currency,
subject to the approval of the Secretary of the Treasury, to fix
the compensation of employees of the OCC and to make a report
thereof to Congress. In setting and adjusting compensation, the
Comptroller is directed to seek to maintain comparability with
compensation paid by the Board of Governors of the Federal
Reserve System, Federal Deposit Insurance Corporation, and the
Chairman of the Federal Home Loan Bank System. The amendment
provides that such compensation shall be determined by the
Comptroller without regard to the provisions of any other law,
including any provision of Title 5 of the United States Code.

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
March 13, 1989
FOR IMMEDIATE RELEASE

LIBRARY. ROOM 5310

Contact-: Bob Levine
(202) 566-2341

Bridge Loan to Venezuela
The 'J. S. Treasury Depaertment welcomes Venezuela's intention
to address its economic and financial situation in a courageous
and decisive manner.
We believe that President Perez' economic program can provide a
basis for sustained economic growth, fiscal consolidation and
effective debt management.
At the request of the Venezuelan authorities, and in
recognition of the quality of their economic and financial
adjustment efforts, the U. S. Treasury has agreed to provide a
short-term bridge loan of $450 million.

NB-170

TREASURY NEWS
department of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
202
LIC:!*RY. ROOM 5310
/ 376-4350
FOR IMMEDIATE RELEASE
March 13, 9189
RESULTS OF TREASURE' S^ WEEKOLY.BILL -AUCTIONS
Tenders for $7,216 million of>£f3Miweek bills and for $7,203 million
of 26-week bills, both to be issued on March 16, 1989,
were accepted today.
RANGE OF ACCEPTED
COMPETITIVE BIDS:

26-week bills
maturing September 14, 1989
Discount Investment
Price
Rate 1/
Rate

13-week bills
maturing June 15, 1989
Discount Investment
Rate
Rate 1/
Price

Low
8.65%a/
8.97%
97.813 : 8.75%b/
9.28%
95.576
High
8.70%
9.02%
97.801 : 8.76%
9.29%
95.571
Average
8.69%
9.01%
97.803 : 8.76%
9.29%
95.571
a/ Excepting 1 tender of $10,000.
b/ Excepting 2 tenders totaling $20,000.
Tenders at the high discount rate for the 13-week bills were allotted 36%.
Tenders at the high discount rate for the 26-week bills were allotted 77%.

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

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Received
Accepted
:
Received
$
41,155
19,113,465
28,725
49,450
68,365
43,795
1,279,900
48,885
12,010
56,515
45,685
1,603,385
472,715

$
41,155
5,531,425
28,725
49,450
68,365
43,595
467,900
35,685
12,010
56,515
37,485
371,135
472,715

$22,864,050

Competitive
$18,808,340
Noncompetitive
1,436,560
Subtotal, Public $20,244,900

TOTALS

:

Accepted

$
29,970
23,863,515
25,155
42,585
62,790
46,535
1,037,400
35,975
10,590
:
-54,260
:
38,465
: 1,511,140
:
451,095

$
29,970
6,283,535
24,695
42,185
62,790
43,260
58,400
27,975
10,590
54,260
28,465
86,005
451,095

$7,216,160

: $27,209,475

$7,203,225

$3,160,450
1,436,560
$4,597,010

:

$2,230,645
1,201,275
$3,431,920

:
i

Type

Federal Reserve
Foreign Official
Institutions
TOTALS

2,363,355

2,363,355

255,795

255,795

$22,864,050

$7,216,160

$22,236,895
'
1,201,275
: $23,438,170
:

2,200,000

2,200,000

:

1,571,305

1,571,305

: $27,209,475

$7,203,225

An additional $71,905 thousand of 13-week bills and an additional $473,795
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/' Equivalent coupon-issue yield

NB-171

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041

For Release Upon Delivery
Expected at 10:15 a.m.
March 14, 1989

STATEMENT OF DENNIS E. ROSS
ACTING ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON "FINANCE
UNITED STATES SENATE
Mr. Chairman and Members of the Committee:
I appreciate this opportunity to speak with you today about
the Administration's pro posal to reduce the rate of tax on long
term capital gains. The President's Budget for fiscal year 1990
includes a number of pro posals that affect revenues, but none
that is more important t o the continued health of the economy and
our future competitivene ss. In my testimony today I will explain
the tax and economic pol icy objectives that support the
Administration's proposa 1 and how the proposal relates to and is
of tax
consistent
obje ctives
I willwith
also the
explain
the basis
for reform.
ou r estimate of the
proposal's revenue effects. We recognize that this aspect of the
debate over the proper tax treatment of c apital gains is highly
controversial. We accept, moreover, that reasonable minds can
differ over the revenue effects of a cut in the capital gain
rate. At the same time, we believe a car eful review of the
available evidence supports Treasury's es timate that the proposal
raises revenue in the budget period and i n the long run.
Accordingly, we have supplied an unpreced ented amount of
information concerning the basis for our estimate. If these
hearings produce no more than a careful e xamination of the issues
involved in estimating a reduction in cap ital gain rates, we will
have advanced debate over an important is sue of tax policy and I
believe also increased the chances that a capital gain preference
will be restored.
NB-172

- 2 The Administration's Proposal
In general, the Administration's proposal would allow
individuals to exclude 45 percent of the gain realized upon the
disposition of qualified capital assets. The maximum tax rate
applicable to any gains on qualified assets would be 15 percent.
A qualified asset would generally be defined as any asset that
qualifies as a capital asset under current law and satisfies the
phased-in holding periods. For example, assuming the holding
period is satisfied, an individual's residence would be a
qualified asset and gain on its disposition would be eligible for
the lower capital gains rate as well as the continued rollover of
gain and the $125,000 one-time exclusion provided under current
law.
Disposition of a qualified asset by a RIC, REIT,
partnership, or other passthrough entity would continue to be
treated as capital gain under the proposal and would be eligible
for the exclusion in the hands of individual investors.
Holding Period and Effective Date. To be treated as
qualified assets eligible for the lower capital gains rate,
assets will need to satisfy the following holding periods: more
than 12 months for assets sold in 1989, 1990, 1991, and 1992;
more than 24 months for assets sold in 1993 and 1994; and more
than 36 months for assets sold in 1995 and thereafter.
The proposal would be effective generally for dispositions
of qualified assets after June 30, 1989. Dispositions of
qualified assets after that date would be fully protected by the
exclusion or maximum rate. That is, there would be no blended
rate for gains realized in 1989 after June 30. Conversely, gains
realized on or before June 30, 1989, would not be eligible for
the exclusion, maximum rate, or any of the other provisions of
the proposal and would be taxable under current law.
Installment sales, including sales preceding the effective
date, would be eligible for the preference to the extent
installments were realized after the effective date.
15 Percent Maximum Rate. A 15 percent maximum tax rate
would apply to capital gains on qualified assets. Thus, while a
taxpayer's ordinary income may be subject to a 33 percent
marginal rate (due to phase-out of the 15 percent rate or
personal exemptions), capital gains would not be subject to a
marginal rate exceeding 15 percent. In some cases, the
application of a 45 percent exclusion would result in an
effective tax rate lower than 15 percent; for example, if the
taxpayer's marginal rate is 15 percent, a 45 percent exclusion
would result in an effective tax rate of 8.25 percent.

- 3 100 Percent Exclusion for Low Income Taxpayers. A taxpayer
would be eligible for a 100 percent exclusion on sales of
qualified assets if the taxpayer's adjusted gross income is less
than $20,000 and the taxpayer is not subject to the alternative
minimum tax. The $20,000 amount would be calculated taking the
45 percent capital gains exclusion into account. Thus, if a
taxpayer's adjusted gross income is $22,000 (including the full
amount of gains realized on capital assets), and a 45 percent
exclusion on capital gains would reduce the taxpayer's taxable
income to less than $20,000, the taxpayer would be eligible for
the 100 percent exclusion.
The $20,000 figure applies to married taxpayers filing
jointly and to heads of households. Single taxpayers and married
taxpayers filing separately would be eligible for the 100 percent
exclusion if their adjusted gross incomes are less than $10,000.
Relationship to the AMT. Taxpayers who are subject to the
alternative minimum tax would not be eligible for the 100 percent
exclusion. In making this determination, a taxpayer's tentative
minimum tax would be compared with his regular tax computed using
a 45 percent exclusion. If the tentative minimum tax exceeds the
regular tax, the taxpayer has liability under the alternative
minimum tax and would not be eligible for the 100 percent
exclusion. The ineligibility for the 100 percent rate would have
no other effect on the taxpayer.
Collectibles Not Treated as Qualified Assets. The proposal
would deny capital gain treatment for gains realized upon the
disposition of collectibles, as defined under the individual
retirement account (IRA) rules. These rules prohibit investments
by IRAs in collectibles, which are defined to include works of
art, rugs, antiques, precious metals, gems, stamps, alcoholic
beverages, and most coins. The Secretary of the Treasury is also
given authority to specify other tangible personal property to be
treated as collectibles. Proposed regulations define
collectibles to include musical instruments and historical
objects.
Depreciable Assets. The Administration's proposal would not
alter the definition of a capital asset; however, gain from the
sale, exchange, or other disposition of depreciable or depletable
property used in a trade or business would not be treated as gain
eligible for the lower capital gains rates. For this purpose,
depreciable property refers to any property which is of a
character subject to an allowance for depreciation under Code
sections 167 or 1-68. Thus, gains realized on the disposition of
intangible property, the cost of which may be recovered through
amortization deductions (see Treasury Regulation Section
1.167(a)-3), such as sports player contracts, would be treated as
ordinary income if the intangible property is used in the
taxpayer's trade or business. The fact that cost recovery of an

- 4 intangible asset may be referred to as "amortization" would not
prevent its being treated as depreciable property under this
provision. Depletable property refers to any property of a
character that is subject to an allowance for depletion, whether
cost or percentage depletion.
Under current law, gains on dispositions of special section
1231 assets, which include certain interests in timber, coal,
iron ore, livestock, and unharvested crops, are eligible for
capital gain treatment while losses on such property are ordinary
losses. Under the Administration's proposal, no assets would be
afforded such asymmetrical treatment.
Gains on nondepreciable property that is used in a trade or
business and is not held for sale in the ordinary course of
business would be eligible for the lower capital gains rates.
Losses on such property would also be treated as capital losses.
Thus, for example, gain or loss realized on the disposition of
land that is used in a trade or business and is not held for sale
to customers would be treated as capital gain or loss.
Capital Losses. Capital losses would be defined as under
current law; however, each dollar of long-term capital loss that
does not offset long-term capital gain could offset only 50 cents
of noncapital gains income, as was the case prior to 1987. The
$3,000 capital loss limitation would remain. Unused capital
losses could be carried over indefinitely.
Preventing Abuses. Special rules will be included in the
legislation to prevent abusive shifting of capital gains from
high income taxpayers to related low income taxpayers in order to
qualify for the 100 percent exclusion, designed for true low and
moderate-income taxpayers. For example, the 100 percent
exclusion might be denied to individuals recently claimed as a
dependent on the return of another taxpayer.
Because the proposal provides favorable tax treatment to
sales of corporate stock, without regard to whether the assets
held by the corporation are qualified assets, it may also be
necessary to adopt rules preventing the use of a corporation as a
vehicle to convert ordinary income to capital gain. For example,
it could be appropriate to restrict or deny altogether capital
gain treatment on sales of S corporation stock, leaving
shareholders to recognize any capital gains through sales of the
S corporation's assets.
Reasons for The Proposal
Encourage Long-Term Investment. A capital gain preference
has long been accepted as an important incentive for capital
investment. In our own country, the first tax rate differential
for capital gains was introduced by the Revenue Act of 1921. For
each of the next 65 years there was always some tax differential
for capital gains. At times there was an exclusion of some

- 5 portion of the nominal gains. At times there was a series of
exclusions that depended upon the length of time a taxpayer held
an asset before selling. At times there was an alternate tax
rate cap. But at no time subsequent to 1921 and prior to 1987
were capital gains ever taxed the same as ordinary income.
Our major trading partners have similarly recognized the
importance of the capital gain preference. Canada, Japan,
Germany and the United Kingdom all provide some level of
preferential treatment for capital gains.
The Administration's proposal further adds to the incentive
effects of the capital gain preference by targeting it to
long-term investment. Currently, investors receive the same tax
treatment whether they hold an asset for 10 years or 10 minutes.
If this country is to maintain its leadership role in the world
economy, we need to encourage investment, and, in particular,
investment that is oriented to long-term growth rather than
short-swing, speculation. By orienting investors more towards
the long term, we will also enable and encourage corporate
managers to take the long view of their companies' businesses,
and to make the investment in research and development needed for
success in future markets.
Lock-In Effect. Under a system in which capital gains are
not taxed until "realized" by the taxpayer, a substantial tax on
capital gains tends to lock taxpayers into their existing
investments. Thus, taxpayers who, independent of tax
considerations, would convert their existing assets to new
investments may instead hold on to their investments to avoid
paying tax on any accrued gains.
This so-called lock-in effect of capital gains taxation has
at least two adverse effects. First, it produces a misallocation
of capital in the economy since it alters the investment
decisions that would be made in a genuinely free market. Second,
the lock-in effect, depending on its strength, may deprive the
government of revenue. To the extent taxpayers defer sales of
existing investments, or hold onto such investments until their
death, taxes that might otherwise have been paid are deferred or
avoided altogether. The combination of these two effects
produces a situation in which both the taxpayer and the
government lose. The taxpayer is discouraged from pursuing what
he believes is a more attractive investment and the government
loses revenue.
Although some lock-in effect exists at any positive rate of
tax on capital gains income, a preference for long term capital
gains diminishes its adverse effects. The 45 percent exclusion
proposed by the Administration would both improve the allocation
of investment capital and trigger enough additional realizations
to produce a net revenue gain to the Treasury.

- 6 Inflation. Although inflation has been kept low under
policies of the past 8 years, even low rates of inflation mean
that every nominal capital gain includes a "fictional" element of
profit attributable to inflation. High rates of inflation, such
as those that existed in the mid and late 1970s, exacerbate the
problem.
Ideally, an income tax would consider only "real" changes in
the value of capital assets; the element of nominal gain
attributable to inflation would be disregarded. Current law
taxation of nominal capital gains in full has the perverse result
that real gains are overstated (and taxed too highly) and real
losses are understated and, in some cases, actually converted by
inflation from losses to gains. The Administration's proposed 45
percent exclusion for long-term capital gains would provide a
rough adjustment for the inflationary element of capital gains.
Although not a conceptually perfect response to the problem of
inflation, this rough adjustment avoids the complexities and
additional record-keeping that a precise inflation adjustment
would require.
Low and Moderate Income Taxpayers. Low and moderate income
individuals typically do not realize capital gains of the same
size or with the same frequency as higher income taxpayers. It
is not true, however, that only high income taxpayers would
benefit from a capital gains tax rate differential. Although a
large percentage of capital gains is realized by high income
taxpayers, most taxpayers who would benefit from the
Administration's proposal have low and moderate incomes. In
1985, the latest year for which detailed tax return data have
been analyzed, one-third of all tax returns with long-term
capital gains reported other (noncapital gain) income of less
than $20,000. Nearly three-fourths of all tax returns with
capital gains had other income of less than $50,000. And less
than 2 percent had other income of $200,000 or more. (See Table
1.)
Economic studies of the behavioral reactions of individuals
to changes in the taxation of capital gains suggest that lower
income individuals are less responsive than higher income
taxpayers to capital gains tax rate changes. The
Administration's proposal for a 100 percent exclusion for lower
income taxpayers provides such taxpayers with an extra measure of
incentive to make direct capital investment.
Collectibles. Investment in so-called collectibles, which
include works of art, stamp and coin collections, antiques,
valuable rugs, and similar items does relatively little to
enhance the nation's economic growth or productivity. For this
reason collectibles do not warrant the preferential treatment
accorded other capital investments.

- 7 Treatment of Gain on Depreciable Property. Depreciable
property sales are not particularly sensitive to changes in the
tax rate. The timing of such sales is more likely to be
determined by the condition of the particular asset or by routine
business cycles of replacement than would be true of capital
assets held by investors. Thus, unlike a preferential rate for
investor held capital assets, a preferential rate for sales of
depreciable assets could not be justified as offsetting a strong
lock-in effect and would lose rather than gain revenue.
Correspondingly, the case for extending a capital gain preference
to depreciable assets would have to rest substantially on the
incentive effects of the preference.
The tax system has historically provided incentives for
investment in depreciable and depletable property through the
cost recovery system. For example, current law allows investment
in plant and equipment to be recovered on an accelerated basis,
permits percentage depletion for a broad range of natural
resources, provides special treatment for the costs of raising
timber, and has a variety of special rules under which the cost
of certain intangibles may be amortized. An additional incentive
in the form of a capital gain preference is at this time neither
necessary nor appropriate.
Moreover, the availability of accelerated cost recovery
coupled with capital gain treatment on sales of depreciable or
depletable property has been a major factor behind tax shelter
activity. Although the passive loss rules adopted in the 1986
Act limit tax shelter activity, restoration of a capital gain
preference could make tax shelters more attractive.
Finally, gains and losses from sales or other dispositions
of depreciable and depletable property should be treated in the
same manner as other business income or loss and gains or losses
from sales of other business property (e.g., inventory). The
asymmetrical treatment of gains and losses from such depreciable
or depletable property provided by pre-1987 law, i.e., the
availability of capital gain treatment for gains and ordinary
loss treatment for losses, is without justification as a matter
of tax policy.
Effects of Proposal on Revenues
As I stated earlier, the effect on Federal tax revenues of
changes in capital gains tax rates is highly controversial.
Studies using different data, different explanatory variables,
and different statistical methodologies have reached different
conclusions. Our estimate was made after a careful review of
empirical studies by experts in government and the academic
community. Our estimate of induced realizations attempts to
approximate a consensus from an admittedly wide range of results.

- 8 Before analyzing our estimate in detail, allow me to make
one point about its source. The revenue estimates reported in
the budget were produced by Treasury's Office of Tax Analysis,
the same Treasury office that provides revenue estimates for all
other legislative and budget proposals. You may have seen press
reports that other offices in Treasury determined the estimates
or that the Office of Tax Analysis produced them with the
proverbial gun to its head. Whether the product of
misinformation or fevered imagination, such reports are simply
wrong. Although there has been a debate for some time at
Treasury as to the proper basis for estimating changes in the
capital gain rate, the simple fact is that these estimates
reflect the same basic assumptions the Office of Tax Analysis has
used for a number of years in analyzing capital gains
proposals.1/
Consistency with Prior Estimates. Perhaps the best place to
start in analyzing the current estimate is with Treasury's
estimate of the 1986 Act changes in capital gain taxation. Many
have asked how Treasury could score restoration of a capital gain
preference as raising revenue when it scored the elimination of
the preference in the 1986 Act as raising revenue. The short
answer to that question is that the current proposal does not
simply reverse the changes made in the 1986 Act. When fully
phased-in, the budget proposal limits the preference to
nondepreciable assets with a 3-year holding period. This
effectively targets assets that are more likely to be sold in
response to a lower tax rate, and turns the budget proposal from
a revenue loser in the long run to a long run revenue gainer.
One factor that masks the consistency in Treasury's
estimates is that our published estimate of the 1986 Act capital
gain change includes revenue not actually attributable to the
elimination of the capital gain preference. Prior to the 1986
Act, there was a 30 percentage point differential in the rates of
tax applicable to capital gains and other income (i.e., a 50
percent maximum rate on ordinary income and a 20 percent maximum
rate on capital gains). That differential created a large
incentive
for taxpayers
to convert
ordinary
income
capital
T7
The general
realization
response
estimated
for to
both
the 1986
gains.
Elimination
the
differential
incentives
for
Act
and this
proposalof is
midway
between eliminated
the time-series
and panel
income shiftingestimates
and consequently
revenue.
cross-section
published raised
in the substantial
1985 Treasury
study of
capital gains.

- 9 Although our published estimates attributed all of the
revenue gain from reduced income shifting to the capital gain
proposal, the greater part of it was in fact a result of the
reduction in ordinary rates from 50 to 28 percent. Thus, even if
the 1986 Act had left capital gain rates at 20 percent, the
reduction in the ordinary rates would have substantially reduced
the capital gain differential and resulted in a revenue pick-up
from diminished income shifting. By including that revenue
pick-up in the line estimate of the capital gain change, the
positive revenue effects of that proposal were substantially
overstated. If that estimate were restated, backing out the
effect of the reduction in ordinary income rates, the capital
gain rate increase raised only modest revenue in the long run.
Revenue Effects of Proposal's Separate Elements. Table 3
shows the separate revenue effects of the various elements of the
capital gains proposal. In addition, it shows the "static" and
behavioral effects incorporated in the estimate. Additional
revenues resulting from positive macroeconomic effects, i.e.,
revenue effects from an increase in economic growth and
productivity, are not included in the revenue estimate. I will
address the macroeconomic revenue impact later.
1. Effect of Tax Rate Reduction on the Level of Current Law
Realizations. Row 1 of Table 3 states the revenue loss that
results from reducing tax rates on capital gains that would be
realized at current law tax rates; i.e., realizations that would
have occurred regardless of a reduction in tax rates. This loss
is what a truly "static" revenue estimate would show. This
"static" revenue loss results from applying the proposal to all
assets held 1 year or longer and is estimated to be $ -11.9
billion in fiscal year 1990 and to be about $ -20 billion a year
and growing gradually thereafter.
The basis for these calculations is reflected in Table 4,
which shows that about $150 billion of net long term capital
gains will be realized in 1989 and that this amount will grow to
about $200 billion by 1994 with no change in law. Because the
Treasury had estimated a greater behavioral response to the 1986
Act change than did the staff of the Joint Committee on Taxation,
it is our understanding that the Joint Committee on Taxation
staff assumes a somewhat higher path of realized gains under
current law and hence a somewhat larger "static" revenue loss.
2. Effect of Increased Realizations. The second row of
Table 3 shows the revenue collected from realizations that would
not occur absent the lower tax rate. These induced gains are
accelerated from realizations in future years, are due to
portfolio shifting to capital gain assets from fully taxable
income sources, or are taxable realizations that would otherwise
have been tax-exempt because they would have been held until
death, donated to charities, or realized but not reported.

-IDAS indicated by a comparison of Rows 1 and 2, we estimate
that revenues from induced realization gains more than offset the
revenue loss from lower rates on current gains. This conclusion
is based on the assumed responsiveness of taxpayers to changes in
the capital gain rate, which is in turn the central and most
controversial aspect of the debate over capital gains and
revenue.
The level of taxpayer responsiveness is generally termed
"elasticity," which in this context is shorthand for the
expression "percentage increase in induced capital gains divided
by the percentage decrease in the overall capital gains tax
rate." Thus, a tax cut will tend to generate a revenue increase
if the elasticity is estimated to be greater than 1, no change in
revenue if the elasticity is exactly 1, and a revenue loss if the
elasticity is less than 1. 2/
Our assumption about capital gain elasticities is based on a
review of government and academic studies examining the question.
A cursory evaluation of these studies, which are listed in
Table 5, reveals that those carried out with so-called cross
section data or)panel data (examining individual taxpayers in a
given year or for several years) tend to yield higher estimates
of taxpayer responsiveness than those carried out with
time-series data (examining taxpayers in the aggregate for a
number of years). Giving consideration to studies of both types,
we believe that the elasticity estimates used by Treasury are
comfortably in the middle of the range reported in the studies.
We estimate an elasticity of 1.2 in the short run, dropping to
about 1.0 in the long run, and to about 0.9 after considering the
impact of converting ordinary income but before targeting the
proposal for certain kinds of assets. It is our understanding
that estimates made by the staff of the Joint Committee on
Taxation employ a much lower long-run estimate — perhaps as low
as 0.7 — which is within the range of the studies, but in our
view clearly at the lower end. This difference in elasticities,
which may seem relatively small, accounts for the great bulk of
~T/ Even this general statement will not always be accurate.
the difference between the Treasury and the Joint Committee on
An elasticity for reduced capital gains realizations that is
Taxation estimates.
slightly less than 1 generally will still generate a revenue
increase because taxpayers paying the highest tax rates are the
most responsive. Induced realizations are disproportionately
distributed with more being taxed at above-average tax rates and
fewer being taxed at below-average tax rates. In addition, the
general statement will not be accurate for studies using "last
dollar" or maximum statutory rates.

- 11 Table 4 shows that for the Administration's basic proposal
(i.e., before targeting assets, extending the holding period to 3
years, and providing additional low income tax relief) the
estimated amount of induced realizations is large: $167 billion
in 1991, nearly doubling the amount of gains that would have been
realized with no change in law. By 1995, induced realizations
would be expected to level off at about 87 percent of the level
of current law capital gains realizations.
This near doubling of realizations, from an estimated $183
billion to about $349 billion at 1989 levels, may seem remarkably
optimistic until it is placed in the following perspective.
0
The total accumulation of unrealized qualifying gains at
the end of 1987 was an estimated $4 trillion. That's
trillion, not billion.
0
If we exclude from this figure gains on personal
residences, which largely escape tax because of the
rollover and one-time $125,000 exclusion, the total pool
of gains that could be realized is still $2 trillion.
-,
0

The year-over-year increase in this accumulation — a
good guide to the potential long-run realizations — has
been running about $350 billion per year, even with
personal residences excluded, and is expected to grow.
3. Effect of Deferring Gains Until After Effective Date.
Row 3 of Table 3 shows that the proposal will induce some
taxpayers to defer realizations in the first half of 1989 until
after the effective date of the proposal. With the announcement
of the proposal in February and the assumed enactment and
effective date of July 1, 1989, some realizations that otherwise
would occur between the announcement date and the effective date
will be delayed in order to benefit from the lower tax rate. The
estimate predicts that about $1.4 billion of revenue will be lost
only over the fiscal year 1989-1990 period due to realizations
deferred until the effective date.
4. Effect of Conversion of Ordinary Income to Capital Gain
Income. The proposal will induce taxpayers to realize additional
capital gains currently and will encourage taxpayers to earn
income in the form of lower taxed capital gains. Since the
advent of preferential tax rates on capital gains in 1922,
taxpayers have found various ways to convert ordinary taxable
income into capital gains. Many of the most obvious conversion
techniques have been stopped, but a capital gains tax rate
differential will encourage taxpayers to shift to sources of
income with lower tax rates.

- 12 Methods of converting ordinary income to capital gain income
include shifting away from wages and salaries to deferred
compensation, such as incentive stock options; shifting out of
fully taxable assets, such as certificates of deposit, to assets
yielding capital gains; and shifting away from current yield
assets to growth assets, including corporations reducing their
dividend payout ratios. It is assumed that the conversion of
ordinary income to capital gain income will occur gradually,
increasing from a negligible amount in 1991 to about $2.5 billion
by the fifth year.
5. Effect of Excluding Depreciable Assets and Collectibles.
The revenue estimate of the proposal is significantly affected by
the exclusion of depreciable assets and collectibles from the
lower rate. The 1985 Treasury study of capital gains found the
responsiveness of capital gain realizations from assets other
than corporate shares to be relatively low.3_/ That is, for some
classes of assets the additional tax 'from induced realizations
will not offset the tax loss from lower tax rates on gains that
would occur under current law. By restricting the lower rates to
more responsive assets, the proposal raises an incremental amount
of additional net revenue, $1.2 billion in 1590, rising to $2.1
billion by 1994.
6. Effect of Phasing In the 3-Year Holding Period
Requirement. The 3-year holding period requirement is phased in
gradually beginning in 1993. Any holding period encourages
taxpayers to defer realizations until they are eligible for the
lower rate. During the transition to the 3-year holding period,
a one-time revenue loss will occur as realizations are deferred.
After the transition is completed, the 3-year holding period
raises revenue because it, like the depreciable asset exclusion,
tends to limit the lower rate to assets more responsive to
changes in capital gains tax rates. Assets sold after only 1 or
2 years for consumption or other purposes, rather than deferred
to 3 years, would generally be less responsive to lower tax
rates.
The phase-in of the 3-year holding period will encourage
many taxpayers to defer realizations that would otherwise occur
after 1 or 2 years until they become eligible for the lower tax
rates. In addition, the phase-in will provide an incentive
during the transition for some taxpayers to accelerate the
realization of some gains. For instance, taxpayers who might
realize
held elasticity
for 18 months
inpanel
early cross-section
1993 might choose
17
The gains
estimated
from
data to
was
accelerate
those gains
into 0.71
calendar
year 1992 torental
be eligible
for
1.07
for corporate
shares,
for residential
real
the
lower
rate
as
1-year
assets.
Thus,
the
phase-in
will
estate, and 0.43 for all other assets.

- 13 increase realizations in 1992 and revenues in fiscal years 1992
and 1993.
Due to the two-step phase-in (the jump to 2 years in
1993 and to 3 years in 1995), the revenue pattern creates
temporary incremental revenue losses in fiscal years 1994 and
1996. By 1998, the long-run effect of imposing a 3-year holding
period is a revenue increase of $1.5 billion.
7. Effect of 100 Percent Exclusion for Low-Income
Taxpayers" The additional provision to exclude all qualified
capital gain realizations from tax for taxpayers with low incomes
will lose approximately $0.3 billion annually. In 1985,
taxpayers with adjusted gross incomes of less than $20,000
accounted for 30.2 percent of returns with capital gains and 11.4
percent of net long-term capital gain realizations. Some of
these taxpayers, however, were taxpayers with low adjusted gross
income due to large tax preferences. The potential cost of this
feature is reduced by limiting the zero tax rate to individuals
who are not subject to the alternative minimum tax rate. The
provision is considered after the initial 45 percent exclusion so
the revenue loss is due only to the rate reduction from 8.25
percent (55 percent times 15 percent) to zero, not the full
reduction from 15 percent to zero.
Total Effect of the Proposal. The Administration's proposal
is estimated to increase Federal revenues in fiscal years 1989
through 1993 due to the large induced realizations in the initial
years from the unlocking of previously accrued gains. During
fiscal years 1994 through 1996, a one-time revenue loss will
occur as the 3-year holding period requirement is phased in,
causing taxpayers to defer short-term realizations. After fiscal
year 1997, the proposal will increase Federal receipts between $1
and $2 billion annually.
Comparison of Treasury and Joint Committee on Taxation Estimates
Table 6 summarizes the principal differences between the
Treasury estimate of the revenue impact and the Joint Committee
on Taxation staff estimate. In order to isolate the various
effects in a comparable way, it is necessary to combine four rows
of the more detailed Treasury revenue table and two rows of the
Joint Committee table.
As discussed above, the main difference between the Treasury
revenue estimate and the revenue estimate made by the staff of
the Joint Committee on Taxation is that the latter estimate
assumes a lower level of responsiveness by taxpayers. This
difference shows up in the first bank of numbers on Table 6. A
second and related difference appears in the third bank of
numbers, dealing with the phase-in of a 3-year holding period.
The Treasury estimate assumes a good deal of shifting on the part
of taxpayers delaying and accelerating certain sales as the
holding period is stretched out, while the Joint Committee on
Taxation staff estimate assumes less responsiveness to shifting
realizations around effective dates.

- 14 Macroeconomic Impact of the Proposal
Our revenue estimates of the Administration's proposal do
not include potential increases in the rate of macroeconomic
growth expected from a lower capital gains tax rate. This
conforms to the general budget practice of including
macroeconomic effects of revenue and spending proposals in the
underlying economic forecast and hence the budget revenue and
outlay totals, but excluding such effects from budget lines
showing revenue impacts of any particular proposal. In the case
of the proposed lower capital gains tax rate, the investment,
savings, and national income growth will be most significant over
the longer term.
There are two ways the Administration's capital gains
proposal would affect growth. First, a lower tax rate on capital
gains that qualify under the Administration's proposal would mean
a lower cost of capital, primarily on corporate sector
investment. Since these investments incur higher than average
taxes under current law, the proposed change helps promote a more
efficient playing field. By itself, this more efficient
allocation of capital among sectors would improve economic
welfare and lead to higher growth.
Second, by lowering the cost of capital generally, the
proposal would encourage more savings and investment, leading
directly to greater capital formation and eventually to a higher
rate of growth in the economy.
One possible approach to quantifying the long-run
macroeconomic effects would be to employ the kind of models and
techniques that were used by Treasury to evaluate long-run
macroeconomic consequences of tax reform. As an illustration, if
we assume a 4 percent constant long-run rate of inflation and a 4
percent after-tax real rate of return required by investors,
these models suggest that the Administration's proposal could
increase real national income by between 0.2 percent and 0.4
percent after the economy fully adjusts. This, in turn, would
translate into a permanent annual increase in long-run tax
revenues of about $3 billion to $5 billion in real 1989 terms.
This revenue increase would be in addition to that reflected in
the budget estimate which I have discussed above.
Consistency with Tax Reform
Many appear to oppose a reduction in the capital gains rate
for fear that it would reopen tax reform. They argue that the
elimination of the capital gains preference was a basic trade-off
in exchange for lower tax rates on other income. On this view,
restoring the capital gain preference would either leave the
system biased in favor of wealthy taxpayers or lead inevitably to
an increase in the rate of tax on other income.

- 15 The low marginal tax rates established in tax reform were an
achievement of historical significance, and plainly should not be
jeopardized. Although we should thus be appropriately cautious
in reexamining decisions made in tax reform, the ultimate test
must be whether, consistent with the principles underlying tax
reform, a proposed change in the tax law improves the efficiency
and fairness of the tax system. Most accept that a capital gain
preference has positive effects on economic efficiency, but we
believe it is also consistent with distributional fairness.
In the first place, our estimates show that the lower
capital gain rate will generate more tax revenue from wealthy
taxpayers. It is difficult to argue that a proposal that
increases the tax liabilities of the wealthy biases the system in
their favor.
Nor do we think this conclusion is inconsistent with the
premises of the 1986 Act. As I stated earlier, the
Administration's proposal raises revenue precisely because it is
not a simple reversal of the changes made in 1986. The capital
gain preference would be restricted to a smaller pool of assets,
with the preference denied to the assets historically used in tax
shelters. In addition, taxpayers will be required to hold their
investments for a substantial period, with the preference denied
to short-swing, speculative activity.
Finally, as this Committee well knows, the 1986 Act was more
complex than a simple trade of lower rates of tax on ordinary
income for an elimination of the capital gain preference. Tax
reform also involved substantial base broadening, the impact of
which landed disproportionately on affluent taxpayers. Even more
fundamentally, tax reform involved a substantial transfer of tax
burden from the individual to the corporate sector, none of which
was factored into the analysis of the legislation's
distributional effects. In that context, the addition of a
capital gains tax rate, limited primarily to holders of corporate
stock, cannot fairly be seen as undermining the progressivity of
T/ If tax changes resulting from induced realizations are taken
the tax income system.4/
Tnto account along with static changes in tax, the restoration of
a capital gains tax rate differential results in a slightly
progressive redistribution of taxes. For example, as shown in
Table 2, before making adjustments for conversion and targeting,
under our basic proposal there would be a 9.2 percent increase in
tax for all taxpayers with over $50,000 of adjusted gross income
and a 3.1 percent reduction in capital gains tax for taxpayers
with less than $50,000 of income.

- 16 Conclusion
In sum, we believe the case for the Administration's capital
gain proposal is compelling. The proposal will provide an
important incentive for long-term savings and investment, which
over time will boost productivity and economic growth.
Importantly, this incentive comes without cost in revenues, and
indeed in our view significantly increases revenues in the budget
period and in the long run.
We recognize that for some the possibility that a cut in the
capital gain rate could increase revenue is "too good to be
true." They dismiss the argument as a fanciful elaboration of
supply-side economics. Although such reactions are
understandable, they miss the critical point that the capital
gains tax rate under current law is elective with taxpayers.
Until a taxpayer sells his asset, the rate of tax is zero.
Capping the statutory tax rate at 15 -percent will cause many
taxpayers, who would otherwise elect a zero tax rate by retaining
their investments, to realize their gains and pay some tax.
Finally, let me emphasize Treasury's willingness to provide
whatever assistance we can as the Committee examines the
Administration's proposal and the tax and economic policy issues
it raises. We have attempted in our testimony to lay out in
detail the policy basis for the proposal and for our estimate of
its revenue effects. We stand ready to supply such additional
information as Committee members would find relevant.
That concludes my prepared remarks. I would be pleased to
respond to any questions.

- 17 Attached Tables and Exhibits
Table 1 showing the distribution of capital gains tax
changes by income class for the basic proposal with induced
realizations included.
Table 2 showing the distribution of returns with capital
gains by non-gains income class.
Table 3 showing the Treasury estimates in detail.
Table 4 showing the distribution of realizations under
current law and under the basic 45%-15% proposal.
Table 5 showing the range of elasticities appearing in
various studies by academic and government economists.
Table 6 showing a line-by-line comparison of the Joint
Committee on Taxation and the Office of Tax Analysis revenue
estimates.

I ,il»l.: 6

Treasury and Joint Committee Revenue Estimates
For the President's Capital Gains Proposal
Item
1. General Proposal 1/
Treasury
Joint Committee on Taxation
Difference
2. Exclusion of Certain Asset Types
Treasury
Joint Committee on Taxation
Difference
3. 3-Year Holding Period
Treasury
Joint Committee on Taxation
Difference
4. Exclusion for Certain Taxpayers
Treasury
Joint Committee on Taxation
Difference
Total Revenue Effect
Treasury
Joint Committee on Taxation
Difference
Department of the Treasury
Office of Tax Analysis

1989

1990 |

Fiscal Years,$ Billions
1992
1991

19.93

1994

-1.2
-11.6
-10.4

39

3.6

1.4

ZA

-6.2
-9.8

-8.9
-10.3

-0.6
-9.8
-9.2

1.7

1.9

2.1

2.1

U
0.1

11

13.

3J.

3J?

1.0

1.0

1.0

1.1

0.0
OO
0.0

0.0

0.4

1.0

-7.4
-1.9

-0.1
-0.1

-0.3
-0.4
. -0.1

0.7

4.8

4.9

3.5

13

-4.0
-8.9

-6.4
-9.7

0.6
0J5
0.0

-1.5

0.2

1.2

<L2
0.0
0.0

M

0.0
0.0

QJ.
-0.1

-1.5

<LQ

<Li

0.0

-0.3

-0.7

5.5

-0.3
-0.4
-0.1

-0.3
-0.4
-0.1

-0.3
-0.5
-0.2

-0.3
-0.5
-0.2

1/ Includes the JCT's 4 5 % exclusion and effective date lines, and Treasury's
sialic estimate, increased realizalions, delayed realizations around effeclive
dale and conversion ol income lines.

(L3

-6.8
-10.9
dBJ
-4.0
-9.1
March 14, 1989

22

Table 5

Long-Term Capital Gains Realization Elasticities
Derived From Academic and Government Studies

Data Type

Studies

Capital Gains
Type

Derived
Realization
Elasticity

ElasticityDerived bv
Simulation

Individual Tax-Return Studies:

No

Feldstein. Slemrod.
and Yitzhaki (1980)

Cross-Section.
High-Income
Sample. 1973

Corporate Stocks

Minarik
(1981)

Cross-Section.
High-Income
Sample. 1973

Corporate Stocks

Range from -.44
to -.79

No

Auten and Clotfelter
(1982)

Panel Data.
Middle-Income
Sample.
1967 to 1973

All Capital Assets

Short-Run Range:
-.91 to -3 46 T
Long-Run Range:
-.36 to -1.45

No

U.S. Treasury
(1985)

Panel Data.
1971 to 1975

All Capital Assets

Long-Run Range:
-1 16 to -2.20

Yes

U.S. Treasury
(1985)

Panel Data.
1971 to 1975

Corporate Stocks
Real Estate
Other Assets

Long Run: -2.07
Long Run: - .71
Long Run: - .43

Yes

U.S. Treasury
(1985)

Time Series.
1954-1985.
All Taxpayers

All Capital Assets

Short Run: -1 3
Long Run: -0.8

No

Lindsev
(1987)'

Pooled CrossSection and
Time Series.
1965-1982

A H Capital Assets

*Short Run: -2.14
*Long Run: -1.37

No

Darhy. Gillingham.
and Greenlees
(1988)

Time Series
1954 to 1985.
All Taxpayers

All Capital Assets

*Long-Run Range:
-.62 to -1 55 ~

No

Congressional
Budget Office
(1988)

Time Series
1954 to 1985.
All Taxpayers

All Capital Assets

* Range from - 79
to - 99

No

Auerbach
(1988)

Time Series
1954 to 1986.
All Taxpayers

All Capital Assets

*Lone-Run Range
-.06 to -1.08

No

-3.75

Aggregate Time-Series Studies:

Department of the Treasury
Office of Tax Analysis
* Not reported by author(s).

March l4*~~W
Derived at 25 4 percent average tax projected for 1988 bv C B O Report (1988). Table 3

Table 4

Realizations of Net Long Term Capital Gains
Under Current Law and an Across the Board Rate Cut 1/
($ Billions)

Tax

Realizations
Under Current

Year

Law

1980
1981
1982
1983
19841985
1986
1987 P
1988 E
1989 E
1990 E
1991 E
1992 E
1993 E
1994 E
1995 E
1996 E
1997 E
1998 E
1999 E
Department of the Treasury
Office of Tax Analysis

71
78
87
117
136
166
319
140
135
151
168
183
193
201
206
210
215
220
225
230

Realizations
Under
Rate Cut 1/

Change in
Realizations
Rate Cut 1/

—
—
—
—
—
—
—
—
288
333
349
357
367
384
393
402
412
421
431

—
—
—
—
—
—
—
—
137
165
167
164
166
178
183
187
192
196
201
March 14, 1989

1/ The estimate assumes a 4 5 % exclusion, 1 5 % maximum rate on capital gains. This does not
include the effect of a limitation to non-depreciable assets, a three year holding period, or a
1 0 0 % exclusion for low income families.
P', Data are preliminary and include short term capital gains.
E', Estimate.

Table 3

Revenue Effects of The President's Capital Gains Proposal
Fiscal Years 1989-1999
Fiscal Years (Sbillions)
Longer Run*

Budget Period

Effects of Proposal

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Effect of Tax Rate Reduction on Existing Gains
Projected For Current Law Realizations

-1.6

-11.9

-17.6

-19.1

-20.2

-21.0

-21.5

-22.0

-22.5

-23.0

-23.5

Effect of Increased Realizations

2.4

17.1 21.8 21.8 21.5 22.3 22.3 22.9 23.4 23.9 24.5

Effect of Delaying Gains Until the Effective Dale

-0.2

-1.2

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Effect of Conversion of Ordinary Income to Capital Gain Income.

0.0

-0.1

-0.6

-1.3

-1.9

-2.5

-2.5

-2.6

-2.6

-2.7

-2.8

Effect of Excluding Depreciable Assets and Collectibles

0.2

1.2

1.7

1.9

2.1

2.1

2.3

2.4

2.4

2.5

2.5

Effect of Phased in Three Year Holding Period

0.0

0.0

0.0

0.4

1.0 -7.4 -2.3 -11.7 -0.1 1.5

-0.0

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

-0.3

0.7

4.8

4.9

3.5

2.2

-6.8

-2.0

-11.3

0.2

1.8

Effect of 1 0 0 % Exclusion for Certain Low Income Taxpayers

TOTAL R E V E N U E EFFECT OF P R O P O S A L
Department of the Treasury
Office of Tax Analysis
Notes:

1.5
-0.3

1.8

March 14,1989

These estimates include changes in taxpayer behavior but do not include potential increases in the level of macroeconomic
Details may not add due to rounding.
Disaggregated effects are stacked in sequence.
* Longer run estimates assume 1994 growth extends past the budget forecast period.

growth.

Table 2

Distribution of Net Capital Gains, and Tax Liability
Under Current Law and an Across the Board Rate Cut 1/
(Calendar Year 1991. $Billions)
Adjusted Gross Income Class
Under Current Law

$10,000
Less Than
$19,999
$10,000 to
$29,999
$20,000 to
$49,999
$30,000 to
$99,999
$50,000 to
$100,000 to $199,999
$200,000 or more
TOTAL

Capital Gain Realizations
Current Law I
RateCuTU

Tax on Capital Gains
"Current Law I
Rate Cut 1/

19
7
8
15
24
23
86

22
10
12
29
54
50
172

0.9
0.9
1.3
3.3
6.3
6.4
22.2

0.7
0.7
1.2
3.6
7.5
6.9
23.7

182

349

41.3

44.3
March 14.1989

Department of the Treasury
Office of Tax Analysis
1/ The estimate assumes a 45% exclusion. 15% maximum rate on capital gains. This does not
^ ^ E X S
a limitation to non-depreciable assets, a three year holding penod. or a
1 0 0 % exclusion for low income families.

Table 1

Distribution of Net Long Term Capital Gains
For Returns With Long Term Capital Gains in 1985
(In Percent)

Adjusted Gross Income Class
Without Capital Gains

Less tllan $10,000
$19,999
$10,000 to
$29,999
$20,000 to
$49,999
$30,000 to
$99,999
$50,000 to
$100,000 to $199,999
$200,000 or more
TOTAL
Department of the Treasury
Office of Tax Analysis
Source: 1985 IRS Statistics of Income

Distribution of
Returns With
Long Term Gains

16.9%
16.5
15.9
24.7
19.7

4.5
1.8
100.0%

Distribution of
Long Term Gains

19.7%

Percentage of
Total Returns With
Long Term Gains

5.1%

5.9
6.1

6.5
9.8

12.0
17.5
12.6
26.2

13.6
24.6
56.2
76.1

100.0%

9.9%
March 14, 1989

TREASURY MEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2041

FOR IMMEDIATE RELEASE

March 13 , 1989

GERALD L. HILSHER
LEAVES TREASURY TO RETURN TO PRIVATE LEGAL PRACTICE
Secretary of the Treasury Nicholas F. Brady announced
today that Deputy Assistant Secretary for Law Enforcement
Gerald L. Hilsher is leaving the Department to return to
private legal practice in Tulsa, Oklahoma, where he will
become "Of Counsel" to the firm of Huffman, Arrington,
Kihle, Gaberirio & Dunn.
As Deputy Assistant Secretary for Law Enforcement,
Mr. Hilsher has responsibility for oversight of Treasury's
law enforcement bureaus, including the Secret Service, the
Customs Service, the Bureau of Alcohol, Tobacco & Firearms,
and the Federal Law Enforcement Training Center. He is also
responsible for the promulgation and enforcement of
regulations under the Bank Secrecy Act. During his tenure,
he has been involved in such diverse matters as Presidential
candidate protection, federal firearms policy, drug
interdiction, anti-money laundering initiatives, white
collar crime, and was deeply involved in the development of
the 198 8 Anti-Drug Abuse Act.
Mr. Hilsher left private practice in Tulsa, to join the
Reagan/Bush Administration as Deputy Assistant Secretary for
Law Enforcement in February, 1987. He was an Assistant
United States Attorney in charge of the Organized Crime Drug
Enforcement Task Force in Tulsa from 1982-1985.
Mr. Hilsher graduated from Northeastern Oklahoma State
University in Tahlequah, Oklahoma and received his law
degree from the University of Texas School of Law in Austin,
Texas. As long-time Tulsa residents, he and his wife Vickie
are
looking forward to their return to the Sooner State.
NB-173-

TREASURY NEWS .
Department of the Treasury • Washington, D.c. • Telephone 566-2041
320

TEXT AS PREPARED
REMARKS BY
THE SECRETARY OF THE TREASURY
NICHOLAS F. BRADY
BEFORE THE NATIONAL ASSOCIATION OF HOME BUILDERS
WASHINGTON, D.C.
MARCH 13, 1989
Good afternoon and thank you for this opportunity to meet
with a group that represents the Nation's residential and
commercial building industry. We believe strongly that the
President's S&L reform package is pro-housing and good for your
business. Hopefully, in the days ahead ve can continue the
dialogue we have started with you to ensure the swift enactment
of the President's reform program to resolve the S&L problem.
I will concentrate most of my remarks this morning on the
President's reform plan for the savings and loan industry. But
before getting to that, I would like to take just a few minutes
to touch on some of the other important priorities the Bush
Administration will be pursuing.
PROMOTING ECONOMIC GROWTH
Our first and foremost economic priority is fostering a
more competitive, economy which will continue to lead the world
as we move toward the 21st century. We are in our 76th
consecutive month of economic expansion and we will do
everything we can to make sure economic growth continues.
Economic growth means rising living standards for working
Americans and new job opportunities for those who are out of
work.
We must remain vigilant against inflation so that it does
not plague our economy as it did in the late seventies. It is
possible to have somewhat differing interpretations of economic
statistics, to think one set of statistics means more than
another, but there is no difference between the Administration
and the Federal Reserve Board on the importance of resisting and
preventing inflation in order to help sustain the economic
NB-174
expansion.

2

CUTTING THE BUDGET DEFICIT
We must recognize as we pursue our goal of inflation-free
economic growth that the greatest obstacle to success is the
federal budget deficit. And the best way to fight inflation and
encourage economic growth is to cut the deficit.
That is why President Bush has proposed to Congress a
budget that will meet next year's Gramm-Rudman-Hollings deficit
reduction target of $100 billion without raising taxes. His
budget takes the more than $80 billion in new revenues resulting
from economic growth and allocates them to deficit reduction and
spending priorities.
The President pledged in his budget address to Congress
that he and his team are ready to work with the Congress, "day
and night, if that's what it takes, to meet the budget targets
and to produce a budget on time." Budget Director Darman,
Governor Sununu and I have begun to negotiate with the Congress
to achieve the budget reduction all of us agree is necessary.
THE S&L PLAN
Now, let me turn to what has been one of our top priorities
from the very first days of this Administration: a sound,
responsible solution to the savings and loan crisis.
President Bush is correct. No simple or painless solution
to this problem exists — a point your testimony noted last
week. Only eighteen days after he was inaugurated however, he
announced the Administration's plan. In doing so, President
Bush reaffirmed our commitment to fix it now, fix it right, and
fix it once and for all.
The Administration's savings and loan industry reform plan
meets these standards. It serves as a blueprint for
comprehensive reform and sound financing. It is pro-consumer - putting deposit insurance on a sound basis for the future to
protect depositors and taxpayers — and it is pro-industry —
for S&Ls and the industries they serve.
RESOLVING INSOLVENT S&Ls
Now, let me turn to a few of the most important details:
On February 7, the day after the President announced his plan,
the FSLIC, FDIC, OCC, and the Federal Reserve worked together to
stabilize insolvent institutions. To date, 118 insolvent S&Ls
have been brought under regulatory control. Within six weeks,
200 of the worst cases should be in the hands of federal
authorities.

3

That action should begin to reduce the cost of funds for
your industry. Moreover, this quick action will give us a head
start on implementing the necessary resolutions of insolvent
thrifts, which will be initiated as soon as Congress provides
the necessary financing.
THE REFORM PLAN
We have also proposed fundamental reforms in the way the
S&L industry is insured and regulated. To correct the systemic
problem of having the regulator act both as an industry advocate
and insurefr, FSLIC will be separated from the Bank Board and
attached administratively to the FDIC.
The combined administrative resources of FDIC and FSLIC will
create an insurer with independence and sufficient capacity to
tackle this job. While a single agency will be created,
separate insurance funds will be maintained for commercial
insured banks and for savings and loans.
The Chairman of the Federal Home Loan Bank System (FHLBS)
will continue to be the chartering authority and the primary
federal supervisor of savings and loans. The current board will
be replaced by a single chairman, who will be subject to the
same general direction by the Secretary of the Treasury as the
Comptroller of the Currency. Let me stress a critical point
here. It is not the intent of the legislation to have the
Treasury Department micro-manage the day-to-day affairs of S&Ls
or the new Federal Home Loan Bank System or advances by the
system to S&Ls. That's the job we expect the Chairman and his
supervisory personnel to do.
SAFETY AND SOUNDNESS
The Administration plan will increase safety and soundness
standards for savings and loan institutions by requiring these
institutions to meet standards equivalent to commercial bank
capital standards by June 1, 1991. The Chairman of the Federal
Home Loan Bank System will administer these capital requirements,
with fairness and flexibility where it is required. For example,
contrary to some comments that have been made, S&Ls that don't
meet the deadline won't be liquidated — they simply will not be
able to grow after 1991 without providing adequate private
capital. Much of the problem we see today is related to
excessive growth in the past without sufficient capital. We have
learned a valuable lesson: Deposit insurance simply will not
work without sufficient private capital at risk and up front.
While we can be flexible in the administration of these capital
standards, we cannot afford to weaken them or delay the date they
become effective.

- 4 -

Incentives for attracting new capital will further increase
the amount of private capital protecting depositors. For
example, bank holding companies will be permitted to acquire an
insolvent savings and loan without the existing cross-marketing
and tandem restrictions. After two years, bank holding
companies will be able to acquire any savings and loan without
these restrictions.
The FDIC will be given enhanced authority to set insurance
standards for all S&Ls, both federal and state-chartered. It
will be able to deny insurance for risky activities that have
been authorized by some states in the past. The FDIC would also
have a "fast whistle" to halt unsafe and unsound practices, while
still protecting insured depositors.
All in all, these steps will create a system of checks and
balances for S&Ls that more closely parallels that of commercial
banks. And that ultimately is in the best interest of S&Ls,
their customers and all of us as taxpayers. As their customers,
you should benefit directly from enacting the President's plan
quickly to ensure a stable business environment in the future.
SOUNDNESS OF THE DEPOSIT INSURANCE FUNDS
Beyond the regulatory reforms which are designed to insure
that massive insolvencies are never allowed to occur again, there
is a fundamental need to put the federal deposit insurance funds
on a sound financial basis. This can be accomplished by
reestablishing the basic principle of industry-financed deposit
insurance funds standing between any future industry problems
and the taxpayer.
The cost of the S&L solution underscores the importance of
requiring all federal deposit funds to be adequately capitalized.
The FDIC insurance fund's reserve-to-insured deposit ratio has
fallen to an estimated all-time low of 0.83 percent. The Plan we
put forward proposes increasing commercial bank premiums to bring
the FDIC fund more in line with its historical reserve-to-deposit
ratio to protect depositors and taxpayers.
THE FINANCING PLAN
The financing portion of the Administration's plan has three
parts. The first $50 billion is to resolve currently insolvent
institutions and any other marginally solvent institutions which
may become insolvent over the next several years. Second, the
plan ensures adequate servicing of the $40 billion in past FSLIC
obligations. Third, the plan provides $24 billion for any
insolvencies that may occur between 1992 and 1999.

- 5 -

At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC) to resolve all S&Ls which are now GAAP
insolvent or may become so over the next three years. The
creation of this new corporation will allow the isolation and
containment of all insolvent S&Ls during the three-year
resolution process and will facilitate a full and precise
accounting of all the funds that are used. The Secretary of the
Treasury will serve as Chairman of the RTC, together with the
Chairman of the Federal Reserve Board of Governors and the
Attorney General as the additional oversight members. Our goal
will be the orderly disposition of assets inherited by the RTC,
without dumping assets on depressed markets.
To provide the $50 billion to the RTC, we have asked the
Congress to create a separate corporation, the Resolution Funding
Corporation (REFCORP), which will issue $50 billion in long-term
bonds to raise the needed funds. REFCORP will use S&L industry
funds — including what is left of the $3 billion Congress
authorized from the FHLBank System in the 1987 legislation
creating the Financing Corporation (FICO) — to purchase zerocoupon, long-term Treasury securities with a maturity value of
$50 billion to assure the repayment of the principal of the bonds
issued by REFCORP.
Interest payments on the REFCORP bonds will come from a
combination of private and taxpayer sources. The $300 million in
FHLBank retained earnings is from funds not available for
dividends and therefore will not directly reduce the earnings of
thrifts. All Treasury funds used to service REFCORP interest
will be scored for budget purposes in the year expended.
Funds for the second component of our plan — servicing the
$40 billion in resolutions already completed by FSLIC — also
will come from a combination of S&L industry and taxpayer
sources.
Funds for the third component of the plan — managing future
S&L insolvencies and building the new Savings Association
Insurance Fund (SAIF) during the post-RTC period — will come
from a portion of the S&Ls' insurance premiums and taxpayer
funds as needed.
A REVITALIZED HOUSING FINANCE SYSTEM
Today, as in the past, the S&L industry plays an important
role in housing finance. The S&L industry's problems do not stem
fundamentally from their traditional business of mortgage
financing. Nonetheless, problems in the S&L industry are a
threat to the viability of our housing finance system and they
must be fixed.

6 -

The Administration's plan is designed explicitly to promote
housing finance by revitalizing the S&L industry and by
maintaining, the FHLBS and its facility for managing advances to
thrifts. The regulatory reforms outlined earlier as well as
oversight by Treasury of the FHLBS help insure a financially
viable S&L industry to serve housing finance. We believe that
the best thing for housing finance in this country is a strong
and sound S&L industry.
Moreover, the plan provides for explicit representation for
the housing industry on the boards of directors of the regional
Federal Home Loan Banks. The objective is to ensure that the
concerns of the housing industry play a direct role in the
policies and practices of these government sponsored enterprises.
Finally, the plan provides funding not just to resolve
insolvent S&Ls, but also includes funding to establish a new S&L
insurance fund for the future. The majority of future S&L
insurance premiums are allocated to this insurance fund; none pay
for REFCORP interest. And taxpayer funds are allocated to the
insurance fund as well, giving tangible proof of our commitment
to the future of the S&L industry as a provider of housing
finance.
CONCLUSION
In conclusion, the Administration's activity of the past few
weeks should illustrate clearly our commitment to a longlasting resolution of the S&L crisis and a commitment to a
strong, vibrant housing finance industry. We have presented a
structurally sound plan. We have proposed a balanced financing
package that requires contributions from the S&L industry and
also lives within the government's means.
The plan will create a healthy thrift industry by removing
the insolvents and requiring those which remain to have capital
and accounting standards equivalent to other financial
institutions. And by requiring that deposit insurance be fully
funded, the plan will reinforce depositor confidence in the
system. In short, we have developed a plan that is good for the
housing industry.
President Bush deserves a great deal of credit for stepping
forward with a plan that will do the job. And that plan deserves
your forthright support. Where we differ on details, let us
continue to talk with one another for the good of the public.

- 7 -

Let me leave you with one final thought and ask for your
firm commitment. We have moved swiftly to present a credible
plan to get the S&L problem off the front pages of the daily
newspapers and create a more stable environment for residential
finance. We now need Congress to act just as swiftly. Delay
costs you and it costs the taxpayers money.
We have encouraging signals from the new leadership of both
the House and Senate Banking Committees, starting with the House
Financial Institutions Subcommittee markup on April 4, followed
by the Senate Banking Committee the next week. We need your
support and help to stay on a fast track. The American people
deserve no less. With your cooperation, we can move ahead and
get this problem behind us once and for all. Thank you very
much.
# # # # *

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR RELEASE AT 4:00 P.M.
March 14, 1989

CONTACT: Office of Financing
2Q2/376-4350

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,400 million, to be issued March 23, 1989.
This offering
will provide about $ 12 5
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $14,270 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 Standard time, Monday, March 20, 1989.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $ 7,200
million, representing an additional amount of bills dated
December 22, 1988, and to mature
June 22, 1989
(CUSIP No.
912794 SF 2 ) , currently outstanding in the amount of $7,254 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $ 7,200 million, to be dated
March 23, 1989,
and to mature September 21, 1989 (CUSIP No.
912794 SY 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 March 23, 1989.
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 $1,756 million as agents for foreign
and international monetary authorities, and $3,717 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)
NB-175

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'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,
Department
of the Treasury • Washington, D.c. • Telephone 566-204!
Text as Prepared
tmoargoed. For Release Upon Delivery
Expected at 10:00 a.m., E.S.T.

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WW 5Z10

Testimony by
^ *°>i!" -J
rc.._
Secretary of the Treasury ^•"'•T*'M ».
Nicholas F. Brady
Before the
Committee on Ways and Means
U.S. House of Representatives
Wednesday, March 15, 1989
Chairman Rostenkowski, Mr. Archer and members of the
Committee, I am pleased to be here today to discuss with you
President Bush's proposed fiscal year 1990 budget. I know that
you have already heard from the Director of the Office of
Management and Budget, Richard Daxman, so in my testimony I will
not repeat a detailed presentation of the Bush budget.
The approach to the budget I wish to take today is from the
perspective of overall economic policy, thus, I will discuss the
importance of deficit reduction to the continued vitality and
strength of our national economy and to maintaining and improving
our position in the world economy.
We are all aware that we continue to be in a period of
extraordinary economic expansion, which has produced millions of
jobs, while reducing inflation. We must equally be aware that to
sustain this expansion we must reduce the deficit.
As you know, the Federal Reserve recently raised the
discount rate one half of a percent to seven percent. I'd like
to say a few words about that. First, and foremost, the Bush
Administration and the Federal Reserve share absolutely a firm
commitment to fighting inflation.
It is possible to have
somewhat differing interpretations of the same economic
statistics, to think one set of statistics means more than
another, and still share the same goal of fighting inflation.
The Federal Reserve is using the strongest weapon in its
arsenal to fight inflation to advance the cause of the long-term
strength and vitality of our national economy.
The strongest
weapon we in the government have to further the cause of our
long-term economic strength is deficit reduction. We must do our
part. Even to delay action costs us — in terms of interest
rates, jobs, the Savings and Loan crisis, the third world debt
problem.
Let us be frank with one another. We are constrained
between revenue levels that are the result of the 1988 election
which validated President Bush's commitment to "No new taxes"
NB-176
and a Gramm-Rudman-Hollings maximum deficit level of $100 billion
prescribed in law. so, there are not funds to do all that we

2
want.
Stepping back from the roar of the budget discussions for a
minute, one could say, "This is where the country wants us to
operate." The key is to have the American people say, "They did
what we wanted with what we gave them."
ECONOMIC ASSUMPTIONS
The Bush Administration is absolutely committed to working
with you to reduce the deficit.
Some have questioned our
economic assumptions.
But, I would like to point out that
historically the executive branch's economic assumptions have not
had a consistent bias toward a rosy scenario. In fact, in the
last seven years, the Reagan Administration underestimated
growth four times and overestimated it three.
For this year, we believe that the economy will continue to
grow, but at a slightly slower pace than last year's drought
adjusted rate. We are projecting that GNP will grow 3.5 percent
next year. But when we exclude the impact of the rebound from
the drought, our forecast is for a moderate 2.8 percent growth
rate.
This is slower than last year's 3.4 percent drought
adjusted growth rate. Our long term forecast for a 3.2 percent
sustainable growth rate is right in line with our experience over
the past 40 years, during which real GNP growth averaged 3.3
percent.
As one who worked for over 30 years in financial markets,
I would like to make a few comments on interest rate assumptions.
During my first year in business, 1954, ten-year government bonds
carried an interest rate of 2.4 percent. They reached 14 percent
in 1981. These same ten-year government bonds were 12.4 percent
as recently as 1984, but declined to 7.7 percent in 1986. They
now carry an interest rate of about 9.3 percent.
Attached as an exhibit to my testimony is a graph showing
the decline in rates surrounding the passage of Gramm-RudmanHollings. From three and one-half months prior to the passage of
this all-important fiscal legislation until three and one-half
months after, interest rates declined 300 basis points. Was it
the only cause of this rapid decline in interest rates? No. Was
it a principal cause? Yes.
This would indicate to me that while there is plenty of
room for honest disagreement about the future level of interest
rates, there is some evidence that fiscal actions have an effect
on interest rates, particularly long-term rates. My conclusion
is that investors and savers all over the world are waiting for a
sign from our government that we are committed to fiscal
prudence, and are willing to do something about it.
Delay in
reaching a budget agreement may only maintain the current high

3
level of interest
unnecessary pain.

rates

and

cost

the

U.S.

and

the

world

In sum, do I think our economic assumptions will prove true
if we don't reduce the deficit? No. will they prove accurate if
we do? I believe so.
I know that you have heard a great deal about the specific
proposals in our budget from Budget Director Darman.
I would
simply like to reiterate the fundamental point that, within the
confines of meeting the Gramm-Rudman-Hollings target, the
President has proposed budget priorities which if adopted will
make a significant investment in our country's future.
THE SAVINGS AND LOAN SOLUTION
The President's budget contains the funding required to
resolve the Savings and Loan crisis. It has three components.
The first part consists of $50 billion to resolve currently
insolvent institutions and those which may become insolvent over
the next several years.
Secondly, the plan ensures adequate
servicing of the $40 billion in past FSLIC obligations.
And third, and perhaps most important, the plan provides $33
billion in financial resources necessary to put S&L deposit
insurance on a sound financial basis for the future.
At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC) , for which the FDIC will be the primary
manager, directed to resolve all S&Ls which are now insolvent or
become so over the next three years.
To provide the $50 billion to the RTC, we will create a new,
separate, privately-owned corporation, the Resolution Funding
Corporation (REFCORP), which will issue $50 billion in long-term
bonds to raise the needed funds. To pay the principal, industry
funds will be used to purchase zero-coupon, long-term Treasury
securities which will grow through compound interest to a
maturity value of $50 billion. This assures the repayment of the
principal of the bonds issued by REFCORP.
Funds to purchase
these zero-coupon bonds will come exclusively from private
sources:
— The FHLBanks will contribute about $2 billion of their
retained earnings — which are currently allocated to,
but not needed by, the existing Financing Corporation
(FICO) — plus approximately 20 percent of their annual
earnings, or $300 million, in 1989, 1990 and 1991;
The S&Ls will contribute a portion of their insurance
premiums; and

4
If necessary, proceeds from the
receivership assets will be used.

sale

of

FSLIC

No Treasury funds or guarantees will be used to repay any
REFCORP principal.
Interest payments on the REFCORP bonds will come from a
combination of private and taxpayer sources:
The FHLBanks, beginning in 1992, will contribute $300
million a year;
The RTC will contribute a portion of the proceeds
generated from the sale of receivership assets, and
proceeds from warrants and equity participations taken
in resolutions; and
— Treasury funds will make up any shortfall.
All Treasury funds used to service REFCORP interest will be
scored for budget purposes in the year expended.
Funds for the second component of our plan — servicing the
cost of the $40 billion in resolutions already completed by FSLIC
— also will come from a combination of S&L industry and taxpayer
sources:
— FICO will issue bonds under its remaining authority and
contribute the proceeds;
— The S&Ls will contribute a portion of their insurance
premiums;
FSLIC will contribute the proceeds realized from the
sale of receivership assets taken in already completed
resolutions, as well as miscellaneous income; and
Treasury funds will be used to make up any shortfall.
The final component of the plan is managing future S&L
insolvencies and building the Savings Association Insurance Fund
(SAIF), the new S&L insurance fund, during the post-RTC period.
The funding will come from a portion of S&Ls' insurance premiums
and Treasury funds as needed.
These sources provide about $3 billion per year to handle
any insolvencies which occur in the 1992-99 period and in
addition contribute at least $1 billion per year to building the
new Savings Association Insurance Fund.
Overall the plan
contains $33 billion in post-RTC funds from 1992 to 1999 to
manage future insolvencies and contribute to building a healthy
new S&L insurance fund. Assuming that $2 4 billion is used for

5
post-RTC resolutions, by 1999 the SAIF fund will still contain
just under $9 billion at a minimum to support the healthy S&Ls.
The net impact of the entire plan — which includes paying
for completed S&L resolutions, paying for the S&L resolutions
still to be completed, and providing for fully funded insurance
funds for both commercial banks and thrifts — is $1.9 billion in
FY90 and $39.9 billion over the next 10 years.
REVENUE PROVISIONS
The President's budget includes important revenue-related
measures that fall within the jurisdiction of the Treasury
Department.
These measures also directly reflect the
President's commitment to a budget that sustains a strong economy
and builds upon it to enhance our future economic power.
CAPITAL GAINS
We propose a major tax initiative designed to enhance
America's long-term growth and competitiveness: a reduction and
restructuring of the capital gains tax to encourage long-term
investment.
Our proposal calls for a 45 percent exclusion of
long-term gains or a 15 percent tax rate cap, whichever is more
advantageous to the taxpayer. As an important part of this plan,
we have targeted the greatest relative benefits to those with
incomes lower than $20,000, if married, and $10,000 if single.
Such taxpayers would be eligible for a 100 percent exclusion—no
tax at all on long-term capital gains.
The policy of a lower tax rate for capital gains was first
established in the Revenue Act of 1921. This policy remained in
effect for 65 years.
During this time it was endorsed by
Democrats and Republicans alike as an important means of
stimulating investment.
The Tax Reform Act of 1986 eliminated
that differential in 1987 while generally reducing taxes. In our
view, the reinstatement of some type of capital gains
differential is totally consistent with one of the major goals of
the 1986 Act. That was, and is, to reduce tax rates to stimulate
entrepreneurial activity.
Our proposal does that by targetting the benefits of those
activities which will expand economic productivity and expand
investment.
I believe the essential benefit of a reduction in
the capital gains tax goes beyond simply encouraging short-term
investment and growth. Over the next four years, we propose to
phase in a three-year holding period for capital assets sold to
qualify for the lower capital gains tax rates. Thus we want to
shift the focus of investors from the short-term to the longterm, because ultimately, it is long-term investment which will
provide our economy with its fundamental strength.
Thus we
propose to restore this long-acknowledged incentive to American

6
enterprise.
RESEARCH AND EXPERIMENTATION
Enhancing incentives for long-term investment is not the
only area in which we need to act if the United states is going
to remain a leader in the world economy. It is equally important
that we take steps to augment policies and programs which
stimulate research and development and which foster our long-term
productive capacity.
To this end, the President's budget increases investment in
basic research by increasing funding for science and technology
programs by 13 percent over the enacted 1989 funding levels.
Furthermore, we propose to make the tax credit for research and
experimentation permanent. For a number of years, we have had a
temporary tax credit to encourage additional research and
experimentation (R&E) by U.S. industry.
The current credit
expires at the end of 1989. It's time we stopped sending stop
and go signals to the business community on the importance of
research to our economic strength.
Accordingly, the President has proposed to make this credit
a permanent feature of the landscape so that U.S. corporations
can make their R&E plans with a longer horizon. with this same
purpose in mind, the President has also proposed a permanent and
more beneficial formula for the allocation of R&E expenses
between domestic and foreign income.
ENTERPRISE ZONES
In order to stimulate local government and private sector
revitalization of economically distressed areas, the President
has proposed an enterprise zone initiative.
This initiative
includes selected federal employment and investment tax credits
to be offered in conjunction with federal, state, and local
regulatory relief. Up to 70 zones may be selected between 1990
and 1993.
CHILD CARE
Mindful of the growing need for child care, the President
proposes to increase assistance to low-income families through
changes in the tax code.
He proposes a new, refundable tax
credit of up to $1,000 for each child under four in low-income
working families. This credit would be available to very lowincome families, in which at least one parent works, in tax year
1990, and will be expanded to include additional families in
following years. By this tax assistance the President's budget
provides vital support to families while permitting them to make
their own choices about child care that best fits their needs.
The President further proposes to make the existing dependent
care credit refundable. In its current state the existing credit

7
is of no value to lower income families who do not pay tax.

SPECIAL NEEDS ADOPTION
The President proposes to permit the deduction from income
of expenses incurred associated with the adoption of special
needs children up to a maximum of $3,000 per child.
MEDICARE HOSPITAL INSURANCE
Currently, state and local employees hired prior to April 1,
1986, are not covered by Medicare Hospital Insurance, nor are
they subject to the tax. The President's budget proposes that as
of October 1, 1989, all state and local government employees
would be covered by Medicare Hospital Insurance.
These are the major revenue-related proposals in the
President's budget.
Let me reiterate that the intent behind
these proposals is to sustain a strong economy while fostering an
equitable distribution of benefits and responsibilities to our
citizens.
INTERNATIONAL CONTEXT
Improving our competitive position in the world economy is
very important to our future international economic position.
Reducing the deficit will not only improve our competitive
position, but is of vital importance to our overall international
economic standing. I wish to take a few minutes to address the
international implications of our work on the budget this year.
The new reality is that there are no more international
boundaries when it comes to the flow of dollars—no border
control, no customs officials and no barriers. The influence of
foreign financial markets on our economy is great and deep. Most
of the world's dollar financial transactions settle daily through
New York.
Before the advent of instantaneous transfer of
information and electronic funds transfers this settling of
accounts would have taken weeks, now it occurs every night.
There are two "wires" through which the transactions settle. The
CHIPS wire which largely handles international transactions, and
the Fed wire which handles mostly, but not exclusively, domestic
transactions. Last month on average about $735 billion worth of
transactions were settled per day on the CHIPS wire. And the
level of activity is increasing on average at a rate of 25
percent a year.
If you approximate the international
transactions settled via the Fed wire, then about $1 trillion of
international transactions are settled every day on these wire
systems.
This amounts to $5 trillion a week, in other words
greater each week than our yearly GNP.

8
Another statistic which demonstrates the power of
international finance on our economy is that at the end of 1987
the recorded stock of U.S. assets held by foreigners was almost
$400 billion greater than the stock of foreign assets held by
Americans. Ten years ago this difference was $50 billion in our
favor. While one can have different views of how to interpret
those numbers, one point is clear — we cannot ignore the effect
of international markets on our balance of payments when
considering the need for deficit reduction.
Both the flow of financial transactions through the Fed wire
and CHIPS and the amount of U.S. assets held by foreigners are
in a sense a measure of foreign confidence in our ability to
maintain a sound economy and reduce our budget 'deficit.
The
tally of the world's opinion of our progress is registered every
day through CHIPS and the Fed wire.
It is vital that we act
decisively to preserve that confidence.
Lest there be any doubt about the extent of the world's
interest and concern about the deficit, let me share with you
some of the feelings of my G-7 colleagues — who met here in
Washington, DC the first week in February. We are engaged in a
team effort, the economic policy coordination process, to provide
a growing world economy. I have been pressing them to stimulate
their domestic economies and open their markets to sustain world
economic growth. They, in turn, are deeply concerned about our
ability to reduce the deficit.
They worry that we lack the
strength of purpose to meet the Gramm-Rudman-Hollings target.
They are knowledgeable about the details of our budget process
and are watching very carefully how we handle our budget
negotiations. They are concerned that our commitment to abiding
by the current Gramm-Rudman targets is less than firm and
unequivocal, that if meeting the $100 billion target becomes too
onerous, we will move the goal line. I assured them on behalf of
us all that people in this government—executive and legislative
branches alike—are firmly and absolutely committed to meeting
the deficit reduction target. I have told them that we will get
there one way or the other.
I know you share this commitment. I am delighted to be here
today to discuss with you how we can achieve this common goal.

INTEREST RATES, SEPTEMBER 1985 TO APRIL 1986
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1985

1986

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
For Release Upon Delivery
Expected at 10:00 a.m., EST
March 15, 1989

STATEMENT OF
DANA L. TRIER
TAX LEGISLATIVE COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
Mr. Chairman and Members of the Committee:
I am pleased to have this opportunity to testify concerning
the Administration's budget. I would like to begin by reviewing
and discussing the specific tax proposals contained in the
budget, except for the capital gains proposal, which was the
subject of separate testimony before your committee yesterday by
Acting Assistant Secretary for Tax Policy Dennis E. Ross. Then I
will discuss expiring tax provisions which have not been proposed
for extension by the budget.
The budget contains the following proposals affecting
receipts: (1) reduction of capital gains rate for individuals;
(2) modification and making permanent the research and
experimentation credit; (3) modification of research and
experimentation expense allocation rules; (4) provision of energy
tax incentives; (5) provision of enterprise zone initiatives; (6)
provision of child tax credit and making refundable child and
dependent care tax credits; (7) permitting deduction for special
needs adoption; (8) extension of Medicare insurance coverage to
state and local employees; (9) repeal of the airport and airway
trust fund tax trigger; (10) extension of the communications
excise tax; and (11) certain miscellaneous proposals affecting
receipts.
The following provisions will expire in 1989 and are not
proposed for extension by the budget: (1) the tax credits for

MB -ni

-2low-income housing credit; and (8) certain provisions relating to
financially troubled thrift institutions. The following
provisions expired in 1988 and, we understand, are the subject of
sufficient interest to your committee to warrant our comment at
this time: (1) exclusion for employer-provided group prepaid
legal services; and (2) exclusion for employer-provided education
assistance.
SUMMARY OF THE PRESIDENT'S BUDGET PROPOSALS
AFFECTING RECEIPTS
Modification and Making Permanent the Credit
for Research and Experimentation
Current Law
Present law allows a 20 percent tax credit for the increase
in a taxpayer's qualified research expenses over a base amount.
The base amount is the taxpayer's average annual qualified
research expenditures over the prior 3 years. This base,
however, is defined so that it can never be less than 50 percent
of current qualified expenditures. The credit is available only
for research expenditures paid or incurred in carrying on the
trade or business of the taxpayer. As a result, new firms and
firms entering a new line of business cannot claim the credit for
qualified R&E until the expenses relate to an ongoing trade or
business.
The amount of any deduction for research expenditures is
reduced by 50 percent of the amount of credit taken for that
year. The current research credit expires at the end of 1989.
Budget Proposal
The proposed R&E credit would retain the incremental feature
of the present credit and its 20 percent rate, but would make the
credit permanent and modify the calculation of the base amount.
The new base would be a fixed historical base equal to the
average of the firm's qualified R&E expenditures for 1983 through
1987 and would be indexed for inflation. Firms also would have
the option of a separate 7 percent credit for expenditures which
exceed 75 percent of the base amount. As with current law, all
firms would be subject to a base equal to at least 50 percent of
R&E expenditures. The proposal also would liberalize the "trade
or business" test so that new firms and firms entering new lines
of business could claim the credit. Finally, the proposal would
reduce the amount of the taxpayer's deduction for research
expenses by the amount of the credit.
Discussion
The Administration is committed to encouraging continued
growth of private, domestic research activities by establishing a
permanent tax credit for research and experimentation (R&E). The
tax credit for research is intended to create an incentive for

-3technological innovation. R&E activity, by its nature, is long
term and taxpayers should be able to plan their research activity
knowing whether the credit will be available. If the credit is
to have the intended incentive effect, it should be made
permanent.
The proposal also would modify the structure of the current
credit to increase its incentive effect and its availability for
firms undertaking research. The proposal would increase the
credit's incentive effect by replacing the current credit's
moving base with a fixed-base structure. The critical feature of
this fixed base is that a firm's current spending will have no
effect on future credits. Thus, unlike the current credit, a
dollar of credit earned in the current year does not reduce
credits in future years.
The proposal also would increase the percentage of
R&E-performing firms eligible for the credit. This increase is
achieved in two ways: (1) through the design of the primary and
alternative bases, which results in a larger number of firms with
R&E expenditures above the base; and (2) by liberalizing the
trade or business test to allow expenditures of new firms and
firms entering new lines of business to claim the credit.
Since the proposal would index the credit base, the amount
of the credit allowable to any firm and the cost of the credit to
the Government would no longer depend on the rate of inflation.
Finally, by disallowing a deduction for R&E expenses to the
extent of R&E credits taken, the proposal would provide similar
tax treatment for all sources of Federal support for research.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ billions)
-0.4 -0.7 -1.0 -1.2
Modification and Making Permanent R&E Expense
Allocation Rules
Current Law
,T5o^Temporary rules for all°cating research and experimentation
(R&E) expenses generally expired on May 1, 1988. Under those
rules, U.S. firms were allowed to allocate 64 percent of their
expenses for R&E performed in the United States to U.S. source
income. The remaining 36 percent of expenses were allocated
between U.S. and foreign source income on the basis of either
gross sales or gross income. The amount allocated to foreign
source income on the basis of gross income had to be at least 30
percent of the amount allocated to foreign source income on the
basis of gross sales.

-4-

Since expiration of the R&E allocation rules, R&E expenses
have been allocated between U.S. and foreign source income under
detailed 1977 Treasury regulations, which were designed to match
R&E expenses with the foreign and domestic source income related
to the expenses.
Budget Proposal
The proposal would permit 67 percent of R&E expenses to be
allocated to U.S. source income. The remaining 33 percent would
be allocated on the basis of either gross sales or gross income.
No limitation would be placed on the allocation to U.S. source
income under the gross income method.
The proposal would apply retroactively to the expiration of
the earlier rules, generally May 1, 1988.
Discussion •
The proposal would increase tax incentives for U.S. firms to
engage in U.S. based research activity. Current law allocates
more R&E expenses to foreign source income and less to U.S.
source income than the proposal. The higher allocation to
foreign source income under current law reduces the amount of
foreign tax credits that firms can use to offset their U.S. tax
liability. Because many firms have excess foreign tax credits,
the existing allocation regulations can reduce firms' U.S.-based
R&E expenditures. Making the rules permanent would provide U.S.
firms with the certainty necessary to assess long-term tax
ramifications of their R&E expenses.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
T$ billions)
-1.7* -0.7 -0.8 -0.9
*The FY 1990 revenue loss includes the retroactive application of
this proposal.
Energy Tax Incentives
Current Law
Current law provides incentives for domestic oil and gas
exploration and production by allowing the expensing of certain
intangible drilling and development costs ("IDCs") and the use of
percentage depletion. Current law does not provide any further
incentive for exploratory drilling or tertiary enhanced recovery
techniques.

-5In general, IDCs include expenditures incurred or paid by an
operating or working interest owner in the development of oil or
gas properties which are neither for the purchase of tangible
property or part of the acquisition price of the oil or gas
property. IDCs include amounts paid for labor, fuel, repairs,
and site preparation. IDCs do not include geological and
geophysical costs, nor do IDCs include surface casing costs. IDC
deductions on successful oil and gas wells are a tax preference
item for purposes of the alternative minimum tax (the "AMT").
Therefore, this tax preference item increases a taxpayer's
alternative minimum taxable income, which may subject such
taxpayer to liability for the AMT. The IDC preference item for
purposes of the AMT is the amount by which a taxpayer's "excess
IDCs" claimed with respect to successful wells exceed 65 percent
of the taxpayer's net income from oil, gas, or geothermal
properties. "Excess IDCs" are the amount by which the IDC
deduction for the year (attributable to successful wells) exceeds
the deduction that would have been claimed had the IDCs been
capitalized and either amortized over a 10-year period or
recovered through depletion.
Independent producers and royalty owners (but not integrated
oil companies) recover capital expenditures with respect to oil
and gas properties using the higher of cost or percentage
depletion. Under cost depletion, the amount of the depletion
deduction is equal to the portion of the taxpayer's basis equal
to the percentage of total reserves produced during the year.
Under percentage depletion, the amount of the depletion deduction
is equal to a statutory percentage of gross income from the
property (15 percent in the case of oil and gas production not in
excess of 1,000 barrels). The percentage depletion deduction,
however, may not exceed 50 percent of the taxable income from the
property for the taxable year, computed without regard to the
depletion deduction. Unlike cost depletion, percentage depletion
may result in deductions over the life of a property in excess of
the taxpayer's basis in the property. The percentage depletion
deduction may not exceed 65 percent of the taxpayer's net taxable
income for the year. The "transfer rule" prohibits percentage
depletion with respect to an oil or gas property that is
transferred after it has been "proven" (i.e., shown to have oil
and gas reserves).
Budget Proposal
The budget contains four provisions intended to strengthen
our domestic oil and gas industry. Two proposals would provide
temporary tax credits that would be phased out if the average
daily U.S. well head price of oil is at or above $21 per barrel
for a calendar year. First, a temporary tax credit would be
allowed for exploratory intangible drilling costs in the amount
of 10 percent of such costs for the first $10 million in
expenditures (per year per company) and 5 percent of such costs
in excess of $10 million. Second, a temporary 10 percent tax
credit would be allowed for all capital expenditures on new
tertiary enhanced recovery projects (i.e. projects that represent
the initial application of tertiary enhanced recovery to a

-6property). These credits could be applied against both the
regular and alternative minimum tax. However, the credits, in
conjunction with all other credits and net operating loss
carryovers, could not eliminate more than 80 percent of the
tentative minimum tax for any year. Unused credits could be
carried forward. These credits would be effective for
expenditures after December 31, 1989.
The third proposal is to eliminate the so-called "transfer
rule" and raise the percentage depletion deduction limitation to
100 percent of the net income from each property. This proposal
would be effective for taxable years beginning after December 31,
1989. Finally, the budget proposal would eliminate 80 percent of
current AMT preference items generated by exploratory IDCs
incurred by independent producers. This proposal would be
effective for expenditures after December 31, 1989.
Discussion
The Administration is committed to an energy policy that is
designed to strengthen our domestic oil and gas industry and
improve the level of domestic energy reserves. The sharp
reduction in world oil prices and the increasing levels of oil
imports may raise both energy security and national security
concerns. The prolonged period of low oil prices has caused a
substantial decline in our domestic energy reserves resulting
from a 70-percent decrease in domestic exploratory drilling, a 20
percent increase in development drilling, and the abandonment of
a large number of marginal wells. The decline in domestic
reserves and our increased dependence on foreign oil may leave
our nation vulnerable to potential supply disruptions. In
addition, our ability to respond to supply disruptions has been
impaired to the extent that the prolonged period of low oil
prices has damaged our domestic oil industry. The special tax
incentives proposed by the budget are appropriate to encourage
higher levels of exploratory drilling and the continued operation
of our marginal wells. This may lead to increased domestic
reserves and a stronger domestic energy industry that would be
better able to respond to supply disruptions.
The level of proven domestic reserves is closely related to
the level of domestic exploratory drilling. Historically,
independent producers have drilled a majority of our exploratory
wells even though they are generally much smaller than the
integrated producers. The tax incentives on which independent
producers have traditionally depended are percentage depletion
and the expensing of intangible drilling costs (IDCs). The
budget proposals would increase the benefit of these tax
incentives and provide additional incentives to encourage
exploratory drilling by independent producers.
The budget proposal would also encourage production from
marginal properties. The transfer rule discourages the transfer
of producing wells from an owner in whose hands the property may
be uneconomic to an owner who may be more efficient. The 50
percent of net income limitation may encourage the abandonment of

-7marginal or high-cost properties which produce a relatively small
amount of net income. By eliminating the transfer rule and
raising the net income from the property limitation to 100
percent, the budget proposal would reduce the likelihood that tax
factors will cause the abandonment of producing properties.
Finally, by providing a tax credit for tertiary enhanced recovery
projects, the budget proposal would encourage the use of such
techniques to squeeze additional production from known fields.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ billions)
10 percent credit
for exploratory
drilling
-0.2
-0.3
-0.3
-0.4
10 percent credit
for tertiary enhanced recovery
*
*
*
*
Eliminate the
transfer rule and
increase the net
income allowance
to 100 percent for
percentage depletion
by independent
producers and
royalty owners
*
*
*
*
Eliminate 80 percent of exploratory
IDC tax preferences
from minimum tax for
independent producers
-0.1
-0.1
-0.1
-0.1
* $50 million or less.
Provision of Enterprise Zone Incentives
Current Law
Existing Federal tax incentives generally are not targeted
to benefit specific geographic areas. Although the Federal tax
law contains incentives that may encourage economic development
in economically distressed areas, they are not limited to use
with respect to such areas.

-8-

Budget Proposal
The proposed enterprise zone initiative would include
selected Federal employment and investment tax credits to be
offered in conjunction with Federal, state, and local regulatory
relief. Up to 70 zones would be selected between 1990 and 1993.
There would be both capital-based and employment-based tax
credits, although the details of the tax credits have not been
specified. The extent of the tax subsidies would vary, with
larger subsidies in the early years that decline over time.
Total Federal revenue losses would gradually rise, however, as
more zones are designated.
The willingness of states and localities to "match" Federal
incentives would be considered in selecting the special
enterprise zones to receive these additional Federal incentives.
Discussion
Despite sustained national prosperity and growth, certain
areas have not kept pace. The enterprise zones initiative would
stimulate local government and private sector revitalization of
economically distressed areas. Enterprise zones would encourage
private industry investment and job creation in economically
distressed areas by removing regulatory and other barriers
inhibiting growth. They would also promote growth through
selected tax incentives to reduce the risks and costs of
expanding in severely depressed areas.
Revenue Estimates
Fiscal Years
1990 1991 1992 1993
( $miHions )
-150 -200 -300 -400
Provision of New Child Care Tax Credit and Making Current
Child and Dependent Care Tax Credit Refundable
Current; Law
The Internal Revenue Code of 1986 (the "Code") provides
assistance to low-income working families through both the earned
income tax credit (EITC) and the child and dependent care tax
credit.
Earned Income Tax Credit. Low-income families with minor
dependents may be eligible for a refundable income tax credit of
up to 14 percent of the first $6,500 in earned income. The
maximum amount of the credit is $910. The credit is reduced by
an amount equal to 10 percent of the excess of adjusted gross

-9income (AGI) or earned income (whichever is greater) over
$10,240. The credit is not available to taxpayers with AGI or
earned income over $19,340. Both the maximum amount of earnings
on which the credit may be taken and the income level at which
the phase-out region begins are adjusted for inflation (1989
levels are shown). Families have the option of receiving the
refund in advance through a payment added to their paychecks.
Child and Dependent Care Credit. Taxpayers may also be
eligible for a nonrefundable income tax credit if they incur
expenses for the care of certain dependents in order to work. To
be eligible for the credit, taxpayers must be married and file a
joint return or be a head of household. Two-parent households
with only one earner generally do not qualify for the credit.
Employment-related expenses eligible for the credit are
limited to $2,400 for one qualifying individual and $4,800 for
two or more qualifying individuals. Further, employment-related
expenses cannot exceed the earned income of the taxpayer, if
single, or, for married couples, the earned income of the spouse
with the lower earnings.
Taxpayers with AGI of $10,000 or less are allowed a credit
equal to 30 percent of eligible employment-related expenses. For
taxpayers with AGI of $10,000 to $28,000, the credit is reduced
by 1 percentage point for each $2,000, or fraction thereof, above
$10,000. The credit is limited to 20 percent of employmentrelated dependent care expenses for taxpayers with AGI above
$28,000.
Dependent Care Assistance Programs. If the employer has a
dependent care assistance program, employees are allowed to
exclude from income amounts paid or incurred by the employer for
dependent care assistance provided to the employee. The amount
excluded from income may not exceed $5,000 per year ($2,500 in
the case of a separate return filed by a married individual). An
employee generally may not take advantage of both the child and
dependent care credit and this income exclusion.
Budget Proposals
Effective January 1, 1990, low-income families containing at
least one worker would be entitled to a new refundable tax credit
of up to $1,000 for each dependent child under age four. The
credit would be equal to 14 percent of earned income, with a
maximum credit equal to $1,000 per child. Initially, the credit
would be reduced by an amount equal to 20 percent of the excess
of AGI or earned income (whichever is greater) over $8,000. In
subsequent years, both the starting and end-points of the phaseout range would be increased by $1,000 increments. In 1994, the
credit would phase-out between $15,000 and $20,000. Families
would have the option of receiving the refund in advance through
a payment added to their paychecks.
The existing child and dependent care tax credit would be
made refundable. Families could claim either the new child

-10credit or the child and dependent care credit, whichever would be
greater.
Discussion
The proposals would increase the resources available to
low-income families, better enabling them to choose the
child-care arrangements which best suit their needs and
correspond to their personal values.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ billions)
Revenue loss
Outlays1
*
1

•

•

.2

1.8

*

2.2

.1
2.4

$50 million or less.

Increased outlays attributable to refunds payable
to eligible individuals with no tax liability.

Permitting Deduction for Special Needs Adoptions
Current Law
Expenses associated with the adoption of children are not
deductible under current law. However, expenses associated with
the adoption of special needs children are reimbursable under the
Federal-State Adoption Assistance Program (Title IV-E of the
Social Security Act) under which the Federal Government shares 50
percent of these costs up to a maximum Federal share of $1,000
per child. Special needs children are those who by virtue of
special conditions such as age, physical or mental handicap, or
combination of circumstances, are difficult to place for
adoption. Reimbursable expenses include those associated
directly with the adoption process such as legal costs, social
service review, and transportation costs.
Budget Proposal
The proposal would permit the deduction from income of
expenses incurred associated with the adoption of special needs
children up to a maximum of $3,000 per child. Eligible expenses
would be limited to those directly associated with the adoption
process that are eligible for reimbursement under the Adoption
Assistance Program. Expenses which were deducted and reimbursed
would be included in income in the year in which the reimbursement occurred.

-11Discussion
The proposal, when combined with the current outlay program,
would assure that reasonable expenses associated with the process
of adopting a special needs child do not cause financial hardship
for the adoptive parents. In addition, the proposal is
responsive to the Administration's concern that adoption of these
children be specially encouraged and may call to the attention of
families interested in adoption the various programs which help
families adopting children with special needs.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($miHions)
-3

-3

-3

* Less than $500,000
Extension of Medicare Hospital Insurance (HI)
to State and Local Employees
Current Law
State and local government employees hired on or after
April 1, 1986, are covered by Medicare Hospital Insurance and
their wages are subject to the Medicare tax (1.45 percent on both
employers and employees). Employees hired prior to April 1,
1986, are not covered by Medicare Hospital Insurance nor are they
subject to the tax.
Budget Proposal
As of October 1, 1989, all State and local government
employees would be covered by Medicare Hospital Insurance.
Discussion
State and local government employees are the only major
group of employees not assured Medicare coverage. A quarter of
State and local government employees are not covered by voluntary
agreements nor by law. However, 85 percent of these employees
receive full Medicare benefits through their spouse or because of
prior work in covered employment. Extending coverage would
assure that the remaining 15 percent have access to Medicare and
would eliminate the inequity and the drain on the Medicare trust
fund caused by those who receive Medicare without fully
contributing.

-12-

Under the proposal, an additional 2 million State and local
government employees would be contributing to Medicare. Of
these, roughly 300,000 employees would become newly eligible to
receive Medicare benefits, assuming an employee has satisfied the
minimum 40 quarters of covered employment.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ billions)
1.8 1.9 1.9 1.9
x

Net of income tax offset.

Repeal of the Airport and Airway Trust
Fund Tax Trigger
Current Law
The Airport and Airway Safety and Capacity Expansion Act of
1987 established a trigger that would reduce by 50 percent
several of the airport and airway trust fund taxes. The trigger
will take effect in calendar year 1990 because the 1988 and 1989
appropriations for the capital programs funded by these taxes
were less than 85 percent of authorizations. The trigger will
reduce by 50 percent the 8 percent air passenger tax, the 5
percent air freight tax, and the 14 cents per gallon noncommercial aviation fuels tax. It will also substantially reduce
the aviation gasoline tax.
Budget Proposal
The proposal would repeal the tax reduction trigger,
resulting in increased airport and airway trust fund receipts of
$1.2 billion in FY 1990 and increased governmental receipts (net
of income and employment tax offsets) of $0.9 billion.
Discussion
Repeal of the trigger is required for the accumulation of
funds for the modernization of airport and airway facilities in
the United States in the early 1990s.

-13Revenue Estimate1
Fiscal Years
1990 1991 1992 1993
($ billions)
0.9 1.6 1.7 1.8
x

Net of income tax offsets. The estimates shown are relative to
current services receipts which assume continuation of trigger
rates through 1994.
Extension of the Communications (Telephone) Excise Tax
Current Law
The Omnibus Budget Reconciliation Act of 1987 (the "1987
Act") extended the communications excise tax until the end of
1990. The tax is imposed at a rate of 3 percent on local and
toll (long-distance) telephone service and on teletypewriter
exchange service. Allowing the tax to expire would reduce
Federal tax receipts by approximately $2.5 billion annually.
Budget Proposal
The proposal would permanently extend the 3 percent Federal
communications excise tax. The tax rate is substantially less
than the 10 percent rate that was in effect between 1954 and
1972, and as low or lower than the rate in effect for any year
since 1932 (except for 1980-82). The base of the tax would not
be broadened.
Discussion
Extension of the communications excise tax would maintain a
revenue source that has been in existence continuously since
1932, and would avoid the disruption that would occur if the tax
were allowed to expire and then were reenacted.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ billions)
0 1.6 2.6 2.8
x

Net of income tax offset.

-14-

Miscellaneous Proposals Affecting Receipts
IRS Enforcement Initiative. The proposal would increase IRS
funding for tax law enforcement to improve compliance and
collection of past due taxes.
Increase NRC User Fees. The proposal would increase user
fees to cover 100 percent of the cost to the Nuclear Regulatory
Commission ("NRC") of regulating nuclear power plants costs,
effective October 1, 1989.
Initiate FEMA User Fees. The proposal would recover 100
percent of costs of regulating the evacuation plans of the
nuclear power industry through user fees, effective October 1,
1989.
Increase D.C. Employer Contribution to CSRS. Under the
proposal, the D.C. government would pay retirement cost-of-living
adjustments (COLAs) to its retirees and their survivors. The
initial annual payment would begin in 1991 because of a proposed
budget COLA freeze for government annuitants in 1990.
Extend Reimbursable Status to Amtrak. The proposal would
exempt Amtrak from the railroad unemployment tax rate, but would
require Amtrak to reimburse the unemployment fund for actual
costs of their employees. The proposal would ensure that public
subsidies Amtrak receives are used for purposes other than paying
for the high unemployment costs of private freight railroads.
Eliminate Superfund Petroleum Tax Differential. The
proposal would equalize the superfund petroleum excise tax rates
applicable to domestic crude oil and imported products through a
slight increase in the tax rate on domestic crude oil and a
slight decrease in the rate on imported petroleum products. This
would achieve a system of petroleum excise taxes that is
consistent with GATT.
Other Proposals. Additional changes affecting receipts
include the Administration's pay raise proposals; extension of
the customs processing fee, which is scheduled to expire
September 30, 1990, at current rates; and the establishment of a
fee for the U.S. Travel and Tourism Administration (USTTA). A
user fee on taxpayer telephone information services is proposed
for 1991; a design evaluation will be conducted in 1989 and 1990
that will include an actual demonstration of the technologies and
systems capabilities.

Revenue Estimates

19
IRS Enforcement
Initiative

0

Increase NRC User
Fees

0

Initiate FEMA User
Fees
Increase DC Government
CSRS Contributions

0

Extend Reimbursable
Status to Amtrak
Eliminate Superfund
Petroleum
Differential
Other Proposals -0

0

-16-

PROVISIONS THAT WILL EXPIRE IN 1989 AND ARE NOT PROPOSED
FOR EXTENSION BY THE BUDGET
Business Energy Tax Credits
Background
A tax credit is allowed under section 46 of the Code for
investments in certain "energy property." For "solar energy
property," the tax credit was 15 percent in 1986, 12 percent in
1987, 10 percent in 1988 and is 10 percent in 1989. For
"geothermal property," the tax credit was 15 percent in 1986, 10
percent in 1987 and 1988, and is 10 percent in 1989. For "ocean
thermal property," the tax credit was 15 percent in 1986, 1987
and 1988. These credits expire at the end of 1989.
Solar property consists of equipment that uses solar energy
to generate electricity or steam or to provide heating, cooling,
or hot water in a structure. Geothermal property consists of
equipment, such as turbines and generators, that converts the
internal heat of the earth into electrical energy or another form
of useful energy. Ocean thermal property consists of equipment,
such as turbines and generators, that converts ocean thermal
energy into electrical energy or another form of useful energy.
The tax credits for solar, geothermal, and ocean thermal
property were originally scheduled to expire at the end of 1985,
but were extended for three years by the Tax Reform Act of 1986
(the "1986 Act").
Discussion
The tax credits for solar, geothermal, and ocean thermal
property were enacted to stimulate the development and business
application of these energy sources as alternatives to
nonrenewable fossil fuels, such as petroleum, natural gas, and
coal. The methods for producing these alternative energy sources
were generally well known, but they were not being fully
exploited because of price and other advantages of fossil fuel
systems. The energy tax credits were intended to increase demand
for property producing or using energy from these alternative
sources^, thereby stimulating technological advances in the
design, production, and operation of such equipment.
We do not believe that the tax credits for solar,
geothermal, and ocean thermal property should be extended. These
investment incentives apply only to certain targeted activities.
Thus, they produce a tax differential among investments that is
inconsistent with the fundamental concepts underlying the 1986
Act. This tax differential distorts the allocation of resources
by encouraging businesses to make investments that, without the
tax credit, would be uneconomical at current and expected future

-17market prices. We do not believe that this allocative
inefficiency can be justified in this case.
Although we oppose extension of the energy tax credits, we
recognize the importance of preparing for increased future use of
alternative energy sources in light of the Nation's limited
reserves of fossil fuels. For this reason, the Federal
government provides substantial support for the development of
alternative energy sources through energy research and
development programs.
The President's fiscal year 1990 budget requests spending
authority of $114 million for solar and renewable energy research
and development. This research covers a broad range of
technologies, with emphasis on the generation of electricity from
solar, biomass, geothermal, and wind energy. We believe that
these research and development expenditures represent the most
appropriate way to promote technological advances with respect to
alternative energy sources.
Revenue Estimate
One year extension of business energy credits
Fiscal Years
1990 1991 1992 1993
(T millions)
-56 -35 4 2
Targeted Jobs Tax Credit
Background
Section 51 of the Code allows employers a tax credit for the
employment of individuals belonging to one of nine targeted
groups. The amount of the allowable targeted jobs tax credit
("TJTC") is generally equal to 40 percent of the first $6,000 of
wages paid to a member of a targeted group in the first year of
employment. The employer's deduction for wages is reduced by the
amount of the credit. A targeted group member must be employed
at least 90 days (14 days in the case of summer youth employees)
or perform a minimum of 120 hours of work (20 hours in the case
of summer youth employees) before an employer qualifies to claim
the TJTC. The credit is unavailable for wages paid to an
individual who begins work after December 31, 1989.
The nine targeted groups of employees are the following:
economically disadvantaged youths (ages 18-22); economically
disadvantaged summer youths (ages 16-17); economically
disadvantaged youths participating in cooperative education
programs; economically disadvantaged Vietnam-era veterans;
economically disadvantaged ex-convicts; certain handicapped
workers; certain work incentive employees (AFDC recipients and

-18WIN program registrants); Supplemental Security Income
recipients; and general assistance recipients.
For purposes of the TJTC, a worker is economically
disadvantaged if the worker's family income is below 70 percent
of the Bureau of Labor Statistics lower living standard income
levels during the prior six months. To claim the credit for an
employee, an employer must receive a written certification that
the employee is a targeted group member. Certifications of
eligibility for employees are generally provided by State
employment security agencies. The employer must have received,
or filed a written request for, a certification on or before the
date a targeted worker begins employment.1/
Discussion
The TJTC was intended to increase employment of targeted
workers who are considered to be low-skilled and difficult to
employ and train by reducing the wage costs of employing these
workers. The credit achieves its desired effect only when it
results in the hiring of targeted employees who would not
otherwise have been hired. Where an employer claims the credit
with respect to workers who would have been hired without regard
to the credit, the credit does not serve its intended incentive
effect, and is merely a windfall for the employer.
The evidence that the credit has not had the intended
incentive effect is quite strong. The Labor Department
estimated, for example, that in 1981 2.4 million to 3.0 million
disadvantaged youths found employment in the private sector of
the economy, whereas only 176,000 economically disadvantaged
youths received certification for the TJTC. Thus, in that year
over 92 percent of economically disadvantaged youths who found
employment did so without benefit of the credit.
A net increase in targeted employment may not result even
when the TJTC is directly responsible for the employment of a
targeted worker. That is, if newly hired certified targeted
employees replace previously employed targeted employees who are
no longer eligible for the credit or are hired in place of
uncertified targeted workers, targeted employment will not
increase on a net basis. A recent study of the TJTC by the
National Commission for Employment Policy found that many
companies retroactively claim the credit, thus receiving a tax
windfall for workers hired without regard to their qualification

1/ If the employer has received a written preliminary
determination that the employee is a member of a targeted group,
the employer may file a written request for a final certification
within five calendar days after the targeted worker begins
employment.

-19-

under the TJTC program.2/ Moreover, we believe it is likely that
any increase in hiring of targeted workers as a result of the
credit is achieved at the expense of other low-skilled workers
who have not qualified for the credit but have job skills similar
to those of the targeted groups. Finally, increases in targeted
employment by firms claiming the credit are partially offset by
the loss of employment in other sectors of the private economy.
Other Federal programs currently provide assistance to many
of those eligible for the TJTC. Under the Job Training
Partnership Act, grants are made to the states to prepare
low-income and unskilled youths and adults for entry into the
labor force, and contracts are also provided for specialized job
training to handicapped persons. The Job-Corps provides remedial
training and job skills training for disadvantaged youth. Other
training programs are targeted to veterans, native Americans, and
migrant and seasonal farm workers.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ millions)
One Year Extension
of the TJTC
-74
-141
-149
-55
Two Year Extension
of the TJTC
-74
-196
-295
-210
Qualified Mortgage Bonds and Mortgage Credit Certificates
Background
In the 1970s, State and local governments discovered that
they could issue tax-exempt mortgage revenue bonds to provide
below-market rate mortgage loans to their residents at no cost
to themselves. By 1980, the issuance of tax-exempt bonds for
owner-occupied housing had grown to 20 percent of total
tax-exempt financing. Prior to the Mortgage Subsidy Bond Tax
Act of 1980 (the "1980 Act"), there were no federal restrictions
on who could benefit from the subsidized mortgages financed with
these tax-exempt bonds. Beginning with the 1980 Act, a series
of legislative changes were enacted to target the subsidy to
first-time homebuyers, to improve the efficiency of the subsidy,
2/ The Targeted Jobs Tax Credit in Maryland and Missouri:
19?2-T587, National Commission for Employment Policy Research
Report No. 88-18 (November, 1988).

-20and to curtail the mounting federal revenue losses from the
issuance of these bonds.
First, in order to target the subsidy to those individuals
with a greater need, the 1980 Act imposed eligibility
requirements on mortgages financed with proceeds of qualified
mortgage bonds. The 1980 Act required that (a) the mortgages
finance only principal residences; (b) the mortgagor not have
owned a principal residence during the immediately preceding
three years; and (c) the acquisition cost of the residence not
exceed 90 percent of the average area purchase price for single
family residences. In certain targeted low-income areas, the
first-time homebuyer requirement was waived, and the purchase
price limitation was increased to 110 percent of the average
area purchase price. These requirements were liberalized by the
Tax Equity and Fiscal Responsibility Act of 1982 (the "1982
Act"). Under the 1982 Act, up to 10 percent of the mortgages in
non-targeted areas could be for existing homeowners, and the
purchase price limits were increased to 110 percent (120 percent
in targeted areas) of the average area purchase price.
The 1986 Act tightened the mortgage eligibility
requirements. The 1986 Act reduced to 5 percent the mortgages
in non-targeted areas that could be for existing homeowners and
reinstated the lower purchase price limits that applied before
the 1982 Act. The 1986 Act also imposed a household income
limit of 115 percent of the higher of the area or Statewide
median income. In targeted areas, the income limit was
increased to 140 percent of the median and was waived for
one-third of the mortgage financing. These income limits were
revised by the Technical and Miscellaneous Revenue Act of 1988
(the "1988 Act"). Under the 1988 Act, the income limits are
determined by reference to area median income (rather than by
reference to the higher of the area or Statewide median), the
limits are reduced to 100 percent (120 percent in targeted
areas) for families with fewer than three persons, and the
limits are increased (to no more than 140 percent) in areas
where housing costs are high in relation to area median income.
The 1988 Act also provides that, in the case of mortgages
originated after December 31, 1990, all or a portion of the
federal tax subsidy from the mortgage during the first 5 years
is to be recaptured through an increase in the mortgagor's
individual income tax liability if the assisted home is disposed
of within 10 years. The maximum recapture amount (1.25 percent
of the mortgage principal amount for each of the first 5 years)
is ratably phased out during the second 5 years. The amount
recaptured is reduced or eliminated if the mortgagor's income
does not increase above a prescribed level and is capped at 50
percent of the gain realized on disposition of the home.
Second, in order to curtail the mounting federal revenue
losses from the issuance of mortgage revenue bonds, the 1980 Act
imposed a volume cap on the aggregate amount of qualified
mortgage bonds that could be issued within a State during a
greater
calendar of
year.
$200 million
The annual
or volume
9 percent
cap offorthe
each
average
State annual
was the

-21amount of mortgages for owner-occupied residences originated in
the State during the preceding three years. The 1986 Act
repealed the separate volume cap for qualified mortgage bonds
and subjected these bonds to the unified volume cap that applies
to private activity bonds generally.
Third, in order to ensure that a greater portion of the
federal subsidy accrued to the homebuyers, the 1980 Act limited
the arbitrage profits that the issuer could earn and retain.
The spread between the interest rate on the mortgages and the
yield on the bonds was limited to one percentage point. (The
allowable spread were increased to one and one-eighth percentage
points by the 1982 Act). In addition, any arbitrage profits
earned from investing the bond proceeds in non-mortgage
investments was required to be paid or credited to the
mortgagors (or, if the issuer elected, to the Treasury). The
1988 Act requires the arbitrage profits to be rebated to the
Treasury and requires bonds proceeds not used to originate
mortgages within 3 years (and mortgage prepayments) to be used
to redeem bonds within 6 months.
Finally, in order to provide an opportunity to review the
effects of the new requirements, the 1980 Act provided that the
qualified mortgage bond program would terminate at the end of
1983. The authority to issue qualified mortgage bonds was
extended through 1987 by the 1984 Act, through 1988 by the 1986
Act, and through 1989 by the 1988 Act.
In the Deficit Reduction Act of 1984 (the "1984 Act"),
Congress tried to improve the efficiency of the mortgage subsidy
by allowing State and local governments to elect to trade some
or all of their qualified mortgage bond authority for authority
to issue mortgage credit certificates ("MCCs"). The trade-in
rate was set at 20 percent of the nonissued bond amount. MCCs
entitle a homebuyer to a nonrefundable income tax credit in the
amount of 10 percent to 50 percent (as determined by the issuing
authority) of interest paid on a mortgage incurred to finance
the mortgagor's principal residence. The maximum annual credit
per recipient is $2,000. Eligibility for the credit is based on
the same criteria as for qualified mortgage bonds. The 1986 Act
increased the MCC trade-in rate from 20 percent to 25 percent.
The authority to issue MCCs is scheduled to terminate at the end
of 1989, along with the authority to issue qualified mortgage
bonds.
Discussion
The Administration opposes any further extension of the
authority to issue qualified mortgage bonds. Other federal
support for owner-occupied housing for low- and moderate-income
families exists. Moreover, tax-exempt qualified mortgage bonds
are very costly and an extremely inefficient means of providing
assistance to low- and moderate-income homebuyers.
The federal income tax rules provide substantial assistance
to homeowners through the allowance of a deduction for interest

-22on mortgages of up to $1 million incurred to purchase a
principal (or second) residence, allowance of a deduction for
real estate taxes, rollover of capital gains on sales of a
principal residence, and allowance of a one-time exclusion of
capital gains of up to $125,000 on the sale of a principal
residence by a taxpayer aged 55 or older. As a result, the
income from owner-occupied housing investments is exempt from
tax over the entire lifetime of most taxpayers. The mortgage
interest and real estate tax deductions allow taxpayers to
reduce their withholding taxes and have more take-home pay with
which to make monthly mortgage payments. We estimate that these
special tax provisions provided over $50 billion in assistance
to owner-occupied housing in fiscal year 1988.
In addition to preferential tax treatment, other federal
programs aid homebuyers. For example, the Federal Housing
Administration and Veterans' Administration provide mortgage
insurance that allows many first-time homebuyers to purchase a
home with a low downpayment.
Tax-exempt financing is an extremely inefficient means of
providing assistance to low- and moderate-income homebuyers.
The subsidy is possible because high-income individuals and
other persons subject to a high marginal rate of tax are willing
to accept lower interest rates on tax-exempt bonds. The portion
of the benefits captured by the purchasers of the bonds is
large, due to the large outstanding volume of tax-exempt bonds,
including mortgage revenue bonds. A GAO study estimates that
because of the inherent inefficiency, as well as the significant
overhead costs of administering the subsidy, less than half of
the tax benefits were passed along to homebuyers. 3/ Because of
these inefficiencies, the program provides a low rate of subsidy
to prospective homebuyers. The program, therefore, is unlikely
to encourage home ownership for persons who would not otherwise
be purchasing homes. This fact is suggested by the GAO study,
which found that two-thirds of assisted households could have
afforded the homes they purchased without assistance and that
most of the rest could have purchased homes in the near future
without assistance.
Finally, the costs of the qualified mortgage bond program
are very high. Revenue estimates that focus on the short-term
revenue loss resulting from a new tax-exempt bond issue vastly
understate the long-term revenue loss. The long-term revenue
loss reflects up to 30 years of tax subsidies. For example, we
estimate that the revenue loss from all outstanding qualified
mortgage bonds in fiscal year 1988 is $1.8 billion, almost all
of 3/
which
isGeneral
attributable
to bonds
issued
before
1988. In
U.S.
Accounting
Office,
Home
Ownership:
Mortgage
addition, the increased supply of tax-exempt bonds resulting

T^8T7

-23-

from the qualified mortgage bond program raises interest costs
for State and local governments for financing traditional public
projects such as schools, roads, sewers, and public buildings.
In summary, extension of the qualified mortgage bond program
is unnecessary, inefficient, and very expensive. The qualified
mortgage bond program is the least cost-effective means of
providing federal assistance to owner-occupied housing and does
not provide sufficient assistance to those who may need it to
justify its large cost. If Congress deems that additional
assistance for first-time homebuyers is necessary, it should
consider providing all such assistance in the form of mortgage
credit certificates to improve the efficiency of the program.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ mi11ions)
One-year
extension
-37
-44
-41
-35
Qualified Small Issue Bonds
Background
In the 1960s, State and local governments discovered that
they could issue tax-exempt industrial development bonds (IDBs)
to provide below-market rate loans to private businesses at no
cost to themselves. Prior to the Revenue and Expenditure
Control Act of 1968 (the "1968 Act"), there were no federal
restrictions on the types of business activities that could
benefit from the subsidized loans provided with these tax-exempt
bonds. Beginning with the 1968 Act, a series of legislative
changes were enacted to restrict the purposes for which
tax-exempt IDBs could be issued and to curtail the mounting
federal revenue losses from the issuance of these bonds.
The 1968 Act primarily restricted tax-exempt IDB financing
to certain exempt activities. The exempt activities for which
such financing continued to be available were those that
traditionally had been carried on by State and local governments
and that furthered some public purpose (e.g., multifamily rental
housing, transportation facilities, and sewage and solid waste
disposal facilities). The 1968 Act, however, also permitted
tax-exempt IDBs to be issued to finance land and depreciable
property of any type for any private business as long as the
bonds qualified under a special exemption for small IDB issues.
Under the 1968 Act, an IDB qualified as an exempt small
issue if the aggregate face amount of the issue did not exceed
$1 million. In determining whether the $1 million limit was

-24exceeded, the aggregate face amount of other exempt small issues
issued primarily with respect to facilities located in the same
locality was taken into account if the principal user of both
facilities was the same. The small issue exemption was amended
by the Renegotiation Amendments Act of 1968 to permit issuers to
elect to apply a $5 million limit in lieu of the $1 million
limit. The $5 million limit was applied by also taking into
account any capital expenditures incurred during a 6-year period
with respect to other facilities in the same locality if the
principal user of the bond-financed facilities and the other
facilities was the same. The 6-year period began 3 years before
and ended 3 years after the date of issue. The $5 million limit
was increased to $10 million by the Revenue Act of 1978.
Between 1976 and 1981, tax-exempt IDB financing grew from
33 percent of total tax-exempt financing to 56 percent of total
tax-exempt financing. During the same period, annual volume of
tax-exempt small issue IDB financing grew from $1.5 billion to
$13.3 billion. Based on this growth, annual volume in 1987 was
estimated by the Joint Tax Committee to reach $31.3 billion.
The proliferation of tax-exempt IDBs was contributing to a
significant narrowing of the spread between tax-exempt and
taxable interest rates, increased interest costs for State and
local governments for financing traditional public projects,
distortions in the allocation of scarce capital resources, and
mounting federal revenue losses. For these reasons, the 1982
Act eliminated the tax-exemption for small issue IDBs issued
after December 31, 1986. The 1982 Act also prohibited use of
more than 25 percent of the proceeds of these bonds for certain
retail and recreational facilities. Despite the restrictions
imposed by the 1982 Act, the volume of tax-exempt IDB financing
continued to grow. By 1983, tax-exempt IDB financing amounted
to 61 percent of total tax-exempt financing.
The 1984 Act imposed additional restrictions on tax-exempt
IDBs. In an effort to curb the continually rising federal
revenue losses from the issuance of these bonds, the 1984 Act
imposed a cap on the volume of tax-exempt IDBs that could be
issued within a State during a calendar year. The annual volume
cap for each State was the greater of $200 million or $150 for
each State resident. Bonds issued for multifamily rental
housing and governmentally-owned transportation facilities were
exempt from the volume cap. The 1984 Act also restricted the
portion of the proceeds of a tax-exempt IDB issue that could be
used to acquire land and generally prohibited the acquisition of
existing property unless a prescribed level of expenditures was
incurred for rehabilitation of the property. Additional
restrictions on tax-exempt small issue IDBs were imposed. To
eliminate the practice of issuing these bonds to finance each
store in a large shopping mall, the $10 million capital
expenditure limitation was clarified to apply to an entire
project. The 1984 Act also restricted the availability of
tax-exempt small issue financing to businesses that benefited
from 1984
no more
$40 million
of outstanding
tax-exempt
The
Act, than
however,
permitted
tax-exempt small
issue IDBs.
IDBs to

-25be issued to finance manufacturing facilities for two additional
years, through December 31, 1988.
The 1986 Act included a comprehensive set of provisions
designed to meaningfully constrain the volume of tax-exempt
bonds issued by State and local governments to subsidize
nongovernmental activities. Between 1975 and 1985, the volume
of tax-exempt private activity bonds (including tax-exempt IDBs,
student loan bonds, mortgage revenue bonds, and bonds for
section 501(c)(3) charitable organizations) increased from $8.9
billion to $124.2 billion. As a share of total State and local
borrowing, financing for these private activities increased from
29 percent to 55 percent. The 1986 Act consolidated the two
separate State volume caps that applied to IDBs and qualified
mortgage bonds into a single unified State volume cap on private
activity bonds. The annual volume cap for each State is the
greater of $150 million or $50 for each State resident. Bonds
exempt from the volume cap are those for airports, docks and
wharves, governmentally-owned solid waste disposal facilities,
and section 501(c)(3) charitable organizations. The 1986 Act
repealed authority to issue tax-exempt private activity bonds
for several exempt activities that were not traditionally
carried on by State and local governments and that primarily
furthered private business interests (e.g., bonds for sports
facilities, air and water pollution control facilities, and
convention and trade show facilities). The 1986 Act also placed
restrictions on the exempt activities for which tax-exempt
financing continued to be available to target the subsidy to
activities that actually served a public purpose (e.g., the lowand moderate-income occupancy requirement for multifamily rental
housing projects was significantly tightened). The 1986 Act,
however, also extended the authority to issue tax-exempt small
issue IDBs to finance manufacturing facilities for one
additional year, through December 31, 1989. These bonds are now
referred to as qualified small issue bonds.
Discussion
The Administration opposes any further extension of the
authority to issue qualified small issue bonds for manufacturing
facilities. As discussed above, tax-exempt financing is not an
efficient or appropriate means of providing a subsidy to private
business, and tax-exempt financing should generally be
restricted primarily to those activities that traditionally have
been carried on by State and local governments and that further
public rather than purely private interests.
Moreover, the use of tax-exempt financing to subsidize
private manufacturing businesses has anti-competitive and
distortive effects on the economy. Manufacturing businesses
that receive tax-exempt financing have significant advantages
over their competitors, which must raise capital with
higher-cost taxable financing. Yet, the availability of
qualified small issue financing depends on the size of a
particular facility, on the amount of capital expenditures
incurred in a particular locality by principal users of the

-26facility, on which localities have the necessary programs in
place and the available private activity bond authority to issue
the bonds, and on the ability of persons to negotiate through
obstacles of State and local law and procedure. It is
unrealistic to assume that qualified small issue bond authority
will necessarily be allocated to financing of private
manufacturing businesses for which any subsidy might actually be
necessary or desirable. Furthermore, the use of private
activity bond authority to finance these purely private business
activities reduces the amount of the subsidy available for the
exempt activities that specifically have been targeted and
approved for tax-exempt financing.
Revenue Estimate
Fiscal Years
1990 1991 1992 1993
($ mi11ions)
One-year
extension

-10

-12

-13

-12

Deduction for Self-Employed Individuals of
25% of Health Insurance Costs
Section 162(1) o.f the Code provides that self-employed
individuals may deduct 25 percent of the amount paid for health
insurance for the individual and the individual's spouse and
dependents. In the case of a self-employed individual who has
employees, the deduction is available only if the health
insurance is provided under a plan that meets the
nondiscrimination requirements of section 89. The deduction
does not apply to amounts paid in years beginning after 1989.
This provision was added to the Code by the 1986 Act to
make more consistent the tax treatment of health insurance
benefits provided to self-employed individuals and employees
(whose employer-provided health insurance is generally excluded
from income), and also to encourage a narrowing of the gap in
health coverage among small businesses.
The Administration supports efforts to better coordinate
the tax- treatment of health insurance expenditures among
employees and self-employed individuals and to narrow the gaps
in health insurance coverage. However, we believe that an
extension of the self-employed health insurance deduction rule
does not significantly address the inconsistencies in the tax
treatment of health care expenditures and would not result in
significant increases in health care coverage. Accordingly, in
light of the significant revenue loss that would result from
extension, the Administration opposes extension of this
provision.

-27-

Providing a deduction to self-employed individuals will
provide more consistent tax treatment to only small segment of
the population. It does not address the more significant
inequity between employees whose employer provides health
insurance and those whose employer does not. Moreover, the
provision will not significantly address the gaps in health
insurance coverage. In many cases, the deduction is being
utilized by self-employed individuals who would purchase health
insurance in any event. In the case of a self-employed
individual who has employees, the value of the deduction will i
many cases not be sufficient to induce the individual to provid
health insurance to the employees. Similarly, the provision
provides no benefit to employees who must purchase health
insurance on their own.
Revenue Estimate
Permanent extension of the section 162(1) deduction
Fiscal Years
1990 1991 1992 1993
( $ mi H i ons )
-147 -268 -319 -368
Exception to the Early Withdrawal Tax for Distributions
from Employee Stock Ownership Plans
Section 72(t) of the Code imposes a 10-percent additional
income tax on distributions received by an individual from
tax-qualified qualified retirement plans prior to age 59-1/2.
Section 72(t)(2)(C) provides an exception from the additional
income tax for certain distributions received from Employee
Stock Ownership Plans ("ESOPs") prior to 1990.
The Administration opposes extension of the exception from
the additional income tax for distributions from ESOPs. The
additional income tax on early distributions is designed to
discourage individuals from withdrawing their retirement saving
prior to age 59-1/2 and to recapture some portion of the tax
savings provided to tax-qualified plans providing retirement
income. ESOPs receive the same advantage of tax deferral and
are subject to the same general distribution rules as other
tax-qualified retirement plans, including eligibility for
five-year forward income averaging and rollover treatment. The
Administration believes that the additional income tax should
apply to ESOPs in the same manner that it applies to other
tax-qualified plans to discourage employees from diverting thei
ESOP savings for nonretirement uses.

-28-

Low-Income Housing Credit
Background
A tax credit is allowed under section 42 of the Code for
qualified expenditures with respect to low-income residential
rental housing. The credit was enacted as part of the 1986 Act,
and was intended to provide tax incentives more efficient than
those under prior law for encouraging the production of
affordable low-income rental housing.
The credit for any low-income building is limited to the
amount allocated to the building by a designated State agency,
which allocation generally must be made in the year in which the
building is placed in service. States may allocate credits each
year subject to annual credit authority limitations for each
State, may not carry unused credit authority from one year to
the next, and may make allocations only through 1989. However,
the 1988 Act permits a building to be placed in service within
the two years succeeding the year in which the credit allocation
is received, provided that (1) the building is part of a project
in which the taxpayer's basis at the end of the allocation year
is more than ten percent of the reasonably expected basis for
the project, and (2) the building involves either new
construction or substantial rehabilitation. Consequently, while
the credit generally is scheduled to expire for property placed
in service after December 31, 1989, certain property placed in
service by 1991 may qualify for the credit.
The credit is claimed with respect to a qualified building
in annual installments during a ten-year period generally
beginning with the year in which the building is placed in
service. After 1987, the annual tax credit percentage for
non-federally subsidized new buildings is determined by the
Secretary of the Treasury to yield a discounted present value
over the ten-year credit period (based upon federal borrowing
rates) equal to 70 percent of the expenditures eligible for the
credit. A lesser tax credit percentage, similarly determined by
the Secretary of the Treasury to yield a discounted present
value equal to 30 percent of eligible expenditures over the
ten-year credit period, is available for certain acquisition
costs of existing buildings and for federally subsidized new
buildings. For these purposes, rehabilitation expenditures are
treated-as a "separate new building," and "federal subsidies"
are defined to include tax-exempt financing and below-market
federal loans.
The credit generally is available only for qualifying
expenditures with respect to units rented to households
satisfying one of two minimum income criteria: (1) at least 40
percent of the units in a project must be rent restricted and
occupied by households having no more than 60 percent of area
median gross income; or (2) at least 20 percent of the units in
a project must be rent restricted and occupied by households
having no more than 50 percent of area median gross income.

-29Gross rents on qualifying low-income units must not exceed 30
percent of the foregoing income limitations.
While the credit is claimed over a ten-year period,
buildings must comply with the low-income housing requirements
for a period of fifteen years. If, during this compliance
period, a building fails to comply with the applicable
requirements, or the taxpayer disposes of the building, the
taxpayer may have to recapture the credit. Non-compliance or
disposition within the first eleven years could result in
recapture of one-third of the credit amount, while recapture
thereafter would be less.
Discussion
The Administration strongly supports the ultimate objective
of the low income housing credit to improve housing for
low-income families and individuals. The Administration has not
proposed an extension of the low income housing credit as
currently structured because the credit does not appear to
provide an efficient subsidy for low income housing.
The relative efficiency of the current credit should be
fully analyzed before any decision is made to extend the credit.
This is especially important as a budget matter because the
revenue cost of the low-income housing credit continues for ten
years with every year that the credit is extended. Based upon
preliminary information for 1987-88, we anticipate that the
revenue cost of the low-income housing credit will be
approximately $295 million in fiscal year 1989. Moreover, we
expect this cost to grow to approximately $715 million in fiscal
year 1993 as a result of increased usage of the credit since
1987, placement in service of qualifying buildings through 1991,
and continuing claims for credits over the ten-year period
following placement in service of a qualifying building.
The motivation for enactment of the low-income housing
credit was the inefficiency of the low-income housing tax
provisions under prior law. Congress was concerned that the tax
preferences under prior law were not effective in providing
affordable housing for low-income individuals. The preferences
under prior law were uncoordinated and not directly related to
the number of low-income households being served. In addition,
there was no incentive for recipients of tax subsidies to
provide more low-income units than the minimum amount required,
nor was there any direct incentive to limit rents.
While the low-income housing credit is a clear improvement
over prior tax incentives and although the structure of the
credit has been significantly improved by recent legislation; we
continue to have significant concerns about the efficiency and
equity of the credit. Some subsidized units simply may replace
units that would have been available in the absence of federal
assistance, and the credit may not result in significant
long-run housing supply increases. The percentage of the cost
of the credit that accrues to the benefit of low-income families

-30is unclear. The additional administrative costs borne by the
IRS, HUD, and State agencies as a consequence of the credit have
not been determined. The credit includes no requirements for
maintenance, and the incentive of landlords renting at
below-market rates to prevent deterioration is unclear where
there may be no corresponding loss of tenants. Without
additional subsidies, project owners may have no economic
incentive to continue to rent to low-income tenants after the
15-year compliance period has elapsed. Finally, the credit may
not make housing available or affordable to households
substantially below the poverty level.
Fiscal Years
Revenue Estimate
19901991
1992
1990
1993
IT"millions)
One Year Extension
of Low-Income
Housing Credit
Two Year Extension
of Low-Income
Housing Credit

-55

-200

-295

-325

-875

-55

-260

-505

-635

-1455

Special Tax Rules Applicable to Reorganizations
of Financially Troubled Thrifts
Prior Law
In the Economic Recovery Tax Act of 1981 (the "1981 Act"),
in order to resolve some of the uncertainties of prior law and
to permit the relevant supervisory authority to arrange mergers
of financially troubled thrift institutions with healthy
institutions at a lower cost to the supervisory authority,
Congress enacted special tax rules for transactions involving
financially troubled thrift institutions.
First, as enacted in 1981, Section 597 provided a special
exclusion from income for amounts received by a domestic
building and loan association from the FSLIC under its financial
assistance program. Section 597 also provides that no reduction
in the basis of the recipient's assets is required on account of
such a payment. Although Section 597 appears to contemplate
that such assistance might be regarded as either a
nonshareholder contribution to capital (which would necessitate
a basis reduction under Section 362(c)) or gross income, the
Treasury Department believes that, in the absence of Section
597, such amounts are generally properly viewed as gross income.
Second, Section 368(a)(3)(D), as enacted in 1981, permitted
certain acquisitions of financially troubled thrift institutions
to qualify as tax-free reorganizations under Section

-31368(a)(1)(G), without regard to the continuity of interest or
distribution requirements ordinarily applicable in the case of
(G) reorganizations. Until December 31, 1988, this rule applied
only if (1) the acquired institution was a thrift institution
(i.e., a domestic building and loan association, a non-stock
cooperative bank organized and operated for mutual purposes and
without profit, or a mutual savings bank); (2) the relevant
supervisory authority certified that the acquired thrift was
insolvent, could not meet its obligations currently, or would be
unable to meet its obligations in the immediate future in the
absence of action by the supervisory authority; and (3) the
acquiring corporation acquired substantially all of the assets
and assumed substantially all of the liabilities (including the
deposits) of the acquired thrift.
Third, in the case of transactions that qualified under the
relaxed rules as a (G) reorganization, section 382(1)(5), as
enacted in 1981, permitted the acquiring corporation to succeed
to the net operating loss carryovers, built in losses, and
excess credit of the acquired thrift, without limitation under
Section 382, provided that the shareholders, creditors, and
depositors of the acquired institution acquire a 20 percent
interest in the acquiring corporation as a result of the
acquisition. For this purpose, depositor interests are
considered interests in the acquired institution.
In the 1986 Act, Congress repealed these provisions
effective December 31, 1988.
Current Law
In the 1988 Act, Congress extended these provisions for one
additional year, though December 31, 1989, but modified them by
requiring that certain tax attributes be reduced by an amount
equal to 50 percent of the agency assistance received and by
making these provisions applicable to FDIC assisted
reorganizations of troubled banks.
Thus, under current law, the provisions of section
368(a)(3)(D) and 382 (1)(5) as described above are retained, and
extended to banks in the case of transactions that meet
certification requirements similar to those required for
thrifts. Section 597 as currently in effect excludes both FDIC
and FSLIC assistance payments from income, but requires that an
amount equal to 50 percent of the amount excludable be applied
to reduce tax attributes in the following order: (1)
pre-assistance net operating losses; (2) allowable interest
deductions; and (3) recognized limit-in losses on certain
portfolio assets.
Discussion
The Administration's plan for the S&L industry, as embodied
in the proposed "Financial Institutions Reform, Recovery and
Enforcement Act of 1989," contemplates permitting these special
tax provisions to expire at the end of this year. Although

-32these provisions have played a role in facilitating the
resolution of insolvent savings and loan institutions, such
indirect subsidies are inherently inefficient and do not permit
the kind of full and precise accounting for costs envisioned by
the Administration's Plan.
The 1986 Act repeal of these special provisions, after a
two year transition period, comported with one of the basic
themes of the 1986 Act, that the tax laws should not provide
beneficial treatment to some industries, or segments of an
industry, and not others. The Treasury Department generally
supported this decision as sound tax policy.
The President's Tax Proposals to the Congress for Fairness,
Growth, and Simplicity in May 1985 specifically recommended that
these provisions be repealed. That recommendation, however,
included a longer transition period, to January 1, 1991. In
March 1988, we testified that the Treasury Department remained
concerned that the two year transition period provided in the
1986 Act was insufficient, and that we would not object to a one
year delay of the repeal of the special provisions. The
Treasury Department thus did not oppose the provisions in the
1988 Act that modified and extended these special rules. We are
strongly opposed, however, to any further extension of these
provisions.
In general, we believe that the subsidization of specific
industries through the Federal tax laws is inefficient. In the
case of the special provisions applicable to reorganizations of
financially troubled thrifts, the subsidy is not only
inefficient, but also more costly than Congress believed when it
acted upon these provisions in 1986 and 1988. As discussed
below, the nature of the activity to which these provisions
apply makes estimation of the revenue costs extremely difficult.
It is difficult to predict the use and value of the tax
benefits provided through the special thrift merger rules.
Because these transactions are seldom, if ever, negotiated on
the premise that the agency should receive 100 percent of the
predicted value of the tax benefits, the use of these rules to
provide Federal assistance to FSLIC is inherently inefficient.
The acquiring firm may receive a sizable portion of the tax
benefits, which means that the cost to the Treasury of providing
indirect assistance to FSLIC through the tax code is greater
than the. cost of providing direct assistance. Even if the deals
were arranged so that FSLIC received 100 percent of the tax
benefits, there would be no reason to believe that the acquiring
firm would not attempt to "trade" the loss of these benefits and
negotiate more advantageous provisions elsewhere in the
acquisition contract. For example, an acquiring firm may agree
that FSLIC will receive all of the tax benefits, but the firm
may demand a lower capital infusion requirement or a higher
guaranteed yield on covered assets.
In the revenue estimating process, the uncertainties of
predicting the use and value of tax benefits available in an

-33individual transaction are compounded by the lack of knowledge
of the tax position of the acquiring firm and the heavy reliance
on outlay estimates provided by FSLIC. This is true because the
ability of the acquiring firm to use the tax benefits available
from a FSLIC assisted merger depends both upon the expected
income of the acquiring firm and on the application of the tax
rules that restrict the use of the tax benefits, including
section 382, section 384, and the separate return limitation
year rules of the consolidate return rules to the particular
circumstances of that transaction. However, this information is
generally not known.
PROVISIONS WHICH EXPIRED IN 1988
Employer-Provided Group Prepaid Legal Services
Background
Prior to 1989, the value of employer contributions to, and
employee benefits provided under, a "qualified group legal
services plan" was excluded from an employee's income under
section 120 of the Code. Amounts excluded from income were also
excluded from an employee's social security tax wage base. A
qualified group legal services plan was defined as a separate
written plan of an employer for the exclusive benefit of its
employees or their spouses or dependents. The plan was required
to provide specified personal (i.e., non-business) legal
services to employees through prepayment of, or provision in
advance for, all or part of an employee's legal fees for such
services. Benefits under the plan were required to be provided
in a manner that did not discriminate in favor of officers,
owners, or highly compensated employees. In addition, no more
than 25 percent of the amounts paid to the qualified plan could
be for the benefit of persons holding a more than five percent
ownership interest in the employer.
Prior to 1988, section 501(c)(20) of the Code exempted from
tax organizations or trusts the exclusive function of which was
to form part of a qualified group legal services plan under
section 120. These organizations were permitted to provide
other legal services or indemnification against legal costs
without jeopardizing their tax-exempt status.
With the expiration of section 120, the benefit to an
employee of coverage under an employer-provided legal services
plan generally is included in the employee's gross income and
social security tax wage base. An offsetting income tax
deduction would be allowable to the employee only in very
limited circumstances.
Discussion
The Administration would oppose the permanent reinstatement
of section 120. This section created inequitable distinctions
among taxpayers that, in our view, cannot be justified.

-34-

The exclusion for group legal services permitted a limited
group of employees to achieve the effect of a deduction for
their personal legal costs (and an exclusion of such amounts
from the social security wage base), simply because their
employers operated qualified group legal services plans.
According to a Labor Department study, only 3 percent of all
employees had access to such plans in 1985. Thus, although the
intent of section 120 was to increase access to legal services
for middle income taxpayers, only a small percentage of
taxpayers actually benefited. Moreover, section 120 produced an
inequitable tax advantage for participants in group legal
services plans as compared to the vast majority of other
individuals, who, because they could not deduct their personal
legal expenses, paid such expenses with after-tax dollars. Even
among participants in a qualified group legal services plan, the
tax exclusion provided the greatest benefits to higher-income
participants who were subject to higher marginal rates of income
tax.
Employer-Provided Education Assistance
Background
Under section 127 of the Code, up to $5,250 of the value of
educational assistance provided by an employer under a qualified
educational assistance program could be excluded from an
employee's income. In 1988, such educational assistance did not
include expenditures for graduate level courses. Specifically,
the exclusion did not apply to any benefits with respect to any
course taken by an employee who had a bachelor's degree or was
receiving credit toward a more advanced degree, if the
particular course could be taken for credit by any individual in
a program leading to a law, business, medical, or any other
advanced academic or professional degree.
In order to qualify for the exclusion, the educational
assistance program was required to meet several conditions,
including that the assistance be provided in a manner that did
not discriminate in favor of officers, owners, or highly
compensated employees. In addition, no more than five percent
of the amounts paid under a qualified educational assistance
program could be for the benefit of persons holding a more than
five percent ownership interest in the employer. Section 127,
which was first enacted in 1978, expired on December 31, 1988.
Section 117(d)(2) excludes from taxable income amounts of
"qualified tuition reduction," i.e., reduced tuition provided on
a nondiscriminatory basis to an employee of an educational
organization for the education (below the graduate level) of the
employee or the employee's spouse or dependent children. This
exclusion is subject to the limitation of section 117(c), which
makes the exclusion inapplicable to any amount that represents
payment
if the
for
receiving
performance
for teaching,
the tuition
of such
research,
reduction.
services
or other
isPrior
required
services
to the
asby
a
expiration
condition
the student
of

-35section 127, section 127(c)(8) provided that, in the case of a
graduate student engaged in teaching or research activities,
section 117(d) was applied without regard to the requirement
that the education be below the graduate level. The 1988 Act
made this provision permanent by adding it to section 117(d).
Accordingly, even though section 127 has expired, section 117
serves to exclude from income the portion, if any, of a graduate
student tuition reduction that is in excess of reasonable
compensation for teaching or research services performed.
With the expiration of section 127, an employer's payment
or reimbursement of an employee's educational expenses generally
must be included in the employee's income unless the cost of the
assistance qualifies under section 117(d) as a tuition
reduction, under section 132 as a fringe benefit, or under
section 162 as a deductible job-related expense of the employee.
In general, educational expenses are treated as job-related only
if the education maintains or improves skills required in an
employee's retention of his job, job status, or rate of
compensation. Education that qualifies the employee for a new
job (with the same or a different employer) is not considered
job-related.
Discussion
The Administration opposes the reinstatement of section 127
chiefly because this provision accorded tax benefits to only a
small proportion of similarly situated taxpayers and did not
principally benefit those most in need of educational
assistance. This view is supported by a study of section 127
conducted by the Treasury Department, as required by Public Law
98-611. That study was issued in June, 1988.
The tax-favored treatment of educational expenses under
section 127 applied to only a small percentage of persons taking
courses to train for a new job or occupation, thus creating
inequitable distinctions among taxpayers. Obviously, the tax
benefit was not available to unemployed persons or to workers
whose employers did not offer such programs. Moreover,
self-employed individuals and many small business owners were,
as a practical matter, unable to benefit effectively from
section 127 plans. 4/ As Table 1 indicates, 84 percent of all
adult education courses taken in 1984 to qualify for a new job
4/ Although section 127 provided that self-employed
individuals and sole proprietors could technically qualify for
the benefits of the section, effectively these benefits were
primarily available only to employees of larger businesses.
Closely held businesses were unable to benefit from section 127
because of the requirement that no more than five percent of the
amounts paid under the educational assistance program be for the
benefit of persons holding a more than five percent ownership
interest in the employer.

-36-

or occupation were paid for by the student himself. Thus, only
16 percent of such training could have benefited from section
127.
Moreover, the Treasury Department study and various other
studies suggest that the section 127 educational assistance
plans failed to achieve the primary objective offered for their
tax subsidy, namely increasing opportunities among lower paid,
lower skilled workers for training for new, better paying jobs
and occupations. Instead, the effect of this tax subsidy may
have been to contribute to the sharp increase since 1978 in
adult education that is related to the current job and is
concentrated among higher paid and better educated workers.5/
Thus, for example, a Labor Department survey found that
higher-paid professional and administrative employees were more
likely than production workers to have employer educational
assistance plans offered to them, and were more likely to be
offered full, rather than partial, reimbursement.6/ In
addition, as Table 2 indicates, less educated worlcers in
lower-paying jobs represented a smaller fraction of participants
in adult education courses in 1984 than in 1969, before the
enactment of section 127.
In summary, although the Administration strongly supports
the objective of promoting education, we believe that section
127 unfairly provided, at a substantial revenue cost,
preferential treatment to a relatively small group of
individuals, a disproportionately high percentage of whom were
higher paid professional and administrative personnel. For
these reasons, the Administration opposes the reenactment of
section 127.
Revenue Estimates
Fiscal Years
1989 1990 1991 1992 1993
($ millions)
Three year
extension
-70
-430
-319
-97
One year
extension
-70
-215
-

5/ Department of the Treasury, Report to the Congress on
Certain Employee Benefits Not Subject to Federal Income Tax, 2
(1988) .
6/ U.S. Department of Labor, Bureau of Labor Statistics,
Employee Benefits in Medium and Large Firms In 1985, Washington
U.S. Government Printing Office (1986).

-37-

This concludes my prepared remarks.
respond to your questions.

I would be pleased to

E M P L O Y E R - P R O V I D E D E D U C A T I O N ASSISTANCE
Table 1
Adult Education in 1984
Reason for Taking Course and Source of Payment
(in thousands)

total Courses

Total
Courses
40,751

Employer Paid

14,800

Improve in
Current Job
19,703
12,328

Jop-Kelated Courses
New Job in
New Job in
New Occupation
Same Occupation
3T8T8
9&T
549
242

Other
~T55T

Non-Job-Related
Courses
TITERS

Unknown
T45~

797

857

28

35.5

0.3

5.8

0.1

5.9

19.3

Row Percentages
Total Courses

100.0

Job-Related
Employer Paid

100.0

Job-Related
Column Percentages
Employer Paid

36.3

2.4

9.4

4.0

75.3

3.8

14.6

6.3

83.0

1.6

3.7

5.3

88.6

1.7

3.9

5.7

24.6

14.4

48.2

48.0

62.6

Source- Tabulated from- U.S. Department of Education, Center for Educational Statistics, Trends in Adult Education
1969-1984, Tables G-H, pp. 33-36.

E M P L O Y E R - P R O V I D E D E D U C A T I O N ASSISTANCE
Table 2
Distribution of Adult Education Participants and
the Adult Population 17 Years and Older,
by Selected Characteristics M a y 1969 and 1984

Characteristic

Adult Participants
1969
1984

Population l / Years Uld and Over
T959
TW

Total number (in thousands)

13,041

23,303

130,251

172,583

Total percent

100%

100%

100%

100%

Sex:
Men
Women
Race:
White
Black
Other
Ethnicity:
Hispanic
Age group:
17-34
35-54
55 and over
Education level:
Less than 12th grade
High school graduates
Some college (1 to 3 years)
Bachelor's degree or higher
Regions:
Northeast
North Central
South
West
Income group:
Above median family income
Below median family income
Labor force status:
Employed
Unemployed
Keeping house, going to school
Other (retired, etc.)
Occupational groups:*
Executive/ managerial
Professional/technical
Administrative support
Sales and service
Other
Source:

52
48

45
55

47
53

47
53

92
7
1

92
6
2

89
10
1

86
11
3

53
36
11

50
38
12

37
35
28

42
30
28

16
38
20
26

8
30
26
36

44
34
12
10

27
38
18
17

23
30
24
23

17
26
31
24

25
28
31
16

22
25
34
20

68
32

65
35

50
50

50
50

78
2
18
3

81
4
12
3

57
3
27
13

61
5
22
13

11
33
17
16
23

15
31
17
20
17

9
13
15
27
36

11
15
16
26
32

U.S. Department of Education, Center for Educational Statistics, Trends in Adult
Education 1969-1984, Table 1, page 3, 1987.

* The basis of these percentages are employed adult education participants and the
employed population 17 years and older.
Not available.
Note:

Details may not add to totals because of rounding.

lepartment of the Treasury • Washington, D.c. • Telephone
FOR IMMEDIATE RELEASE

LfBiU?!'March IB?,'! 1989

Mm? 17 8 - f M ^ n
OLPARTHthi •

Richard W. Porter
Appointed Deputy Assistant Secretary
(Policy Review and Analysis)

Secretary of the Treasury Nicholas F. Brady today announced the
appointment of Richard W. Porter to serve as Deputy Assistant
Secretary of the Treasury for Policy Review and Analysis in the
Office of Policy Development, effective Monday, February 27,
1989. Mr. Porter will be responsible for providing the Assistant
Secretary for Policy Development with analysis and briefings on
the full range of the Department's policies.
Mr. Porter served as the Transition Office Contact for the
Department of Labor and was an analyst and the chief writer of
the Domestic Policy group in the Bush/Quayle campaign. Prior to
that, he worked as a lawyer-economist for Lexecon, Inc. in
Chicago. He also served as a law clerk for Judge Richard A.
Posner of the U.S. Court of Appeals for the Seventh Circuit.
Mr. Porter received his J.D. with honors from the University of
Chicago Law School in 1989. He was awarded the John D. Olin
Prize for the outstanding graduate in law and economics and was a
member of Order of the Coif. He received his B.A. with high
honors from Middlebury College in 1981 and was elected to Phi
Beta Kappa.
Mr. Porter was born on November 20, 1959 in Mt. Kisco, New York.
to William P. and Barbara W. Porter.

NB-178

•2041

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

March 15, 1989

Emily Landis Walker
Appointed Executive Secretary
Office of the Assistant Secretary
(Policy Develoment)
Secretary of the Treasury Nicholas F. Brady today announced the
appointment of Emily Landis Walker to serve as Executive
Secretary to the Secretary of the Treasury effective February 27,
1989. In this position, Mrs. Walker will be responsible for the
Department•s Executive Secretariat which processes and
coordinates all written and policy materials for the Secretary
and Deputy Secretary.
Since 1988, Mrs. Walker has served as Deputy Assistant Secretary
of the Treasury for Policy Review and Analysis. From 1984-1988
she served as Assistant to the U.S. Executive Director of the
International Monetary Fund (IMF) while he was serving
concurrently as Senior Deputy Assistant Secretary of the Treasury
for International Economic Policy. Prior to that she worked in
the Exchange and Trade Relations Department of the IMF.
Mrs. Walker received her M.A. in 1981 from Johns Hopkins School
of Advanced International Studies, attending the Bologna Center
in Italy, and a B.A. in International Affairs and French from the
University of North Carolina at Chapel Hill in 1978. She also
attended the Vanderbilt-in-France program.
Mrs. Walker was born on July 2, 1956 in Clarendon Hills, Illinois
to George H. and the late Jane M. Landis. She resides in
Alexandria, Virginia with her husband, William J. Walker and
daughter, Sarah Jane.

NB-179

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
TEXT AS PREPARED

*>^U

*«/? ,•",•••-

REMARKS BY
THE SECRETARY OF THE TREASURY
NICHOLAS F. BRADY
BEFORE THE NATIONAL COUNCIL OF SAVINGS INSTITUTION'S
1989 GOVERNMENT AFFAIRS ROUNDTABLE
WESTIN HOTEL
WASHINGTON, D.C.
MARCH 14, 1989

Good morning. Thank you for this opportunity to meet with a
group that represents the leaders of the savings and loan
industry-. President Bush has asked me to tell you how much we
appreciate your support of the Administration's reform plan. It
is, as you know, a solid foundation for the solution to the
problems caused by the large number of insolvent S&Ls. We salute
your leadership in urging swift passage of the reform plan. We
also recognize that you have raised some concerns about
particular aspects of the proposal. We are optimistic that in
the days ahead we can continue the dialogue we have started with
you to resolve our remaining differences.
My remarks this morning will center on the President's
reform plan for the savings and loan industry. But before
getting to that, I would like to take just a moments to touch on
some of the other economic priorities the Bush Administration is
pursuing.
PROMOTING ECONOMIC GROWTH
Our first and foremost economic priority is fostering a more
competitive, innovative economy that will continue to lead the
world as we move toward the 21st century. I am pleased to say
that our economic outlook is good. Broad-based economic growth
means rising living standards for working Americans and new job
opportunities for those who are out of work.
We remain vigilant against inflation. The Bush
Administration will not allow inflation to plague our economy as
it did in the late seventies. Now, as all of us know, it is
NB-180

- 2 -

possible to have somewhat differing interpretations of economic
statistics, to think one set of statistics means more than
another. But there is no difference between the Administration
and the Federal Reserve Board on the importance of resisting and
preventing inflation in order to help sustain the current
economic expansion.
CUTTING THE BUDGET DEFICIT
As we pursue our goal of inflation-free economic growth,
the greatest obstacle to success is the federal budget deficit.
And the best way to fight inflation and encourage economic growth
is to cut the deficit.
That is why President Bush has proposed to Congress a budget
that will meet next year's Gramm-Rudman-Hollings deficit
reduction target of $100 billion without raising taxes. His
budget takes the more than $80 billion in new revenues resulting
from economic growth and allocates them to deficit reduction and
spending priorities.
The President pledged in his budget address to Congress that
he and his team are ready to work with the Congress, "day and
night, if that's what it takes, to meet the budget targets and to
produce a budget on time." Budget Director Darman, Governor
Sununu and I have begun to negotiate with the Congress and we're
making real progress.
THE S&L PLAN
Now, let me turn to what has been one of my other top
priorities since the day I was sworn in as Secretary of the
Treasury: a sound, responsible solution to the savings and loan
crisis.
President Bush is correct. No simple or painless solution
to this problem exists — a point your testimony noted last week.
Only eighteen days after he was inaugurated, however, President
Bush announced our plan. In doing so, he reaffirmed our
commitment to fix it now, fix it right, «and fix it once and for
all.
The reform plan meets these standards. It serves as a
blueprint for comprehensive reform and sound financing. It is
pro-consumer — putting deposit insurance on a sound basis for
the future to protect depositors and taxpayers as well — and it
is pro-industry — benefitting S&Ls and the housing industry.

- 3 -

RESOLVING INSOLVENT S&Ls
Now, let me turn to a few of the most important details: On
February 7, the day after the President announced his plan, the
FSLIC, FDIC, OCC, and the Federal Reserve acted together to
place insolvent institutions under supervisory control. To date,
118 insolvent S&Ls have been brought under regulatory control.
In short order, 200 of the worst cases should be in the hands of
federal authorities.
That action should begin to reduce your cost of funds.
Moreover, this quick action will give us a head start on
implementing the necessary resolutions of insolvent thrifts. We
can begin as soon as Congress provides the necessary financing.
THE REFORM PLAN
We have also proposed fundamental reforms in the way the
S&L industry is insured and regulated. To correct the systemic
problem of having the regulator act both as an industry advocate
and insurer, FSLIC will be separated from the Bank Board and
attached administratively to the FDIC.
The combined administrative resources of FDIC and FSLIC will
create an insurer with independence and sufficient capacity to
tackle this big job. While a single agency will be created,
separate insurance funds will be maintained for commercial
insured banks and for savings and loans.
The Chairman of the Federal Home Loan Bank System (FHLBS)
will continue to be the chartering authority and the primary
federal supervisor of savings and loans. The current board will
be replaced by a single chairman, who will be subject to the
general direction of the Secretary of the Treasury in the same
manner as is the Comptroller of the Currency. Let me stress a
critical point here. It is not the intent of the legislation to
have the Treasury Department take a heavy-handed approach and
micro-manage the day-to-day affairs of S&Ls or the new Federal
Home Loan Bank System. We expect the Chairman and his
supervisory personnel to maintain regulatory independence within
the general oversight of the Treasury.
SAFETY AND SOUNDNESS
The Administration plan will increase safety and soundness
standards for savings and loan institutions by requiring
standards equivalent to commercial bank capital standards by
June 1, 1991. The Chairman of the Federal Home Loan Bank System
will administer these capital requirements, with fairness and
with flexibility. For example, contrary to some comments that

- 4 -

have been made, S&Ls that don't meet the deadline won't be
liquidated — they simply will not be able to grow after 1991
without adequate private capital at risk.
Much of the problem we see today is related to excessive
growth in the past without sufficient capital. We understand
that these standards in the legislation impose burdens on some
institutions which have engaged in mergers under the oversight of
regulators, and we are willing to discuss appropriate
modifications.
But we have learned a valuable lesson: Deposit insurance
simply will not work without sufficient private capital at risk
and up front. While we can be flexible in the administration of
these capital standards, we cannot afford to weaken them or delay
the date they become effective.
Incentives for attracting new capital will further increase
the amount of private capital protecting depositors. For
example, bank holding companies will be permitted to acquire an
insolvent savings and loan without the existing cross-marketing
and tandem restrictions. After two years, bank holding
companies will be able to acquire any savings and loan without
these restrictions.
The FDIC will be given enhanced authority to set insurance
standards for all savings and loans, both federal and statechartered. It will be able to deny insurance for risky
activities that have been authorized by some states in the past.
The FDIC also would have a "fast whistle" to halt unsafe and
unsound practices, while still protecting insured depositors.
All in all, these steps will create a system of checks and
balances for savings and loans that more closely parallels that
of commercial banks. There will be no more unfair competition
from insolvent institutions. And that even-handed approach
ultimately is in the best interest of S&Ls, your customers and
all of us as taxpayers.
SOUNDNESS OF THE DEPOSIT INSURANCE FUNDS
Beyond the regulatory reforms that are designed to insure
that massive insolvencies are never allowed to occur again, there
is a fundamental need to put the federal deposit insurance funds
on a sound financial basis. This goal can be accomplished by
reestablishing the basic principle of industry-financed deposit
insurance funds standing between any future industry problems
and the taxpayer.

- 5

The cost of the S&L solution underscores the importance of
requiring all federal deposit funds to be adequately capitalized.
The FDIC insurance fund's reserve-to-insured deposit ratio has
fallen to an estimated all-time low of 0.83 percent. We also
propose increasing commercial bank premiums to bring the FDIC
fund more in line with its historical reserve-to-deposit ratio
also to protect depositors and taxpayers.
You obviously have a number of concerns: first, increasing
your current premium by 2 basis points in 1990 (it drops from 2 3
to 18 basis points in 5 years); second, the increased
requirements for private capital at risk to stand ahead of the
deposit insurance fund; and third, using a portion of future
funds of the Federal Home Loan Bank System to put the S&L system
on a sound footing.
We understand your concerns and we pledge to continue to
work with you, as we have in the past, to address those concerns
where it's possible.
THE FINANCING PLAN
The financing portion of the Administration's plan has three
components. The first $50 billion is to resolve currently
insolvent institutions and any other marginally solvent
institutions that become insolvent over the next several years.
Second, the plan ensures adequate servicing of the $40 billion in
past FSLIC obligations. Third, the plan provides $24 billion for
any insolvencies that may occur between 1992 and 1999.
At the heart of our plan is the creation of a Resolution
Trust Corporation (RTC) to resolve all S&Ls which are now GAAP
insolvent or become so over the next three years. The creation
of this new corporation will allow the isolation and containment
of all insolvent S&Ls during the three-year resolution process.
It will also facilitate a full and precise accounting of all the
funds that are used.
To provide the $50 billion to the RTC, we have asked the
Congress to create a separate corporation, the Resolution Funding
Corporation (REFCORP), which will issue $50 billion in long-term
bonds to raise the needed funds. REFCORP will use S&L industry
funds to purchase zero-coupon, long-term Treasury securities with
a maturity value of $50 billion to assure the repayment of the
principal of the bonds issued by REFCORP.

- 6

Interest payments on the REFCORP bonds will come from a
combination of private and taxpayer sources. All Treasury funds
used to service REFCORP interest will be scored for budget
purposes in the year expended. No S&L insurance premiums will be
used to pay interest on REFCORP borrowings.
Funds for the second component of our plan — servicing the
$40 billion in resolutions already completed by FSLIC — also
will come from a combination of S&L industry and taxpayer
sources.
Funds for the third component of the plan — managing future
S&L insolvencies and building the new Savings Association
Insurance Fund (SAIF) during the post-RTC period — will come
from a portion of the S&Ls' insurance premiums and Treasury funds
as needed. Approximately $33 billion will go to SAIF (with $24
billion for possible future case resolution), demonstrating a
fast funding-up of your new insurance fund and our tangible
commitment to the future of this all-important industry.
CONCLUSION
In conclusion, the Administration's activity of the past few
weeks should illustrate clearly our commitment to a longlasting resolution of the S&L crisis and a commitment to your
industry. In our opinion, we have presented a structurally sound
plan. We have proposed a balanced financing package that
requires contributions from the S&L industry in meaningful
amounts and also lives within the government's means.
For too long we have allowed undercapitalized thrifts to
remain in business, providing government subsidized competition
to healthy financial institutions. The result has been higher
deposit costs, reduced operating margins and declining public
confidence in the thrift system.
The Administration's plan will change this. It will create
a healthy thrift industry by removing the insolvents, reducing
over capacity, reducing deposit costs, and requiring those that
remain to have capital and accounting standards equivalent to
your commercial bank competition. And by requiring that deposit
insurance be fully funded, the plan will reinforce depositor
confidence in the system.
President Bush deserves a great deal of credit for stepping
forward with a plan that will do the job. We appreciate your
support for the plan so far. We believe it deserves your
continued and forthright support. Where we differ on details,
let us continue to work together for the good of the public and
for the S&L industry.

- 7

Now is clearly time for action. I'm here today to ask for
your help. We have moved swiftly to present a credible plan that
will put the S&L crisis behind us and at the same time create a
more stable environment for your business. Congress needs to act
decisively and swiftly. Delay costs you and the American
taxpayers money.
At this moment, we have encouraging signals from the new
leadership of both the House and Senate Banking Committees. The
House Financial Institutions Subcommittee is going to markup the
bill on April 4. The Senate Banking Committee follows the next
week. We must stay on course and maintain a fast track. The
American people deserve nothing less than our best efforts. With
your cooperation, we can move ahead to get this problem behind us
once and for all. Thank you very much.
# # # # #

REPORT O N THE TAXATION OF SOCIAL SECURITY A N D RAILROAD
RETIREMENT BENEFITS IN CALENDAR YEAR 1986

Office of Tax Analysis
U.S. Department of the Treasury
January 1989

THE SECRETARY OF THE TREASURY
WASHINGTON

February 27, 1989

The Honorable Lloyd Bentsen
Chai rman
Committee on Finance
United States Senate
Washington, D.C. 20510
Dear Mr. Chairman:
Section 121 of Public Law 98-21, the Social Security
Amendments of 1983, provides that "the Secretary of the Treasury
shall submit annual reports to the Congress and to the Secretary
of Health and Human Services and the Railroad Retirement Board
on:
(A) the transfers made...-during the year, and
the methodology used in determining the amount
of such transfers and the funds or account to
which made, and
(B) the anticipated operation of this....during the
next five years."
Pursuant to that section, I hereby submit the "Report on
the Taxation of Social Security and Railroad Retirement Benefits
in Calendar Year 1986."
Copies of the report are being sent to Representative
Dan Rostenkowski, Chairman of the Committee on Ways and Means,
Acting Secretary Donald Newman of Health an«i Human Services, and
Chairman Robert Gielow of the Railroad Retirement Board, Chicago,
Illinois.
Sincerely,

Nicholas F. Brady
Enclosure

THE SECRETARY OF THE TREASURY
WASHINGTON

February 27, 1989

The Honorable Dan Rostenkowski
Chai rman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
Section 121 of Public Law 98-21, the Social Security
Amendments of 1983, provides that "the Secretary of the Treasury
shall submit annual reports to the Congress and to the Secretary
of Health and Human Services and the Railroad Retirement Board
on:
(A) the transfers made....during the year, and
the methodology used in determining the amount
of such transfers and the funds or account to
which made, and
(B) the anticipated operation of this....during the
next five years."
Pursuant to that section, I hereby submit the "Report on
the Taxation of Social Security and Railroad Retirement Benefits
in Calendar Year 1986."
Copies of the report are being sent to Senator Lloyd
Bentsen, chairman of the Committee on Finance, Acting Secretary
Donald Newman of Health and Human Services, and Chairman Robert
Gielow of the Railroad Retirement Board, Chicago, Illinois.
Sincerely,

Nicholas F. Brady
Enclosure

TABLE OF CONTENTS
Page
INTRODUCTION AND SUMMARY

I

METHODOLOGY AND ESTIMATES OF BENEFIT
TAXATION FOR THE INITIAL CALENDAR YEAR
1986 TRUST FUND TRANSFERS

2

ADJUSTMENTS TO TRANSFERS FOR ACTUAL
1986 TAX RETURN INFORMATION

6

FORECAST OF TRANSFERS TO TRUST FUNDS
FOR 1987-1991

7

DISTRIBUTION OF TAXABLE BENEFITS
AND TAX LIABILITY ATTRIBUTABLE TO
TAXATION OF BENEFITS

9

LIST OF TABLES
Pace
TABLE I: COMPARISON OF ASSUMPTIONS USED
TO ESTIMATE INITIAL TRANSFERS
FOR CALENDAR YEAR 1986 WITH
ACTUAL RESULTS
TABLE 2: ADJUSTMENTS TO TRUST FUNDS FOR
CALENDAR YEAR 1986 BASED ON
COMPARISON OF THE INITIAL
TRANSFERS WITH ACTUAL
RESULTS
TABLE 3: FORECAST OF THE NET TRANSFERS
FOR CALENDAR YEARS 1987-1991
DUE TO THE SOCIAL SECURITY
AMENDMENTS OF 1983
TABLE 4: DISTRIBUTION OF TAXABLE SOCIAL
SECURITY AND RAILROAD RETIREMENT
BENEFITS AND RESULTING TAX
LIABILITY FOR TAX RETURNS WITH
TAXABLE BENEFITS, BY ADJUSTED
GROSS INCOME CLASS
TABLE 5: DISTRIBUTION OF TAXABLE SOCIAL
SECURITY AND RAILROAD RETIREMENT
BENEFITS AND RESULTING TAX
LIABILITY FOR TAX RETURNS WITH
TAXABLE BENEFITS. BY ADJUSTED
GROSS INCOME PLUS THE UNTAXED
PORTION OF BENEFITS

10

I.

INTRODUCTION A N D

SUMMARY

The Treasury Department annually transfers to the Social Security and
Railroad Retirement trust funds income tax collections derived from (he
taxation of Social Security and Railroad Retirement benefits as required by
the Social Security Amendments of 1983 (P.L. 98-21). The Act required that
beginning in January 1984 Social Security and Tier 1 Railroad Retirement
benefits be partially taxable for high income taxpayers. The Act further
specified that the Treasury Department estimate the tax liability attributable
to these benefits and transfer these amounts to the Federal Old Age and
Survivors Insurance (FOASI). Federal Disability Insurance (FDI), and Railroad
Retirement trust funds. In addition, the Act required adjustments in the
amounts transferred to the trust funds in the event that the estimates of the
tax liability attributable to the benefits, m a d e before the year's tax returns
become available, are subsequently shown to be incorrect. This report meets
the requirement for the transfers of 1986 calendar year tax liabilities. The
1986 tax return data for the required adjustments were obtained in 1988 from
the Internal Revenue Service (IRS). This report also meets a requirement in
the Act that an annual report be made to the Congress on the methodology and
forecasted transfers over the five subsequent years.
The amounts transferred to the Social Security trust funds are calculated
as the difference between tax liabilities with and without the inclusion of
benefits in taxable income for returns with taxable Social Security and Tier I
Railroad Retirement benefits. A taxpayer adds taxable wages, interest.
dividends, and other taxable income to one-half of Social Security and Tier 1
Railroad Retirement benefits plus tax-exempt interest on state and local
obligations to obtain a sum which is compared to certain thresholds. The
threshold for single taxpayers is $25,000 and for joint returns it is $32,000.
A m a x i m u m of 50 percent of the Social Security and Tier 1 Railroad Retirement
benefits are includable in Adjusted Gross Income (AGI) if a taxpayer's income
exceeds the threshold. For taxpayers with incomes slightly above the
threshold amounts or with relatively large Social Security and Tier I Railroad
Retirement benefits, the percentage of such benefits includable in A G I is
often lower than the 50 percent m a x i m u m .
The initial calendar year 1986 transfers of $3,656 million to the trust
funds were $126 million higher than the amount of tax liability calculated
from actual 1986 tax return data. Transfers to the FDI and Railroad
Retirement accounts were initially overstated by $116 million and $39 million.
respectively. These overpayments were partially offset by an underpayment to
the F O A S I account of $29 million. Correcting adjustments were m a d e in the
July 1988 trust fund transfers. Transfers to the trust funds for calendar
years 1987 through 1991. including the adjustment for 1986 and an anticipated
adjustment for 1987. are estimated to be $20,085 million.

-2This report also contains a section which presents the distribution of
beneficiaries w h o include F O A S I . FDI. and Tier I Railroad Retirement benefits
in taxable income. W h e n returns are classified according to A G I . nearly half
of the tax liability attributed to the inclusion of benefits is paid by filers
with A G I less than $50,000. However, the proportion of benefits includable in
A G I varies a m o n g taxpayers, with beneficiaries including an average of
39 percent of benefits in A G I . W h e n the income classifier is expanded to
include the non-taxable portion of benefits, about one-third of the tax
liability resulting from the taxation of benefits is paid by filers with A G I
plus non-taxable benefits of less than $50,000.

II.

M E T H O D O L O G Y A N D ESTIMATES OF BENEFIT
T A X A T I O N F O R T H E INITIAL C A L E N D A R Y E A R
1986 T R U S T F U N D T R A N S F E R S

The Treasury Department's Office of Tax Analysis ( O T A ) has the
responsibility for estimating the tax liability attributable to the Social
Security and Tier I Railroad Retirement benefits received by high-income
beneficiaries. The O T A provides the information to the Treasury Department's
Office of Finance and Planning, which has the authority to transfer funds from
general revenues to the Social Security and Railroad Retirement trust funds.
The OTA estimated the 1986 tax liability effects of the benefit taxation
provision of the Act using the Office's Individual Income Tax Model. The
Individual Income Tax Model contains information from a stratified random
sample of seventy-five thousand tax returns selected from the IRS's Statistics
of Income file, various imputations of data not available from tax returns.
and a tax calculator which computes changes in tax liabilities attributable to
changes in the tax code. Computations based on this model are weighted to
produce results that are representative of the population that filed returns
in the year the sample was selected. The imputations and the tax calculator
are described below, after which the initial 1986 transfers are discussed.
Imputation of data items not available from tax returns was necessary to
make initial revenue estimates of the additional tax liability attributable to
the taxation of Social Security and Tier 1 Railroad Retirement benefits.
First, the Individual Income Tax Model was modified to include data on taxable
pension benefits. For example, total payable benefits, as provided by the
Social Security Administration and the Railroad Retirement Board, was
distributed a m o n g appropriate taxpayers. This distribution was based on the
most recent Current Population Survey data from the Census Bureau. Second, an
imputation was made for tax-exempt interest on state and local obligations
because it is included in the benefit inclusion formula but is not reported in
IRS statistics.

-3Calculation of the tax liability effect of the n e w legislation required
forecasts of 1986 revenue when 1984 tax data were the latest available.
Forecasts of tax effects beyond 1984 required that the data items on the
Individual Income Tax Model be adjusted for three types of growth. First, an
adjustment was m a d e for the forecasted growth in Social Security and Tier I
Railroad Retirement pension benefits provided by the Social Security
Administration and the Railroad Retirement Board.
Second, an adjustment was made to capture the maturing of the beneficiary
population. T h e current structure of the Social Security system ensures that
for the near future n e w beneficiaries subject to tax have both greater
benefits and higher incomes than prior entrants. Finally, the thresholds were
adjusted to reflect the effect of inflation on their real value.
The
thresholds which trigger taxation of Social Security and Tier I Railroad
Retirement benefits are not adjusted for inflation, so the real value of the
thresholds erode with s o m e beneficiaries becoming taxable as inflation raises
their incomes over the thresholds.
These imputations and forecasts are inputs to the tax calculator which
utilizes information from each potential filing unit to calculate each unit's
Federal income tax liability. For purposes of making the initial 1986
transfers, the Individual Income Tax Model was used to estimate 1986 tax
liabilities with and without Social Security and Tier I Railroad Retirement
benefits included in A G I . T h e Tax Model takes account of changes in itemized
deductions which are affected by A G I (e.g.. as A G I increases, it becomes more
difficult to meet the criteria for deducting medical and casualty expenses).
the individual m i n i m u m tax. and the usage of tax credits (the increased
liability resulting from inclusion of Social Security benefits in A G I enables
some taxpayers to use credits which otherwise might not be usable in that
year). T h e Tax Model calculates the percentage of total benefits included in
A G I as a result of the special benefit inclusion formula, and the associated
marginal tax rates.
Estimates of the additional tax liability from the partial taxation of
Social Security benefits for calendar year 1986 were m a d e in late 1985 and
were adjusted as n e w information was obtained. Transfers to the trust funds
on a quarterly basis are authorized by Treasury Department regulations. T h e
amount transferred each quarter equals one-fourth of the estimated change in
calendar year tax liability as a result of the Act (plus adjustments for
prior transfers). T h e transfers required by the Act are allocated to the
following accounts:
Federal Old Age and Survivors Insurance (FOASI)
Federal Disability Insurance (FDI)

-4Railroad Retirement (Tier 1):
- Social Security Equivalent Benefit Account (SSEBA)
- Railroad Retirement Account (RRA)
Since October 1984. the tax attributable to receipt of Tier I Railroad
Retirement benefits has been transferred into two trust funds maintained by
the Railroad Retirement Board. T h e Social Security equivalent benefit account
( S S E B A ) was established in October 1984 by the Railroad Retirement Solvency
Act of 1983. From the S S E B A . the Railroad Retirement Board pays retired rail
workers the amount of Tier 1 Railroad Retirement benefits which is equivalent
to the Social Security benefits they would have received had their service
been covered under the Social Security system rather than the Railroad
Retirement system. T h e tax liability attributable to the Social Security
equivalent benefits is transferred into the S S E B A . The remaining portion of
Tier I benefits is paid from the Railroad Retirement Account ( R R A ) , and
consequently, the tax liability attributable to this portion is transferred
into the R R A .
The Consolidated Budget Reconciliation Act of 1986 (COBRA) modified the
taxation of Tier 1 Railroad Retirement benefits. Social Security equivalent
benefits will continue to be taxed in the same manner as Social Security
benefits, with the tax liability transferable to the S S E B A . However, under
C O B R A , the remaining portion of Tier I benefits was m a d e taxable in the same
manner as private pension benefits beginning with tax year 1986. (Tier 2
Railroad Retirement benefits have been treated for tax purposes as private
pension benefits since 1984.) T h e tax collections from the Tier I n o n - S S E B A
benefits, along with the liabilities attributable to Tier 2 benefits, will
continue to be transferred to the R R A until September 30, 1989. Since C O B R A
was not enacted until April 1986. two transfers had already been m a d e to the
R R A based on the prior law treatment of n o n - S S E B A Tier I benefits. With the
passage of C O B R A , an adjustment was m a d e to the account to correct for the
resulting change in 1986 liability.
For purposes of this report, Tier 1
benefits will henceforth refer only to the S S E B A portion of the Railroad
Retirement benefits.
Table I compares the assumptions used to estimate the initial transfers for
calendar year 1986 with the actual results. T h e top section of the table
indicates that for F O A S I , it was initially assumed that 5.8 percent of the
$177,350 million of benefits paid out in 1986 would be included in A G I at a
marginal tax rate of 32.4 percent, yielding an initial transfer of
$3,353 million. Similar assumptions were used to obtain the initial estimates
of the tax liability associated with Tier 1 Railroad Retirement benefits:
5.6 percent of the $3,781 million paid out in Tier 1 Railroad Retirement

TABLE 1
C O M P A R I S O N O F A S S U M P T I O N S U S E D T O E S T I M A T E INITIAL
T R A N S F E R S F O R C A L E N D A R Y E A R 1986 W I T H A C T U A L R E S U L T S 1
Initial Transfer Assumptions'

Trust Funds

Total Benefits
Paid ($millions)

Benefits Includable
in A G I (%)

Federal Old Age & Survivors Insurance
Federal Disability Insurance
Railroad Retirement Tier I

177,350
19.714
3,781

5.8

Total

200,845

5.6

3.7
5.6

Tax Rate on Benefits Initial Transfers
Includable in A G I (%) ($ millions)
32.4
31.6
32.4

3.353
234
69

32.3

3,656
T^

Actual Results

Trust Funds

Total Benefits
Paid ($millions)

Benefits Includable
in A G I (%)

Federal Old Age & Survivors Insurance
Federal Disability Insurance
Railroad Retirement Tier 1

176,738
19,849
3.781

6.1

200.368

5.7

Total
Department of the Treasury
Office of Tax Analysis

2.6
2.9

Tax Rate on Benefits Initial Transfers
Includable in A G I (%)
($ millions)
31.2
22.6
27.5

3.382

30.8

3.530

118
30

January 10. 1989

Different assumptions were used for each quarterly transfer. This table presents a weighted average of these quarterly transfer
assumptions. Rounding of results may prevent exact matching of totals.
Source: The total benefits paid data were estimates provided by the Social Security Administration and the Railroad Retirement
Board: the other data came from the Individual Income Tax Model of the Office of Tax Analysis
Source: The total benefits paid data are from the Annual Statistical Supplement for 1987 of the Social Security Bulletin the
Social Security Administration and the Railroad Retirement Board: the other data come from t h e l n l e T n a T ^ n T ^ ^ u v ' ,
Individual Master File data.

-6benefits were included in A G I at a 32.4 percent marginal tax rate, yielding a
$69 million transfer. Relative to retirees, recipients of Social Security
disability benefits have lower incomes. As a result, smaller tax parameters
were used in the estimation of the initial transfer of disability benefits:
3.7 percent of the $19,714 million in FDI benefits were included at a
31.6 percent marginal tax rate resulting in a transfer of $234 million. The
actual results are discussed in the following section.

III. ADJUSTMENTS TO TRANSFERS FOR ACTUAL 1986 TAX
RETURN INFORMATION
The Social Security Amendments of 1983 require that transfers made on the
basis of estimates be subsequently adjusted when actual tax return data become
available. T o calculate the additional tax liability for calendar year 1986
resulting from partial taxation of Social Security~and Railroad Retirement
benefits, the IRS created a datafilebased on Form 1040 records. All filers
who report taxable Social Security or Tier I Railroad Retirement benefits on
their Form 1040 are included in this datafile.While the Form 1040 provides
information on the total amount of benefits includable in taxable income, it
does not indicate whether thefilerreceived FOASI, FDI or Tier I Railroad
Retirement benefits. Such information is necessary for the appropriate
allocation of revenues among the trust funds. T o obtain this information, the
Form 1040 records belonging to those beneficiaries w h o report taxable benefits
were matched to the Form 1099 records provided by the Social Security
Administration and the Railroad Retirement Board. (While the actual Forms
1099-SSA do not distinguish between retirement and disability benefits, the
records provided by the Social Security Administration to the IRS do include
the source of benefits.)
The IRS then calculated the number of tax returns with benefits which might
be includable in A G I . the gross dollar amount of benefits ultimately paid to
beneficiaries w h o filed tax returns, the amount of benefits included in A G I .
and the additional taxes resulting from inclusion. Next, total taxable
benefits were subtracted from taxable income, and the tax liability was
recalculated. The difference between thefilers'true tax liabilities and the
reestimated liabilities, when benefits are not included in taxable income.
equals the amount of revenues attributable to the taxation of benefits.
The lower section of Table 1 shows the additional tax liability
attributable to partial inclusion of Social Security and Railroad Retirement
benefits calculated from actual 1986 tax returns. In 1986, the Social
Security Administration and the Railroad Retirement Board paid out
$200,368 million in FOASI, FDI, and Tier I Railroad Retirement benefits. As a
result of the Social Security Amendments of 1983. $1 L47I million in benefits

-7were added to AGI for calendar year 1986. O n average, these benefits were
taxed at a marginal rate of 30.8 percent, yielding $3,530 million in
additional revenues. For all trust funds, initial transfers exceeded actual
receipts by $126 million.
During the previous year, the trust funds returned a total of $12 million
back to general revenues, as a consequence of IRS data on actual 1985 tax
liabilities. However, in 1985. the transfer to the FOASI account was
corrected by an amount nearly equal - but opposite in sign - to the combined
transfers to the FDI. SSEBA. and R R A funds. The 1986 correcting adjustment
to the FOASI account is substantially smaller than the 1985 correction, while
the adjustments for FDI and Tier I Railroad Retirement have not changed
significantly from the previous year.
The 1986 IRS tax return data show that $29 million should be transferred
from general revenues to the FOASI account. Initial estimates of total
benefits paid out in 1986 were in excess of actual benefit expenditures by
$612 million. In addition, the initial estimate of the marginal tax rate
erred on the positive side, by 1.2 percentage points. But. the proportion of
benefits includable in taxable income was initially understated by threetenths of a percentage point, and the total amount of tax liabilities
transferred consequently fell short by $29 million.
As in 1985. the initial assumptions regarding the proportion of FDI and
Railroad Retirement Tier I benefits included in AGI and the applicable
marginal tax rates were too high. In the FDI account, the initial estimates
assumed that 3.7 percent of benefits would be taxable at a marginal tax rate
of 31.6 percent. Instead. 2.6 percent of benefits were taxable at a marginal
tax rate of 22.6 percent. Similarly, the initial estimates for the Tier I
Railroad Retirement benefit accounts overstated the amount of benefits
includable in A G I and the applicable tax rate by 2.7 and 4.9 percentage
points, respectively.
As a result of the reconciliation of estimated and actual 1986 tax
liability, the July I. 1988 transfer included an upward adjustment in the
FOASI account and downward adjustments in the FDI and Railroad Retirement
accounts. These adjustments reflect the changes from the initial transfers
and are presented in Table 2.

IV.

FORECAST OF TRANSFERS T O TRUST FUNDS
F O R 1987-1991

The Social Security Amendments of 1983 required that the annual report
include a forecast of transfers to the trust funds for the next five years.

-8TABLE 2
ADJUSTMENTS TO TRUST FUNDS FOR CALENDAR YEAR 1986 BASED ON
COMPARISON OF THE INITIAL TRANSFERS WITH ACTUAL RESULTS
($ millions)

Trust Funds

Initial Transfers
for Calendar Year

Actual
Results

Change from
Initial
Transfer

Federal Old A g e
& Survivors
Insurance

3.353

3.382

+ 29

Federal Disability
Insurance

234

118

-116

69

30

l52

3.656

3.530

-126

Railroad Retirement
Tier 1
Total

Department of the Treasury
Office of Tax Analysis

January 25. 1989

-9T h e forecast is produced by the O T A using the methodology described in Section
II. Social Security and Railroad Retirement benefit forecasts are obtained
from the respective agencies, and the percent of aggregate retirement benefits
includable in A G I and marginal lax rates are obtained by extrapolating the
Individual Income Tax Model in accordance with the Administration's budget
forecasts.
In addition, the estimates of future transfers reflect the
information obtained from the IRS compulation of marginal tax rates and
benefits includable in A G I reported on tax returns for calendar year 1986.
D o w n w a r d adjustments have been m a d e in the percentages of FDI and Tier I
Railroad Retirement benefits includable in A G I for 1988 through 1991 as a
result of the information from 1986 and prior year tax returns.
The estimated transfers for calendar years 1987-1991. including the 1986
adjustments and anticipated adjustments for 1987. are presented in Table 3.
It is expected that the Act will result in $20,085 million being transferred
to the Social Security and Railroad Retirement trust funds in calendar years
1987-1991. T h e Tax Reform Act of 1986 lowers the tax liability effect of the
Social Security Amendments of 1983. causing approximately a $3 billion decline
over the 1987-1991 period due to decreases in marginal tax rates.

V.

DISTRIBUTION O F T A X A B L E BENEFITS A N D T A X
LIABILITY A T T R I B U T A B L E T O T A X A T I O N O F B E N E F I T S

This section contains an analysis of the distributions of returns with
taxable Social Security and Tier I Railroad Retirement benefits by A G I class.
The analysis is based on the preliminary 1986 Statistics of Income (SOI): a
stratified random sample of approximately 89.000 individual income tax
returns. Weights are applied to individual returns in order to creafe a
representative sample of taxpayers. Because of sampling error, the SOI
provides a less precise measure of taxable benefits than the special IRS data
base containing the universe of recipients with taxable benefits, used in the
calculation of the 1986 tax liability. However, the SOI includes more data
from the Forms 1040, 1040A, and supporting forms and schedules, permitting a
more extensive distributional analysis.
As shown in Table 4. approximately 3.2 million filing units report taxable
benefits. Since each filing unit m a y contain more than one beneficiary, the
number of beneficiaries paying income tax on their benefits cannot be inferred
without making some assumption regarding the number of beneficiaries per
filing unit. Since married couples, filing joint returns, constitute about
two-thirds of this total, it is reasonable to assume that no more than
5.3 million beneficiaries report taxable benefits. In 1986, 38 million
persons received retirement or disability benefits, suggesting that
approximately 8 to 14 percent of beneficiaries paid taxes on their benefits.

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TABLE 4
DISTRIBUTION OF TAXABLE SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS
AND RESULTING TAX LIABILITY FOR TAX RETURNS WITH TAXABLE BENEFITS.
BY ADJUSTED GROSS INCOME CLASS

1

1

1 Amount of |
1 Additional | Tax

Adjusted Gross Income

Returns
With
Taxable
Benefits
(000)

Less than $30,000
$30,000 to $50,000
$50,000 to $100,000
$100,000 to $200,000
Greater than $200,000

594
1,584
769
167
61

15,409
61,467
50,918
22,286
31,262

. 5.392
12,348
7,024
1,921
729

843
4,966
3,512
963
365

16
40
50
50
50

200
1.402
1,270
412
156

24
28
36
43
43

3,175

81,342

27,414

10.649

39

3,441

32

Total

Adjusted |
Gross
|
Income
|
($ millions)!

|

Amount of |
of Total
|
Benefits
|
($ millions)!

Amount of |
Rate
Taxable | Inclusion! Tax
| on Taxable
Benefits | Rate
| Liability | Benefits
($ million)! (percent)! ($ million)! (percent)

Department of the Treasury
Office of Tax Analysis
Source: Preliminary 1986 Statistics of Income and Treasury Individual Tax Model runs.

January 26. 1989

*

-12Table 4 shows that nearly 600.000 filers with taxable benefits or
18 percent of all recipients with taxable benefits have A G I between $20,000
and $30,000. A n additional 1.6 million filers with taxable benefits report
A G I between $30,000 and $50,000. Since the income test for the taxation of
benefits includes tax-exempt interest, it is possible for s o m e taxpayers to be
liable for tax on benefits with A G I significantly below the income thresholds.
However, this number is probably small, with only one percent of beneficiaries
reporting A G I below $20,000. With over half of recipients with taxable
benefits reporting A G I below $50,000. a sizable number of recipients appear to
be close to the income thresholds which determine the amount of taxable
benefits.
Other data in Table 4 confirm this hypothesis. Taxable benefits are
compared to the total benefits received by the filers in order to derive
inclusion rates. O n average, beneficiaries in the taxable range include
39 percent of benefits in A G I . One-third of beneficiaries with taxable
benefits are in the phase-in region for the taxation of benefits. A m o n g these
beneficiaries, the rate of inclusion of benefits is about 25 percent. T h e
other two-thirds of beneficiaries with taxable benefits include the statutory
m a x i m u m 50 percent of benefits in A G I .
In general, taxable Social Security and Railroad Retirement benefits
represent a relatively small proportion of A G I regardless of the proximity of
the beneficiary to the income thresholds. Taxable benefits constitute about
six percent of A G I . with the greater share of taxable income derived from
interest, dividends, capital gains, earnings and pensions. For recipients
with taxable benefits, about half of A G I consists of interest, dividends and
capital gains. T h e importance of labor income in A G I varies according to
marital status, ranging from 7 percent a m o n g singlefilersto 25 percent a m o n g
married filers.
The distribution of returns reporting taxable benefits is classified
according to A G I plus non-taxable benefits in Table 5. As would be expected.
the inclusion of all benefits in the income classifier shifts the distribution
upwards. With A G I only as the classifier,filersin the under $50,000 range
bear 4 7 percent of the tax liability attributable to the inclusion of benefits
in A G I .
With the expanded A G I classifier, this proportion falls to
35 percent. Note that this expanded A G I classifier still excludes certain
income items, such as tax-exempt interest income, which m a y affect the
relative well-being of the high-income elderly.

TABLE 5
DISTRIBUTION OF T A X A B L E SOCIAL SECURITY A N D RAILROAD RETIREMENT BENEFITS
A N D RESULTING T A X LIABILITY FOR T A X RETURNS WITH T A X A B L E BENEFITS.
BY ADJUSTED G R O S S I N C O M E PLUS T H E U N T A X E D PORTION OF BENEFITS

Adjusted Gross Income
Plus The Untaxed
Portion of Benefits
Less than $30,000
$30,000 to $50,000
$50,000 to $100,000
$100,000 to $200,000
Greater than $200,000

Returns
With
Taxable
Benefits
(000)

151
1,755
1,018

180
70

Adjusted |
Gross
|
Income
|
($ millions)!
3,282
61,126
61,170
22,682
33,082

1

1

1

Amount of |
of Total
|
Benefits
|
($ millions)!
. 809
13.741
9.904
1,980

980

1 Amount

Amount of|
|
Inclusion!
Taxable
Rate
|
Benefits
($ million)! (percent)!

1
1

193
4.253
4,721

992
490

24

31
48
50
50

of |
Additional | Tax Rate
Tax
| on Taxable
Liability | Benefits
($ million)! (percent)
45
1,148
1,615

424
209

23

27
34
43
43

i
UJ

1

total

3.175

181,342

27,414

10,649

' 39

Department of the Treasury
Office of Tax Analysis
* Less than $1 million.
Source: Preliminary 1986 Statistics of Income and Treasury Individual Tax Model runs.

3,441

32

January 26, 1989

-14FOOTNOTES
The "Report on the Taxation of Social Security and Railroad Retirement
Benefits in Calendar Year 1985." released in July 1987 by the Office of
Tax Analysis, contains a description of the methodology used to estimate
and adjust transfers of the 1985 tax liability attributable to receipt of
Social Security and Tier 1 Railroad Retirement benefits.
The IRS data are not available until approximately one and one-half years
after the close of the applicable calendar year due to the normal lags in
tax returnfiling,processing, transcription, and analysis.
The OTA does not estimate the liability attributable to the receipt of
Social Security benefits by non-resident aliens. One-half of any Social
Security benefit received by a non-resident alien is subject to a
30 percent tax rate, and this amount is automatically withheld by the
Social Security Administration (SSA).
Each month. S S A sends a
certification of the amount withheld to the Office of Finance and Planning.
and the transfer of the withheld amount from the trust fund to general
revenues and back again to the trust fund is effected. (In practice, the
monies never leave the trust fund.) Since S S A has information on the
actual amounts withheld, the Office of Tax Analysis does not estimate these
withheld amounts.
A detailed description of the Individual Income Tax Model can be found in a
paper by James C. Cilke and Roy A. Wyscarver entitled "The Individual
Income Tax Simulation Model" in the Compendium of Tax Research 1987.
Washington. D . C : Government Printing Office. 1987.
While Form 1040 has a place where taxpayers are asked to list how much
state and local government interest is included in the benefit inclusion
calculation, these numbers were not tabulated by the IRS for tax year 1986.
The IRS will tabulate this item beginning in tax year 1987.
These projections do not include benefits received by non-resident aliens.
No allowance was made for the option to income average. This effect was
judged to be minor and the Committee Report on the Social Security
Amendments of 1983 specifically noted that this effect could be omitted
from consideration if it was thought to be of little consequence: see p. 29
of Senate Report 98-23, Social Security Amendments of 1983. March 11,
1983.

-15-

Durinp thefirsthalf of |Q86. $4 million were transferred to the R R A based
on the p r e - C O B R A treatment of n o n - S S E B A Tier I benefits. After the passage
of C O B R A , this amount was transferred back to general revenues in July
1986. But this negative adjustment was more than offset by a positive
correcting adjustment of $34 million back to the account to reflect the
greater liability resulting from the treatment of n o n - S S E B A benefits as
private pensions. This positive correction also occurred in July 1986.
A comparison of Tables I and 4 show that the SOI underestimates the amount
of taxable benefits by $824 million. T h e 1986 SOI data file used in the
preparation of Tables 4 and 5 is preliminary, and subsequent revisions to
the file m a y reduce this discrepancy. Remaining differences between the
SOI and the special IRS data base reflect sampling error in the former.
The marginal tax rates as estimated by the Individual Tax Model are
slightly larger than those from the special IRS data base, thus reducing
the differences in the computation of the 1986 tax liability.

This study was prepared by Janet Holtzblatt of the Office of Tax Analysis'
Revenue Estimating staff, under the direction of Howard Nester.

TREASURY NEWS

Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
March 15 , 1989

CONTACT:

Lawrence Batdorf
202/566-2041

President's Child Tax Credit Proposals
Under President Bush's Child Care Tax Credit Proposal sent to
Congress today (the "Working Family Child Care Assistance Act of
1989"), low income families containing at least one worker would
be entitled to take a new tax credit of up to $1,000 for each
child under the age of four. For each such child, families could
receive a credit equal to 14 percent of earned income with a
maximum credit equal to $1,000 per child.
Initially, the credit would be reduced by an amount equal to
20 percent of the excess of adjusted gross income or earned income
(which ever is greater) over $8,000. As a result the credit would
not be available to families with adjusted gross income or earned
income greater that $13,000 (13,000-8,000 - 5,000 X .20 - 1,000).
—
Children under the age of four are unlikely to be in
either pre-school or school and their families incur greater cost
for their care than they do for older children.
— The credit would be refundable and be effective for tax
years beginning January 1, 1990.
After 1990, both the starting and end-point of the
phase-out range would be increased by $1,000 increments.
the credit would phase-out between $15,000 and $20,000.
Families would have the option of receiving the refund in
advance through a payment added to their paycheck.
— An estimated 3.5 million families would be eligible for
the credit when it is fully implemented.

In 1994

(2)

A second proposal (also sent to Congress today) would make
the current child and dependent care credit refundable providing a
benefit to about one million additional families with children
under the age of thirteen.
— Taxpayers would continue to claim this credit on their
tax returns in the same manner as they do now. Taxpayers eligible
for both the new child tax credit and the existing child and
dependent care credit would have the option to claim either credit
for each child under the age of four.
— The proposals reflect the President's commitment to
emphasize parental choice in child care and to the special
obligation to first provide additional assistance to families most
in need.
*
—
The Treasury Department estimates the cost of the
proposals to be $187 million for fiscal 1990, increasing to $2.5
billion by fiscal 1993. These amounts are included in the
President's fiscal 1990 budget.

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

For Release Upon Delivery
Expected at 9:00 A.M.
Thursday, March 16, 1989
Statement by the Honorable David C. Mulford
Assistant Secretary of the U.S. Treasury
for International Affairs
before the
Subcommittee on International Finance and Monetary Policy
United States Senate
Mr. Chairman and members of the Subcommittee:
I welcome this opportunity to discuss the two reports
that have been transmitted to your full Committee, the
Administration's review of the international debt strategy, and
our suggestions for strengthening international efforts to
alleviate the debt burden in developing countries.
In mid-December, then President-elect Bush called for a
thorough reassessment of current public policy on this issue.
At that time, the Treasury Department was in the midst of
preparing reports, as required by law, that have had a direct
bearing on the policy recommendations that we have developed.
Therefore, I will open my remarks with a summary and conclusions
of the reports.
International Discussions on an International Debt Management
Authority
Turning to the report on the negotiation of an International
Debt Management Authority, the Treasury Department has reviewed
many international debt facility proposals. Most of these
proposals have several common elements, including a significant,
up-front injection of capital and the assumption of full risk
on principal and interest.

NB-181

- 2 -

As required by the legislation, the report assesses the
use of IMF gold stock and World Bank uncommitted liquid assets
to establish an Authority. With regard to use of IMF gold
stock, the report notes that mobilization of gold for the
Authority could only be accomplished through the sale of gold,
with proceeds made available to the authority. Such sales
would reduce the IMF's basic reserves, which serve as backing
for creditor claims on the IMF. They could have an adverse
impact on gold prices and international gold reserves of the
U.S. and other countries. Since only a small segment of IMF
membership would benefit directly from this use of gold stocks,
it would be extremely difficult to obtain the 85 percent
majority vote necessary to authorize IMF gold sales for the
authority.
The use of World Bank resources to establish such an
authority would also be constrained by financial and legal
obstacles. The Bank's liquid assets are earmarked to fund
contractual lending commitments. These assets afford the Bank
a margin of flexibility in raising funds in the international
capital markets. Pledging Bank assets to a debt authority
could affect the Bank's creditworthiness and increase its cost
of funding. On the legal side, the Bank's Articles of Agreement
do not cover the pledging of liquid assets. Moreover, pledging
of the Bank's assets could raise questions concerning negative
pledge clauses in agreements under which the Bank is the
borrower. Each such clause typically provides that the Bank
cannot pledge its assets to secure its obligations unless the
benefits of the pledge are shared equally by the lenders which
are parties to the agreement.
Our assessment concluded that negotiation of an Authority
could materially increase the likelihood of payment interruptions
and a further decline in secondary market prices. We believe
that the suggested, market-oriented approach outlined by
Secretary Brady on March 10 addresses Congressional concerns
with less risk to taxpayers.
Voluntary debt reduction techniques have been developed by
the commercial banks and debtor countries in response to both
the banks' strategies and goals, and debtor nations' appetite
for capturing the discount on their debt. All of the 15
heavily indebted middle income countries, with the exception of
Colombia, Ivory Coast and Morocco, have participated in
voluntary, market-driven debt reduction operations totaling $28
billion since 1985.
We have concluded after months of study that debt reduction
and debt service reduction can be successfully accomplished in
the market place.

- 3 -

We have reviewed numerous debt facility proposals in
preparing the report at hand and, I would stress, not with
jaundiced eyes but with a fresh view. In the final analysis,
however, we have reaffirmed a market-oriented approach that
would encompass both voluntary reduction in debt and access to
private capital, while minimizing the expense and risk to the
public sector.
The Report on Special Purpose Allocation of SDRs
Pursuant to the 1988 Trade Act, we have studied the
feasibility of a special purpose allocation by the IMF of
Special Drawing Rights (SDRs) to the poorest countries for use
in repaying their debt to foreign governments and international
financial institutions. The report concludes that the use of SDRs
would undermine adjustment incentives, contribute to inflationary
pressures, weaken the liquidity of the SDR and its usefulness
as a monetary asset, and undermine the ability of the United
States to mobilize its SDR holdings.
The report determined that the IMF's Enhanced Structural
Adjustment Facility (ESAF) is a preferred alternative for helping
the poorest countries. It suggests that the Administration's
request for a $150 million contribution to the ESAF represents
a more effective means of providing U.S. support for efforts to
deal with the balance of payments and debt problems of the
poorest countries.
The Report on the World Bank's Strategy in Debtor Countries
I would like to take a moment to review the conclusions of
the report transmitted yesterday to your colleagues in the House
of Representatives. As required by H.R. 4645, we have carefully
reviewed the World Bank's role in debtor countries. In our
judgment, one of the World Bank's most vital functions in these
countries is to promote sound economic reform programs through
its adjustment programs and to catalyze additional financial
support.
In short, after careful study, we have come to conclusions
somewhat parallel to the intent of legislators as expressed in
H.R. 4645.
Additional financial resources and an easing of
debt service burdens can strengthen and sustain debtor nations'
commitment to economic adjustment programs. The report
summarizes our ideas on possible initiatives for voluntary,
market-based debt reduction through use of Bank resources. I
would underscore, at this juncture, that such funds would be
available only for those countries undertaking adjustment
programs, and individual transactions would be negotiated
between debtors and coinmercial creditors.

- 4 -

Strengthening the Debt Strategy
The debt difficulties of developing countries remain a
serious global problem which requires cooperative efforts on the
part of all parties. Following a thorough review of the current
approach by the Administration, Secretary Brady has recently
outlined suggestions for strengthening the international debt
strategy.
Our suggested approach builds upon the basic
principles that have guided international efforts in recent
years. It recognizes the continued vital importance of stronger
growth, debtor reforms, external financial support, and a caseby-case approach to individual nations' problems.
Our suggestions would maintain a central role for the IMF
and World Bank within the debt strategy in encouraging debtor
policy reforms and catalyzing financial support, and recognize
the continuing need for new lending from commercial banks.
However, we would also place stronger emphasis on new investment
flows and the repatriation of flight capital as alternative
sources of private capital. To this end, we would encourage the
IMF and World Bank to work with debtor nations to focus on
specific measures to improve the investment climate and encourage
the return of flight capital as part of their policy-based loan
programs, in addition to vital macroeconomic and structural
reforms.
In addition, we would focus international efforts on
achieving more rapid and broadly based, voluntary debt reduction
during the next three years in order to ease debt burdens and
improve prospects for stronger growth. One of the key factors
at play in determining the extent of voluntary debt reduction
activity is the legal constraints within existing commercial bank
agreements, which must be waived by most or all commercial bank
participants for each individual debt reduction transaction.
Debt/equity swaps and sales in the secondary market are
exceptions, but there is a strong interest within debtor nations
in obtaining more direct benefits from commercial banks'
willingness to reduce their own exposure — as can be obtained
through debt/bond exchanges or cash buybacks.
A waiver of such provisions as sharing and negative pledge
clauses in existing commercial bank loan agreements could go far
to free up market activity in this area, and to accelerate the
pace of debt and debt service reduction with direct benefits to
debtor nations. Such waivers might have a limited life of
perhaps three years, to stimulate activity within a short but
measurable time frame.

- 5 -

In addition, an integral part of the approach would be for
debtor nations engaged in debt reduction to maintain viable
debt/equity swap programs, which have helped to substantially
reduce the stock of debt in several countries. Provisions
which permit domestic nationals to engage in such transactions
can also contribute to the repatriation of flight capital, as
we have seen in the case of Chile.
As debtor nations negotiate policy-based loan programs with
the IMF and the World Bank, a portion of these loans would be
set aside to finance debt reduction transactions negotiated
between the debtor and the banks. Such "set-aside" amounts
would be used to collateralize discounted debt/bond exchange
transactions or to replenish debtor reserves following cash
buybacks.
For debtor nations which have negotiated agreements to
reduce the stock of debt, the IMF and World Bank could also make
available support for interest payments on a rolling basis for
a limited period. Such support could be available for
transactions which involve either a substantial discount of
principal or a major reduction in interest rates.
While the IMF and World Bank would set guidelines on how
their funds are used, the negotiation of transactions would
remain in the market place — encouraged and supported but not
managed by the international institutions.
Such transactions could lead to considerable improvements
in the cash flow positions of the debtor countries, reducing
their need for external financial support to more manageable
levels. Nevertheless, new lending would still be needed — in
addition to efforts to repatriate flight capital and attract
new investment. Such new financing could include a range of
special purpose loans such as trade credits and project loans,
as well as club loans by a group of banks or continued concerted
lending in individual cases.
As part of this approach, creditor governments should also
continue to reschedule or restructure their own exposure through
the Paris Club, and to maintain export credit cover for countries
with sound reform programs. In addition, creditor countries
which are in a position to provide additional financing in
support of this effort may wish to consider doing so. This could
contribute significantly to the overall success of this effort.
We believe that creditor governments should also review their
regulatory, accounting, and tax regimes with a view to removing
impediments to debt reduction, where these exist.

- 6 -

Broad international support is critical to strengthening the
current strategy. It will require cooperative efforts by
creditor and debtor governments, the commercial banking
community, and the international financial institutions. We have
consulted closely with these groups and have sought suggestions
from Members of Congress prior to developing the ideas introduced
last week by Secretary Brady. The Japanese have expressed
their strong support, including a willingness to provide
supportive financing, and a number of other creditor and debtor
nations have made favorable responses to the general approach
we have outlined.
Conclusion
Taken together, the ideas I have discussed today represent
a basis on which we can work together to revitalize the current
debt strategy. We must address key problems — the restoration
of private financial flows, the return flight capital, the need
for sustained economic reforms in many countries, and preservation of the financial soundness of the multilateral institutions
— if we are to renew progress in addressing international debt
problems.
We believe that through the suggestions we have outlined,
including efforts to stimulate broader voluntary debt and debt
service reduction, substantial benefits can be provided for
debtor nations in the form of more manageable debt service
obligations, smaller and more realistic financing needs, stronger
economic growth, and higher standards of living for their people.
I look forward to consultations with members of Congress in
the weeks and months ahead, and ask you for your support as we
develop within the international community a more specific
agenda for further action. Thank you.

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

For Release Upon Delivery
Expected at 11:30 A.M.
March 16, 1989

Statement by the Honorable David C. Mulford
Assistant Secretary of the U.S. Treasury
for International Affairs
before the
Subcommittee on International Development Finance,
Trade and Monetary Policy
U.S. House of Representatives
Mr. Chairman and members of the Subcommittee:
I welcome this opportunity to discuss the three reports
that were transmitted to your full Committee, the Administration's review of the international debt strategy, and our
suggestions for strengthening international efforts to
alleviate the debt burden in developing countries.
In mid-December, then President-elect Bush called for a
thorough reassessment of current public policy on this issue.
At that time, the Treasury Department was in the midst of
preparing reports, as required by law, that have had a direct
bearing on the policy recommendations that we have developed.
Therefore, I will open my remarks with a summary and conclusions
of the reports.
The Report on the World Bank's Strategy in Debtor Countries
As required by H.R. 4645, we have carefully reviewed the
World Bank's role in debtor countries. In our judgment, one
of the World Bank's most vital functions in these countries is
to promote sound economic reform programs through its adjustment
programs and to catalyze additional financial support. Various
Bank programs designed to achieve these twin goals are outlined
in the report.

NB-182

- 2 -

While we call upon the Bank to increase its efforts to
return borrowers to the growth path, we recognize that sustained
growth in many countries has been elusive; aggregate data for 17
heavily indebted nations are included in the report which support
these findings. This is not to say that the "Baker Plan" has
been a failure — far from it. The review of the debt strategy
has reaffirmed the effectiveness of a case-by-case approach which
emphasizes growth and debtor country reform. Highlighted in the
report are achievements of the past four years, including
improved export performance; sustained adjustment efforts of
several major debtors, including Chile, Colombia, Mexico,
Morocco and the Philippines; and declines in the stock of debt
through voluntary, market-based techniques.
However, further progress on adjustment programs will
require the release of additional financial resources as well as
an easing of debt service burdens in order bring about sustained
growth. It is recognized that the debt strategy needs to be
strengthened especially in this area. In addition to new
lending, negotiated reductions in debt and debt service burdens
can provide important external financial support. Other nondebt creating methods, which we continue to strongly advocate,
are direct and portfolio investment, debt/equity swaps, and,
importantly, the return of flight capital.
We strongly believe that the international financial
institutions should retain central roles in the debt work-out
process. This will help win the confidence of the creditor
community, and nurture a market-place where both debt reduction
and new money can be negotiated in parallel.
But we must also
preserve the financial integrity of these institutions, and
minimize risk to creditor governments and taxpayers.
By discussing several of our new ideas for facilitating debt
reduction, the report directly addresses Congressional interest
in expanding the World Bank's role in debt reduction. The report
summarizes our ideas on possible initiatives in this area. I
would underscore, at this juncture, that such funds would be
available only for those countries undertaking adjustment
programs, and individual transactions would be negotiated
between debtors and commercial creditors.
In short, after careful analysis and review, we have come
to conclusions somewhat parallel to the intent of legislators as
expressed in H.R. 4645. Additional financial resources and an
easing of debt service burdens can strengthen and sustain
debtor nations' commitment to economic adjustment programs.

- 3 -

The Report on Special Purpose Allocation of SDRs
Pursuant to the 1988 Trade Act, we have studied the
feasibility of a special purpose allocation by the IMF of
Special Drawing Rights (SDRs) to the poorest countries for use
in repaying their debt to foreign governments and international
financial institutions. The report concludes that the use of
SDRs would undermine adjustment incentives, contribute to
inflationary pressures, weaken the liquidity of the SDR and its
usefulness as a monetary asset, and undermine the ability of
the United States to mobilize its SDR holdings.
The report determined that the IMF's Enhanced Structural
Adjustment Facility (ESAF) is a preferred alternative for helping
the poorest countries. It suggests that the Administration's
request for a $150 million contribution to the ESAF represents
a more effective means of providing U.S. support for efforts to
deal with the balance of payments and debt problems of the
poorest countries.
International Discussions on an International Debt Management
Authority
Turning to the report on the negotiation of an International
Debt Management Authority as required by the 1988 trade
legislation, the Treasury Department has reviewed many international debt facility proposals. Most of these proposals have
several common elements, including a significant, up-front
injection of capital and the assumption of full risk on
principal and interest.
As required by law, we fully examined possible use of IMF
gold stocks or World Bank liquid assets, but determined that
such measures would face significant obstacles. I refer you to
the detailed analysis at the end of the report.
Our assessment concluded that negotiation of an Authority
at this point could materially increase the likelihood of payment
interruptions and a further decline in secondary market prices.
We believe that the suggested, market-oriented approach
outlined by Secretary Brady on March 10 addresses Congressional
concerns with less risk to taxpayers.
Voluntary debt reduction techniques have already been
developed by the commercial banks and debtor countries in
response to both the banks' strategies and goals, and debtor
nations' appetite for capturing the discount on their debt.
Voluntary, market-driven debt reduction operations since 1985
now add up to an estimated $28 billion.

- 4 -

Strengthening the Debt Strategy
The debt difficulties of developing countries remain a
serious global problem which requires cooperative efforts on
the part of all parties. Following a thorough review of the
current approach by the Administration, Secretary Brady has
recently outlined suggestions for strengthening the international
debt strategy.
Our suggested approach builds upon the basic
principles that have guided international efforts in recent
years. It recognizes the continued vital importance of stronger
growth, debtor reforms, external financial support, and a caseby-case approach to individual nations' problems.
Our suggestions would maintain a central role for the IMF
and World Bank within the debt strategy in encouraging debtor
policy reforms and catalyzing financial support, and recognize
the continuing need for new lending from commercial banks.
However, we would also place stronger emphasis on new investment
flows and the repatriation of flight capital as alternative
sources of private capital. To this end, we would encourage the
IMF and World Bank to work with debtor nations to focus on
specific measures to improve the investment climate and encourage
the return of flight capital as part of their policy-based loan
programs, in addition to vital macroeconomic and structural
reforms.
In addition, we would focus international efforts on
achieving more rapid and broadly based, voluntary debt reduction
during the next three years in order to ease debt burdens and
improve prospects for stronger growth. One of the key factors
at play in determining the extent of voluntary debt reduction
activity is the legal constraints within existing commercial bank
agreements, which must be waived by most or all commercial bank
participants for each individual debt reduction transaction.
Debt/equity swaps and sales in the secondary market are
exceptions, but there is a strong interest within debtor nations
in obtaining more direct benefits from commercial banks'
willingness to reduce their own exposure — as can be obtained
through debt/bond exchanges or cash buybacks.
A waiver of such provisions as sharing and negative pledge
clauses in existing commercial bank loan agreements could go far
to free up market activity in this area, and to accelerate the
pace of debt and debt service reduction with direct benefits to
debtor nations. Such waivers might have a limited life of
perhaps three years, to stimulate activity within a short but
measurable time frame.

- 5 -

In addition, an integral part of the approach would be for
debtor nations engaged in debt reduction to maintain viable
debt/equity swap programs, which have helped to substantially
reduce the stock of debt in several countries. Provisions
which permit domestic nationals to engage in such transactions
can also contribute to the repatriation of flight capital, as
we have seen in the case of Chile.
As debtor nations negotiate policy-based loan programs with
the IMF and the World Bank, a portion of these loans would be
set aside to finance debt reduction transactions negotiated
between the debtor and the banks. Such "set-aside" amounts
would be used to collateralize discounted debt/bond exchange
transactions or to replenish debtor reserves following cash
buybacks.
For debtor nations which have negotiated agreements to
reduce the stock of debt, the IMF and World Bank could also make
available support for interest payments on a rolling basis for
a limited period. Such support could be available for
transactions which involve either a substantial discount of
principal or a major reduction in interest rates.
While the IMF and World Bank would set guidelines on how
their funds are used, the negotiation of transactions would
remain in the market place — encouraged and supported but not
managed by the international institutions.
Such transactions could lead to considerable improvements
in the cash flow positions of the debtor countries, reducing
their need for external financial support to more manageable
levels. Nevertheless, new lending would still be needed — in
addition to efforts to repatriate flight capital and attract
new investment. Such new financing could include a range of
special purpose loans such as trade credits and project loans,
as well as club loans by a group of banks or continued concerted
lending in individual cases.
As part of this approach, creditor governments should also
continue to reschedule or restructure their own exposure through
the Paris Club, and to maintain export credit cover for countries
with sound reform programs. In addition, creditor countries
which are in a position to provide additional financing in
support of this effort may wish to consider doing so. This could
contribute significantly to the overall success of this effort.
We believe that creditor governments should also review their
regulatory, accounting, and tax regimes with a view to removing
impediments to debt reduction, where these exist.

- 6 -

Broad international support is critical to strengthening the
current strategy. It will require cooperative efforts by
creditor and debtor governments, the commercial banking
community, and the international financial institutions. We have
consulted closely with these groups and have sought suggestions
from Members of Congress prior to developing the ideas introduced
last week by Secretary Brady. The Japanese have expressed
their strong support, including a willingness to provide
supportive financing, and a number of other creditor and debtor
nations have made favorable responses to the general approach
we have outlined.
Conclusion
Taken together, the ideas I have discussed today represent
a basis on which we can work together to revitalize the current
debt strategy. We must address key problems — the restoration
of private financial flows, the return flight capital, the need
for sustained economic reforms in many countries, and preservation of the financial soundness of the multilateral institutions
— if we are to renew progress in addressing international debt
problems.
We believe that through the suggestions we have outlined,
including efforts to stimulate broader voluntary debt and debt
service reduction, substantial benefits can be provided for
debtor nations in the form of more manageable debt service
obligations, smaller and more realistic financing needs, stronger
economic growth, and higher standards of living for their people.
I look forward to consultations with members of Congress in
the weeks and months ahead, and ask you for your support as we
develop within the international community a more specific
agenda for further action. Thank you.

DEPARTMENT OF THE TREASURY

Interim Report to the Congress
Concerning
International Discussions on an
International Debt Management Authority

March 1989

Interim Report to the Congress
Concerning
International Discussions on an
International Debt Management Authority
*

Legislative Requirements

Section 3111 of the Omnibus Trade and Competitiveness Act
of 1988 (P.L. 100-418) (the Act) requires the Secretary of the
Treasury to study the feasibility and advisability of establishing
an International Debt Management Authority (the Authority) to
purchase and restructure the sovereign debt of less developed
countries. According to the provisions of the Act, in studying
the feasibility and advisability of establishing the Authority,
the Secretary may determine that the initiation of international
discussions on the establishment of the Authority would:

cause a material increase in the discount on sovereign debt,
materially increase the probability of default on such
debt, or
materially enhance the likelihood of debt service disruption.

If such determination is not made, the Secretary must initiate
discussions with those countries he determines to be appropriate
for the purpose of establishing the Authority. The Secretary
must include in interim reports to the Congress an explanation
in detail of the reasons for the determination.

- 2 -

Section 3112 of the Act requires the Secretary of the
Treasury to review all potential resources available to the
International Monetary Fund (IMF) and the World Bank which could
be used to support the creation of the Authority and to direct
the U.S. Executive Directors of the International Monetary Fund
and World Bank to determine the amount of, and alternative
methods by which, the IMF gold stock and World Bank uncommitted
liquid assets could be pledged as collateral to obtain financing
for the Authority.

The Act requires two interim reports on the progress being
made on the study or in international discussions on establishing
an Authority, as well as a final report on the study or discussions
and recommendations. This is the first of the two interim
reports. The second is due on August 23, 1989. The first report
must also include the findings of the U.S. Executive Directors on
the potential use of IMF and World Bank resources to support such
a facility. This report responds to these legislative
requirements.

Debt Strategy Review

The Administration has undertaken a major review of the
international debt strategy. As a part of this review, we have
had discussions on debt problems with the G-7 industrial countries

- 3 as well as with a number of developing countries. Both our
internal review and the international discussions are designed to
consider possible measures to strengthen the current debt
strategy. Our focus has of necessity extended beyond the narrow
parameters of Sections 3111-3113 of the Trade Act. Consequently,
as a part of this review and pursuant to Section 3113 of the Act,
we have approached the IMF and the World Bank to study alternative
ways to deal with international debt problems.

As one element of the broader review, we have looked at a
variety of proposals for an international debt facility, including
the specific proposal included in this legislation. In this
context, we have considered whether an international debt
facility which assumes substantial risk on outstanding commercial
bank debt is necessary or desirable, or whether alternative
measures are available which can encourage greater voluntary debt
reduction without a broad shift in risk to the public sector.

Virtually all debt facility proposals have several elements
in common. Generally, they provide for the new facility to
purchase commercial bank debt paper outright or to swap new
securities issued by the facility for such debt, both at a
discount. Some portion of this discount would be passed on to
the debtor nations. Creditor governments and perhaps the IMF or
the World Bank would back these transactions and assume the risk
on the debt transferred to the Authority. Significant up-front

- 4 costs to the participating creditor governments and international
financial institutions would be involved. These would require
additional budgetary expenses for creditor nations, where budgets
are already constrained. Use of IMF and World Bank resources to
collateralize funding for the Authority will be discussed later
in this report. In addition to bearing the risk on the claims
assumed by the Authority, the creditor governments (and the
international financial institutions) would become contingently
liable for the payment of interest due until the debt is repaid.
If the facility were to issue consols (perpetual debt) to
commercial banks in exchange for their claims, as in some
proposals, the contingent liability for payment of interest to
banks could be permanent.

The potential cost to U.S. and other industrial country
taxpayers could be substantial - there is some $275 billion of
commercial bank debt to the 15 heavily indebted middle income
debtors1 alone.

These proposals inherently shift the risk on developing
country loans from commercial banks to the international financial
institutions or creditor governments as the principal means of
solving international debt problems. Several of the key industrial
countries, moreover, have strongly opposed the concept of an
1

Includes Argentina, Bolivia, Brazil, Chile, Colombia,
Ecuador, Ivory Coast, Mexico, Morocco, Nigeria, Peru,
Philippines, Uruguay, Venezuela, and Yugoslavia.

- 5 international debt facility and such a broad shift in risk to the
public sector.

On the other hand, voluntary debt reduction measures are
already occurring without the need for centralized facilities
that control, manage, and possibly mandate prices for the debt
reduction process. Various voluntary debt reduction
techniques have reduced the external debt of 15 major debtor
countries owed to commercial banks by more than $26 billion
during the past four years. As shown in Table 1, nearly half of
this reduction was from debt/equity swaps ($12.5 billion), to
which we could add $2 billion in repatriation of flight capital
by Chilean nationals for domestic investment purposes. In
addition, commercial banks have undertaken some $7 billion in
private debt restructurings (primarily in Mexico) and nearly $7
billion in other types of swaps, including informal debt
conversions (primarily Brazilian and Argentine) and the 1988
Mexican debt/bond exchange. The vast bulk of these agreements
($26 billion) have been reached in the past two years with more
than $18 billion in 1988 alone. With further encouragement from
the debtor countries, the industrial countries, and the
international financial institutions, the commercial banks would
probably increase their participation in debt sales and debt
conversions, as well as in other voluntary debt reduction
II
techniques. There are a number of factors encouraging commercial

- 6 banks to move in this direction. These factors are discussed in
more detail below.

Table 1
Debt Reduction by Category
1985 - 1988
Debt/Equity Swaps

$12.5 bn

Private Debt Restructuring

7.0 bn

Repatriation of Flight Capital
via Swaps (Chile)

2.1 bn

Informal Debt Conversions

5.0 bn

Debt/Bond Swap (Mexico)

1.1 bn

Cash Buybacks (Bolivia and Chile)

0.6 bn

TOTAL

$28.3 bn

Treasury Estimates.

Secretary of the Treasury Nicholas F. Brady recently
suggested a new approach to revitalize the current international
debt strategy, which if pursued could provide substantial
benefits for the debtor nations through lower levels of debt,
more manageable debt service obligations, smaller and more
realistic financing needs, stronger economic growth, and higher
standards of living in debtor nations. It is envisioned that
this new approach would catalyze new opportunities for voluntary,
market-based transactions and would better tap the potential for
alternative sources of private capital. Several of these

- 7 potential benefits have also been put forth as justification for
the establishment of an international debt facility. However,
unlike in the case of a debt facility, this suggested approach
would (1) minimize the cost or contingent shift in risk to
creditor governments, (2) avoid mandatory prices for debt
exchanges (with prices pre-set by the facility), and (3) maintain
a market-oriented approach to debt restructurings.

This new approach: (1) builds upon the fundamental principles
of the current debt strategy; (2) focuses international efforts
on achieving more rapid and broadly based, voluntary debt
reduction to ease debt burdens and improve prospects for strong
growth; (3) recognizes the continuing need for new lending from the
commercial banks in conjunction with voluntary debt reduction,
while placing stronger emphasis on new investment flows and the
repatriation of flight capital; (4) maintains a central role for
the IMF and the World Bank within the debt strategy in encouraging
debtor policy reforms and catalyzing financial support; and (5)
redirects and increases available IMF and World Bank resources —
from their current capital stock — to support debt and debt
service reduction transactions agreed upon by the commercial
banks and debtor nations as an additional spur to growth in the
debtor nations.

Consequently, in the light of ongoing discussions and these
ideas recently put forward by Treasury Secretary Brady on

- 8 measures to strengthen the current international debt strategy,
we do not believe that it is appropriate to begin formal
negotiations concerning the Authority at this point. Our
suggestions can produce substantial results in terms of debt and
debt service reduction with less shift in risk to the public
sector. Furthermore, it is the determination of the Secretary of
the Treasury that such negotiations in the current atmosphere
could materially depress secondary market prices and materially
enhance the likelihood of debt service disruption. Indeed, past
discussions of such facility proposals have contributed to
domestic pressures to restrict debt/equity swap programs, which,
in turn, have had a negative impact on secondary market prices.
Considerations underlying this determination are discussed in
detail below.

Secondary Market Prices

Prices in the secondary market are influenced by market-wide
demand and supply conditions, country-specific developments, and
general expectations regarding future developments. Short-term
factors are clearly more dominant in determining secondary market
prices than the prospects over time for individual nations to
return to voluntary access to markets. This is due in major part
to the lack of long-term demand for these claims. Moreover,
there is a tendency for transaction prices for all of these
countries to be affected by significant developments in one or

- 9 more individual countries, with insufficient market differentiation
among individual countries. Chilean debt prices, therefore, can
be adversely affected by Brazilian or Venezuelan actions which
depress prices for external debt owed by these countries.

Estimates of the size of the secondary market in 1988 range
from $15 to $40 billion, depending upon the nature of transactions
being measured. Because of the nature of the market (a series of
individual transactions undertaken by a variety of players with
no central "market"), data on specific and aggregate transactions
are not readily available. Transactions in some countries' debt
paper can be rather infrequent, and as in the case of any "thin"
market, the quoted price is not generally an appropriate indicator
of the underlying value of the paper or even the price at which
it will be sold. Quoted prices for a country's debt are for the
debt paper most frequently traded, and this varies from country
to country. Since the debt paper of a single debtor country is
heterogeneous — different spreads, interest rate basis, and so
forth — multiple prices for a country's debt may prevail. The
average discount of 30 percent at which Mexican debt was
voluntarily exchanged for new 20-year bonds last spring was
substantially lower than the 50 percent discount prevailing in
the secondary market for Mexican paper at that time.

Demand for debt in this market arises predominantly from
debt-for-debt swaps, cash sales, and direct debt conversions into

- 10 alternative instruments. Debt-for-debt swaps usually involve banks
exchanging claims on one country for claims on another, although
they may also involve exchanges of debt owed by different parties
within the same country. These transactions may account for as
much as 75 percent of secondary market activity, according to
some analysts. Generally these exchanges are undertaken for
portfolio or strategic reasons specific to a given bank or banks'
situations: These may include a desire to concentrate holdings
in countries where the bank has strategic business interests, or
to diversify holdings to spread risk.

Cash sales by banks, on the other hand, are primarily
designed to reduce or exit from LDC exposure as a means of
boosting stock values and the ability to raise capital. Such
sales may be made: (1) to financial institutions accumulating
paper for package swaps; (2) to corporations for direct investment
through debt/equity swaps; or (3) to charitable or academic
institutions for environment, education or development swaps.
None of these produce a direct benefit to the debtor nations,
unless they end up as debt/equity swaps.

On the other hand, sales of debt to a debtor nation through
direct cash buybacks reduce directly its outstanding indebtedness
and debt service obligations. In spite of these advantages and
their having been successfully used recently, for example, by
both Bolivia and Chile, their adoption is generally hampered by

-lithe need to get waivers from the commercial banks of the sharing
clauses existing in most bank loan agreements, and this can be
time consuming.

Banks also engage in direct debt/equity swaps for their own
account, as well as other debt conversions such as the 1988 Mexican
debt/bond exchange and Brazilian exit bonds. These instruments
all convert commercial bank claims into alternative financial
instruments and may involve a reduction in principal amount, a
reduction in interest rates, and/or a more marketable claim.
Banks may or may not continue to include these new instruments
in the calculation of their LDC loan exposure.

Secondary markets for cash sales remain fairly thin,
although the volume of transactions has been growing. Prices
quoted reflect the most recent transactions rather than a
homogeneous, highly liquid market. The final demand for debt
paper, other than by commercial banks, however, appears to be
primarily debt/equity swaps, underscoring the importance of
debt/equity programs as a key factor in determining secondary
market prices. The debtor countries themselves would be the most
natural purchasers of the debt held by the commercial banks, but
again, as mentioned above, they are restricted in implementing
such buyback schemes by the obligation to get a waiver of the
%haring clause in the bank loan agreements. Speculative demand
appears to be quite narrow, perhaps in part because banks prefer

- 12 to "sell" debt paper to (1) other financial institutions willing
to assume any new money obligations coincident to the loans, or
(2) entities anticipating specific conversions (into equity,
environmental use) which may have been agreed in advance of the
transaction.

Over the last two years, secondary market prices have
fallen sharply. As illustrated in the accompanying chart, the
weighted average price for commercial bank debt of the 15 major
debtors was 68 cents per dollar of face amount in January 1987,
while in January 1989, it was only 36 cents: a decline of 47
percent. As of the first of February 1989, the average price
for individual country debt varied from 4 cents for Peru, the
lowest price among the 15 major debtors, to 60 cents for Chile, the
highest. Of the largest debtors, Mexican paper was trading at 37
cents on the dollar, during the first week in February; Brazilian
paper, at 33 cents; and Argentine paper at 18 cents on the
dollar. Secondary market prices for the 15 major debtors over the
last two years are given in Table 2.

- 13 Table 2
Secondary Market Prices for the 15
Major Debtors' Bank Debt
(Selected Dates and in Cents per Dollar)

1987

1989

1988

Feb

Dec

Mar

Aug

Jan

Feb

Argentina
Bolivia
Brazil
Chile
Colombia

65.0
9.0
69.0
68.0
86.0

33.5
11.0
46.0
61.0
65.0

28.0
11.0
47.0
57.0
65.0

21.8
10.0
46.3
59.5
66.5

19.5
10.0
34.0
60.0
56.0

18.3
9.0
29.3
58.5
51.0

Ecuador
Ivory Coast
Mexico
Morocco
Nigeria

.64.0
77.0
57.0
69.0
36.0

36.5
40.0
50.0
52.0
29.0

31.5
30.0
48.5
50.0
28.5

21.0
26.5
46.8
50.0
27.0

12.5
19.0
38.3
47.0
19.0

12.5
15.0
35.8
46.5
21.0

Peru
Philippines
Uruguay
Venezuela
Yugoslavia

18.0
70.5
71.0
75.0
78.0

7.0
50.0
59.0
57.0
49.0

5.0
50.5
59.5
53.3
46.5

5.0
52.5
60.0
50.0
47.0

5.0
46.3
59.5
37.8
44.0

4.0
41.8
59.5
34.3
44.0

Weighted Average

64.5

46.6

45.0

43.4

35.2

32.3

Country

Source:

Salomon Brothers.

As indicated in the chart, there were two major declines in
secondary market prices. The first decline of 32 percentage
points largely reflected the impact of the Brazilian moratorium
and substantial reserving by U.S. money center banks in -early to
mid-1987.

- 14 Provisioning has been instrumental in determining the banks'
willingness to supply claims to the secondary market, in addition
to other factors such as portfolio considerations and long-term
business interests. The market discount, tax treatment,
regulatory requirements, capital adequacy concerns, and accounting
practices are also important. Citibank began this first wave of
provisioning on May 19, 1987 when it announced that it was
transferring $3 billion to its reserves for possible credit
losses. This action raised its reserves to 25 percent of its
exposure to heavily indebted developing countries. The remaining
money center banks and some regional banks chose to follow
Citibank's lead and soon built reserves up to an average of 25
percent of LDC exposure.

Smaller banks in Europe and the Middle East, according to IMF
estimates, were the major suppliers of debt to the market prior
to the mid-1987 increase in provisioning by major U.S. money
center banks, followed by additional provisioning by Canadian,
British, and Japanese banks, as well. British authorities
released guidance in August 1987 on reserving against LDC claims.
On December 17, 1987, the Bank of Boston signaled a second wave
of provisioning by the regional banks by increasing its loan loss
reserves by 54 percent. In the third quarter of 1988 the
Canadian authorities issued requirements that Canadian banks
should increase their provisioning against LDC claims from 15
percent to a range of 30 - 4 0 percent.

- 15 -

The second major decline in secondary market prices occurred
from mid- to late 1988. Declines of over 20 percent were
registered in the prices of debt of Brazil, Venezuela, Ecuador,
the Ivory Coast and Nigeria. Declines of 10-20 percent were
registered in the prices of debts of Argentina, Colombia, Mexico
and the Philippines. Market participants have suggested that
this decline was generated by adverse market psychology fueled,
in part, by the impression that investment opportunities in the
debtor countries were narrowing and, in part, by the regional
banks selling off claims to clear their books of LDC debt by the
end of the year. Canadian provisioning requirements may also
have increased the supply of Canadian paper for sale. Moreover,
a number of country-specific developments reflected either
worsening domestic economic situations or increased rhetorical
stridency within some of the key debtors which appear to have had
a dramatic impact on secondary market prices. In particular,
news of possible debt service suspensions, as well as heightened
publicity on establishing debt facilities in the latter part of
1988, also contributed to the downward pressures on prices.

Given the importance of debt/equity swaps (and less
significant so far, other debt conversions), any disruptions in
the operation of debt/equity programs can have a major impact on
the demand for debt in the secondary market, and hence on secondary
market prices. Mexico's temporary suspension of its debt/equity

- 16 swap program in early November 1987 caused the prices of its
debt to drop only slightly, because demand for Mexican debt for
purposes other than conversion into equity remained strong
according to some market traders. However, Brazil's suspension
of its debt/equity program in January 1989 may have contributed
to a drop of more than 5 cents in its secondary market price.

Debt Service Disruptions

Interest or principal arrears by debtor countries can also
disrupt the market, since non-payment of debt service on
outstanding claims could increase the risk of holding them.
Holders of these claims have the choice of either selling them
immediately for whatever price possible or taking a further
reduction in earnings.

The last few years offer numerous examples of debt service
disruptions and associated accumulations in arrears.

Peru began limiting public external debt service payments to
10 percent of export revenues in July 1985. Since this ceiling
was imposed, Peru's external payments arrears have accumulated to
almost $10 billion, equivalent to over half of its current debt.
More recently, Ecuador imposed a moratorium on interest payments
to the commercial banks in January 1987. As a result, arrears

- 17 began to accumulate and have grown to approximately $1 billion in
two years.

In February 1987, Brazilian authorities announced a
moratorium on interest payments for medium-term bank claims.
This moratorium generated some $4 billion in interest arrears
during 1988, but was formally terminated in December 1988 with the
conclusion of a new financing package with commercial banks. The
new package included commitments for a broader debt/equity
program (cited above) and had a positive impact on secondary
market prices.

In January 1989 Venezuela decided to halt principal
repayments to commercial banks to conserve reserves, pending
negotiations to reopen the 1987 commercial bank rescheduling.
Because of the size of their debt, both the Brazilian and
Venezuelan actions further reduced secondary market values for
their debt and depressed the market for Latin American debt in
general.

On the positive side, Chile has maintained an open, flexible
debt conversion program, implemented far reaching economic
reforms and reduced inflation to nearly 10% per year, one of the
lowest inflation rates in Latin America. Consequently, the
Secondary market for its debt remains comparatively active at
prices that are the highest of the major debtors.

- 18 -

In addition to these countries' specific activities, broader
consideration and pressures for an international debt facility
have also contributed to expectations of across-the-board debt
relief and debtor actions to restrict debt/equity programs in the
hope of obtaining larger scale relief without such conversions.
Discussion of a series of proposals during mid to late 1988 has fed
these expectations. These include, in particular, congressional
discussions of debt facility proposals as part of deliberations
on the Omnibus Trade and Competitiveness Act of 1988.

It has been one of the proposals actively considered by the
Latin American Group of Eight2 (G-8) which met in Punta del Este
in October 1988, in part, to consider alternatives for resolving
the region's debt problems. In subsequent meetings, the G-8
nations specified that a multilateral debt facility was one
possible mechanism through which their objectives could be
achieved.

Such discussions of the potential for an international debt
facility were not the only factor affecting secondary market
prices during the summer of 1988. However, when combined with
the strong rhetoric warning of possible suspension of debt
service in the absence of generalized debt relief and actual
2

Members are Argentina, Brazil, Colombia, Mexico, Peru,
Uruguay, and Venezuela. Panama was originally part of the group
but has been excluded due to domestic political circumstances.

- 19 suspensions of Venezuelan debt service and Brazilian debt/equity
and relending programs, they clearly had a depressing effect on
secondary market prices.

In sum, it is our view that the best way to respond to the
concerns of Congress as reflected in this legislation and to
accomplish the objectives of reducing debt and debt service
burdens is through the approach recently suggested by the Secretary
of the Treasury to revitalize the current debt strategy.

Potential Resources to Support an Authority

Section 3112 of the Act provides that no "funds,
appropriations, contributions, callable capital, financial
guarantee, or any other financial support, or obligation, or
contingent support of the United State Government may be used for
the creation, operation, or support of the International Debt
Management Authority" without the express approval of Congress
through subsequent law. The Section directs-the Secretary of the
Treasury to review all potential resources available to the
multilateral financial institutions, particularly the IMF and
World Bank, which could be used to support the creation of such a
facility. As required by legislation, the U.S. Executive
Directors of the IMF and the World Bank have reviewed the amounts
of, and alternative methods by which, the IMF gold stock and
World Bank uncommitted liquid assets could be used to support the

- 20 creation of the Authority, and alternative methods for their use.
Their findings are summarized below.

Use of IMF Gold

Section 3112(a)(1) of the Act provides for a determination
of the amount of, and alternative methods by which, the gold
stock of the (IMF) could be pledged as collateral to obtain
financing for the Authority. Such use of IMF gold raises a
number of important legal, financial and policy issues which
require careful consideration in making such a determination.

The IMF owns 103 million ounces of gold with a book value of
SDR 3.6 billion (about $4.8 billion at end February 1989 exchange
rates) and a current market value of roughly $40 billion. The
gold represents the IMF's basic reserve and, together with other
IMF assets, is available to satisfy creditors' claims on the
Fund. In addition, the IMF can mobilize its gold assets to help
achieve the purposes of the IMF as specified in its Articles of
Agreement.

In this connection, the IMF may sell gold either at market
prices, to members or the private market, or at book value (SDR
35 per fine troy ounce) to countries that were members on August
31, 1975, in proportion to their IMF quotas on that date. The
proceeds from such sales can be used for regular IMF operations

- 21 (and thus is an alternative to an increase in quota subscriptions
or borrowing) or to provide balance of payments assistance on
special terms to developing countries in difficult circumstances.

The IMF Articles of Agreement do not permit the use of the
Fund's gold as collateral for financing by a debt management
authority that would be a separate legal entity independent from
the IMF. Moreover, the IMF could not borrow from members or the
private market using gold as collateral and provide the resources
to the Authority. However, the IMF could sell gold at market
related prices, with the profits made available to a debt
management authority whose purposes were determined to be
consistent with and supportive of those of the Fund.

A decision to sell or otherwise mobilize IMF gold requires
an 85-percent majority vote of the IMF's Executive Board.
Subsequent decisions on use of the proceeds require a 70-percent
majority vote for regular IMF operations and an 85-percent
majority for all other purposes. Moreover, under Section 5 of
the Bretton Woods Agreements Act (22 U.S.C. 286c), congressional
authorization would be required for the United States to support
a decision to use IMF resources, including gold, for the special
benefit of a segment of the IMF membership.

The provisions on mobilization of IMF gold became effective
in 1978 as part of the amendment of the IMF's Articles of

- 22 Agreement. These provisions reflected an agreement which
carefully balanced diverse and strongly-held views about the
proper role of gold in the international monetary system, the
desirability of retaining gold as a sort of ultimate IMF reserve,
and the distribution of the proceeds of any IMF gold sales. The
increase in the voting majority on key gold-related decisions
from 70 to 85 percent was designed to assure a broad consensus
and, in particular, to provide the United States, the largest
member with about 20 percent of the total voting power, a veto
over such decisions.

The IMF sold 50 million ounces of gold during 1976-1980 as
part of the agreement on the amendments to the Articles of
Agreement. However, no action has been taken to mobilize the
Fund's gold since the late 1970s despite several proposals to use
the gold to back a dollar substitution account and as an
alternative to the 1983 increase in IMF quotas. This situation
reflects the continued wide divergence of view on the appropriate
use of IMF gold among IMF members and the difficulty of obtaining
the 85-percent majority vote for gold-related decisions.

A decision to sell IMF gold and use the profits to support a
debt management authority would reduce the resources potentially
available for the IMF traditional balance of payment financing
responsibilities and could accelerate the need for a quota increase
and/or new IMF borrowing. At present, the IMF's financial

- 23 position is relatively strong with some $45 billion in liquid
assets available for lending. However, this situation can change
rapidly as occurred in the late 1970s and early 1980s. The
ability of the IMF to sell gold to replenish its currency
holdings provides a necessary safety net to deal with unforseen
contingencies. The use of the gold for a debt management
authority could necessitate earlier and larger resource additions.

A contingency that is of particular concern to the United
States and other creditors relates to the role of the Fund's gold
as backing for creditors' claims on the IMF. These claims arise
from use of members' quota subscriptions and from loans by
members to the Fund. They are considered liquid reserve assets
by the member and may be used automatically, and on short notice,
to acquire currencies from the IMF to meet a balance of payments
need.

In the event creditors sought to encash their claims to meet
balance of payments financing needs, and the IMF's available
usable currency resources proved inadequate, the Fund would be
able as a last resort to mobilize the gold to acquire the
necessary currencies. Moreover, the creditors would have first
claim on the gold should other resources be insufficient. A
decision to sell IMF gold to support a debt management authority
T/ould compromise the ultimate security of creditor claims and
thus the liquidity and monetary character of IMF related reserve

- 24 assets. Therefore, creditors have strongly opposed use of IMF
gold to expand IMF financing and are likely to resist use of the
Fund's gold for a debt management authority. Indeed, some
creditors have indicated that they would consider seeking early
repayment of loans to the IMF in the event that the IMF's gold
reserves were reduced.

Creditor claims on the IMF currently total about SDR 28
billion (at end-1988). The United States is the IMF's single
largest creditor with reserve claims of roughly SDR 7.2 billion,
approximately 25 percent of the total. The U.S. reserve position
in the IMF also accounts for more than one-quarter of total U.S.
foreign exchange reserves.

Similarly, the use of IMF gold for a debt management authority
would benefit a minority of the Fund membership (for example, 39
of the 151 IMF members have restructured commercial bank debt).
Other members, particularly the poorest countries, can be
expected to oppose use of IMF gold for this purpose. At a
minimum, these countries can be expected to press for concessions,
either in terms of use of gold for them or measures to expand and
ease the conditions on IMF financing to deal with their problems.
This could result in actions that would hasten the need for a
quota increase and/or measures that would weaken the monetary
character of the institution.

- 25 As noted above, IMF support for the Authority would probably
require the sale of the Fund's gold and use of the proceeds in
excess of book value for the authority. Sale of the entire 103
million ounces at current market prices (about $400 per ounce)
would result in profits of about $36 billion, or 15 percent of
the total commercial bank debt of the middle-income debtors.

However, it is unlikely that profits of this magnitude could
be realized. The gold markets are thin and volatile, and the IMF
would not be able to sell 103 million ounces without depressing
the gold price, perhaps drastically. In recent years, for
example, the annual supply of gold from mine production reaching
the market has amounted to about 50 million ounces, less than 45
percent of the total IMF gold stock. The previous IMF market
sales of 25 million ounces of gold were stretched over 4 years,
1976-1980, in an attempt to avoid market disruption.
Nevertheless, the price dropped by about one-third during the
year following the decision to sell gold as the market positioned
itself to absorb the new supplies. The United States is a major
gold holder, with about 260 million ounces ($104 billion at
current market prices), and a drop in gold prices would reduce
the value of these holdings as well as impact adversely on
domestic gold producers.

In conclusion, while use of IMF gold to support the purposes
of the Authority is possible under the Fund's Articles of

- 26 Agreement, such action could pose serious risks to the IMF's
financial integrity and is likely to be strongly opposed by many
members. It is therefore extremely unlikely that the necessary
85-percent majority vote could be obtained for this purpose.

World Bank Liquid Resources

Section 3112(a)(2) of the Act provides for a determination of
the amount of, and alternative methods by which, liquid assets
controlled by the World Bank, and not currently committed to any
loan program could be pledged for obtaining financing for an
international debt management authority. It is our determination
that there are significant financial and legal obstacles to such
use of the Bank's liquid assets.

As of end December, 1988 the Bank's liquid assets (cash and
short-term investments) amounted to $19.4 billion equivalent.
The principal reason why the Bank holds these investments is to
fund contractual lending commitments. Unlike commercial banks,
the Bank typically disburses its loans over several years, so
that at any point in time there is a substantial overhang of loan
commitments which have been legally contracted but not yet
disbursed. This overhang, the Bank's undisbursed loan balance,
amounted to $43.1 billion at end December, 1988. Other contractual
obligations — for borrowers to repay the Bank and for the Bank
to repay its own borrowings — roughly balance each other. Thus

- 27 the Bank's $19.4 billion in investments are in effect already
committed to contracted but undisbursed loans of over $43
billion, of which approximately $12 to $13 billion is projected
to be disbursed annually over the next few years. Consequently,
the Bank's liquid assets represent no more than a partial advance
funding of these contracted loan commitments.

A related aspect of the Bank's level of investments is the
flexibility it affords to the Bank in its funding strategy, which
is heavily dependent upon borrowings in the international capital
markets. That the Bank has this margin of flexibility in its
need to borrow is perceived as an important element of strength
by the financial markets and has been explicitly noted as such by
the bond rating agencies. If a portion of those liquid assets
were pledged to some other purpose, in connection with the credit
enhancement of commercial bank loans, the financial markets and
rating agencies would take note of the pledge and reassess the
Bank's financial standing accordingly. Since the debt facility
would certainly be viewed by the markets as a risky undertaking,
the perceived value of the pledged assets and the Bank's
creditworthiness would suffer.

Finally, the Articles of Agreement of the Bank specifically
authorize the Bank to extend loans and guarantees but do not
mention the pledging of the Bank's liquid assets. There are thus

- 28 legal questions about the Bank's authority to enter into such a
pledge transaction.

Pledges of the Bank's liquid assets could also raise
questions concerning the Bank's negative pledge made in connection
with its market borrowings. The Bank invariably undertakes, in
support of its bond issues and other funding transactions, that
it will not cause or permit to be created on its assets any
mortgage, pledge, or other lien as security for bonds, notes, or
other evidences of indebtedness which have been issued or
guaranteed by the Bank unless the transactions containing this
undertaking receives similar security. In other words, the Bank
cannot pledge its assets (liquid or otherwise) to secure specific
Bank obligations unless the benefits of the pledges are shared
equally by the holders of all Bank debt containing a negative
pledge clause.

S E C O N D A R Y MARKET PRICES
In Cents per $1 Face Value

J F M A M J J A S O N D J
1987 1988 1989
Weighted Average for 15 major debtors
Source: Salomon Brothers

F M A M J J A S O N D J

DEPARTMENT OF THE TREASURY

First Report to the Congress
Concerning
World Bank Strategy and Lending Programs
in Debtor Countries

March 1989

DEPARTMENT OF THE TREASURY

First Report to the Congress
Concerning
World Bank Strategy and Lending Programs
in Debtor Countries

March 1989

TABLE OF CONTENTS

Page
SECTION ONE: Introduction 1
SECTION TWO: The World Bank's Role under the 3
Current Strategy
SECTION THREE: Progress and Recent Developments 12
SECTION FOUR:

Suggestions for Strengthening
the Current Approach

23

First Report to the Congress Concerning
World Bank Strategy in Debtor Countries
SECTION ONE: Legislative Requirements

This report responds to the legislative requirement in H.R.
4645, Section 3(d)1 that the Secretary of the Treasury prepare
a report addressing World Bank strategy and lending programs in
debtor countries. The legislation reflects Congressional
interest in developing a stronger role for the World Bank in
supporting debt reduction — particularly through the use of
policy-based lending to facilitate debt service reduction and
through World Bank partial guarantees on debt service payments
in financing packages involving significant debt reduction.

Section II of this report examines the current role of the
World Bank in the international debt strategy. It describes
the World Bank's strategy and lending programs in the "Highly
Indebted Countries"2, as well as in the seriously indebted
countries of Sub-Saharan Africa. It spells out the Bank's
focus on promoting structural reforms in developing countries
to facilitate long-term growth and to ease the burden of debt
on these economies.
1

As enacted into law by Section 555 of the Foreign
Operations, Export Financing, and Related Programs Appropriations
Act, 1989 (P.L. 100-461).
2
The World Bank identifies the following as "Highly
Indebted Countries:" Argentina, Bolivia, Brazil, Chile,
Colombia, Costa Rica, Cote d'lvoire, Ecuador, Jamaica, Mexico,
Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, and
Yugoslavia.

2
Section III surveys progress made by debtor countries and
recent developments in the market vis-a-vis debt reduction.
The experiences of debtor countries in implementing adjustment
programs and pursuing long-term growth are examined in aggregate
and as individual country examples. Further, the report
discusses countries' efforts to reduce their debt through
market mechanisms and highlights the World Bank's role in
facilitating these and other negotiations between debtors and
their commercial bank creditors.

The final section of the report summarizes U.S. suggestions
for strengthening the current strategy. The new ideas discussed
include a greater role for the World Bank in facilitating debt
reduction.

SECTION II: The World Bank's Role under the Current Strategy

The debt problems encountered by developing countries in
the 1980s have to some extent disrupted the World Bank's efforts
to promote development and alleviate poverty in these countries.
The international strategy for addressing debt problems has
assigned the World Bank an important role in assisting developing
countries to undertake programs that will facilitate growth and
ease the burden of their debt. The Bank cooperates extensively
with the International Monetary Fund to advise countries on
policies aimed at both macroeconomic stability and structural
reform. Both these institutions are crucial actors in the debt

3
workout process. However, this report will focus exclusively
on the World Bank's role.

The Bank's Strategy in the Highly Indebted Countries

The strengthened debt strategy set out in 1985 focused on
the need for debtor countries to achieve stronger, sustained
growth through comprehensive macroeconomic and structural
reforms. The World Bank's long-term strategy for helping the
Highly Indebted Countries manage and reduce their debt burden is
based on such growth-led recovery.

The Bank's lending programs in each of these countries are
designed to facilitate — through a variety of economic
forces — renewed growth that will gradually reduce debt ratios
and lead over time to restored access to financing from private
markets. The success of such efforts by the Bank rests in
large measure on individual debtor countries' own ability and
willingness to implement adjustment programs, as well as the
availability of additional financial resources or other financial
support for adjustment.

The Bank promotes economic reforms in debtor countries
through advice in both the design and execution of adjustment
programs. Adjustment lending was introduced in 1980 to help
developing countries restore their trade and balance of payments
deficits to sustainable levels. Since 1982 and particularly

4
since 1985, adjustment lending has taken on greater importance
due to ongoing economic and financial difficulties in many of the
borrowing countries. Accordingly, the scope of adjustment
lending has been expanded to provide more comprehensive support
for reforms which help countries overcome structural weaknesses
and regain sustained growth.

The objectives of adjustment programs are multiple and
vary for each country, which is primarily responsible for the
design and implementation of its own program. Bank adjustment
lending complements investment lending by promoting the
appropriate macroeconomic and sectoral policies vital to the
success of individual projects. Adjustment programs have been
particularly oriented toward:
o market-opening measures to encourage foreign direct
investment and capital inflows;
o liberalization of trade, including the reduction of
export subsidies;
o reform of tax systems and labor markets;
o development of financial markets to mobilize domestic
savings and facilitate efficient investment; and
o increased reliance on the private sector to help
increase employment and efficiency.

The Bank's tools for promoting structural adjustment
include both Structural Adjustment Loans (SALs) and Sectoral
Adjustment Loans (SECALs), which vary mainly in the breadth of
the policy and institutional reforms they involve. SALs
generally support economy-wide programs to increase domestic

5
resource mobilization and to improve efficiency through reform
of trade policies, pricing regulations, government revenue
collection and government expenditures. SECALs focus on reforms
in specific sectors such as finance, trade, agriculture,
industry and energy and target mechanisms including sectoral
pricing and the elimination of subsidies for a particular
sectoral product or input, for example. The Bank has recently
increased its emphasis on SECALs over SALs because their
implementation seems to be more manageable for governments.

The Bank has recently evaluated adjustment lending as a
mechanism for economic reform and growth inducement. While some
shortcomings of methods and implementation were identified, the
general conclusion has been that realistic programs are useful
instruments for assisting governments in the reform and
restructuring of their economies that can help them achieve
sustained growth.

The other primary component of Bank strategy in its efforts
to promote sustained growth and recovery in developing nations
is mobilization of financial resources. Bank programs attempt
to tap available resources within an economy that can spur
growth; they also facilitate financing from other sources.

Investment financing is the most direct mechanism available
to the Bank to stimulate expansion of an economy, and project
loans still make up approximately 75% of total Bank lending.

6
The need for capital, foreign exchange, and technical expertise
are essential elements of any program aimed at sustainable
economic growth. Direct project financing in the production,
social, and infrastructure sectors is a proven mechanism for
supplying those elements. Moreover, this type of capital
transfer permits the Bank to pinpoint the bulk of its assistance
in those sectors it sees as impeding economic growth. Project
loans can rehabilitate or restructure existing enterprises;
they also work to expand productive capacity. These loans have
financed country projects in transportation, education, industry,
agricultural and rural development, energy, health and nutrition,
water supply and sewerage, urban development, and
telecommunications.

The World Bank's role in the reform of individual economies
has also enabled it to catalyze additional financial support for
adjustment programs. As discussed above, the success of the
Bank's efforts in helping a country undertake growth-oriented
reforms depends not only on that country's willingness and
ability but also on financial support from other sources. The
World Bank has taken a more active role in helping countries
secure financing in recent years as a means of assuring that
adequate resources were available to support reform programs.

The Bank's role in assisting debtor countries to adopt
effective reform programs has been the most effective means to
mobilize external financial resources required for growth.

7
Official creditors and commercial banks see the World Bank (and
IMF) as credible institutions whose involvement with countries'
economic programs serves as certification of these countries'
determination to implement effective policies. Such validation
has often been the basis for facilitating restructurings and
new money packages for the major debtor countries.

Part of the Bank's role in catalyzing external finance has
been informational: the Bank attempts to keep creditor groups
— including bilateral lenders, credit insurers, and commercial
banks — up to date on the adjustment programs, prospects, and
financing needs of individual countries. The Bank has also
provided ongoing technical advice to the countries regarding
the design of economic policies as well as the calculation of
financing needs.

In addition to this role of technical advisor, the Bank
has used other mechanisms to stimulate lending to countries
that have adopted appropriate reform programs. Parallel
financing has been used by the Bank to encourage commercial
banks to provide additional new money for major debtor countries
implementing reform programs. Under a parallel financing
program, commercial bank disbursements are generally linked to
disbursements under World Bank loans.

In exceptional circumstances, the World Bank has also
used credit enhancement techniques, such as guarantees, to

8
provide some financial support under the debt strategy. In
each of these instances, it was determined that the enhancements
were necessary to help complete new financing packages which
catalyzed significant additional financial flows from other
sources. These techniques have been used with caution by the
Bank — and only in a limited number of cases — in order to
preserve the leverage they have on private financing, as well
as the Bank's own financial standing.

We believe that the major focus of the Bank on helping
countries pursue structural adjustment and achieve growth in
order to ease their debt burdens has been appropriate. However,
we also believe that further measures should be taken to release
resources for growth in reforming countries through reducing
their debt and debt service burdens. In this context, we
discuss below U.S. ideas about the use of World Bank and IMF
resources from current capital to support debt reduction.

A number of other economic and resource concerns have
played an increasing role in the Bank's efforts to promote
long-term growth in the Highly Indebted Countries, as well as
in other countries. The Bank monitors carefully the impact of
adjustment programs on the poor. Deliberate efforts are being
made to mitigate the costs reforms impose on such vulnerable
groups. Furthermore, such groups are now being recognized as
economic actors who can potentially contribute to growth. The
role of women in developing economies is also receiving greater

9
attention.

In many countries, various factors constrain the

ability of women to participate in the economy.

Better training

and access to economic opportunities can help these groups
increase their productivity.

The Bank is also taking greater care to consider the
impact of its projects on the environment.

The future economic

potential of developing countries depends in part on the wellbeing of their natural environment, and the Bank now recognizes
the need for countries to pursue conservation and environmental
planning.

The United States has been encouraging the Bank to

integrate environmental concerns more thoroughly into the
project cycle, particularly at the earlier stages, and to
develop better procedures to assess the environmental impact of
the projects they fund.

We are working with other member

countries of the Bank to improve policies in a number of areas
such as access to information, outreach to non-governmental
organizations in borrowing countries, and greater sensitivity to
the need to protect fragile eco-systems such as tropical forests
and wetlands.

By addressing these special concerns and helping countries
undertake effective structural reforms, the World Bank seeks to
facilitate and nurture long-term, sustained growth in developing
countries, thereby easing the burden of their debt.

10
The Bank's Strategy in Other Seriously Indebted Countries

The need for realistic, comprehensive, and wellimplemented adjustment programs to ensure recovery and sustained
growth also guides the Bank's work in other seriously indebted
countries.

This is particularly true in the case of the low-

income countries of Sub-Saharan Africa.

The major difference

in Bank strategy for this group of countries is that less
emphasis can be placed on the mobilization of resources from
private financial markets.

Rather, Bank efforts center on

official financial support for such countries, since the bulk
of exposure in these countries comes from official creditors.

As mentioned above, investment lending remains the- primary
activity of the Bank.

The role investment projects play in

building infrastructure and enhancing the physical and human
resource base is particularly important for long-term growth
and development in the least developed countries.

However,

macroeconomic and structural adjustments are also critical to
restoration of growth in these economies.

Financing adjustment programs and other resource needs in
the least developed countries has presented a challenge to the
Bank and the international community.

Special mechanisms to

mobilize and coordinate financing efforts have thus been created.
These rely on the adoption of internationally accepted
adjustment programs as criteria for eligibility.

The World

11
Bank, through its International Development Agency (IDA),
plays a major role in providing financing from its own resources
and in serving as a catalyst for financial support from other
sources for economic adjustment programs in the poorest
countries.

In this regard, the World Bank has taken the lead in
developing a Special Program of Assistance to increase
disbursements for low-income Sub-Saharan African countries
implementing economic reforms.

World Bank support is provided

through IDA, and the Bank encourages donors to increase
concessional resource flows through cofinancing arrangements
with the Bank.

Country eligibility is cefined in terms of

commitment to and implementation of economic reform programs.
In particular, Policy Framework Papers —

designed to describe

borrower objectives over a three-year period and drawn up with
the assistance of the IMF and World Bank —

play an important

role by providing consistent guidelines for growth-oriented
adjustment and resource mobilization through the programs
described above and the IMF's Enhanced Structural Adjustment
Facility.

12
SECTION III: Progress and Recent Developments

The Highly Indebted Countries have progressed at various
rates in their pursuit of recovery and sustained economic
growth. Even in the best conditions, correcting the serious
macroeconomic imbalances that had accumulated in these countries
must be recognized as a long-term process. Success in achieving
balanced macroeconomic conditions and a healthy economy depends
heavily on the ability of individual countries to sustain
adjustment efforts. In reality, individual countries have
shown different degrees of dedication: while adjustment efforts
have remained strong in some countries, they have faltered in
others. This variable commitment to reforms has affected
growth as well as access to external finance.

The attached (Table 1) highlights the aggregate performance
of the fifteen major debtors since 1981.3 Aggregate GDP growth
for this group has improved from -0.5 and -2.7 in 1982 and 1983
to 3.8% in 1986, 2.5% in 1987, and 1.5% in 1988. It should be
noted that data for GDP growth in 1987-88 are heavily influenced
by a sharp reduction in Brazilian and Argentine growth.
Excluding Brazil, growth for the group increased from 1.6% in
1986 to an estimated 2.6% in 1988.

3

As published in the IMF World Economic Outlook, October
1988. The fifteen major debtors include Argentina, Bolivia,
Brazil, Chile, Colombia, Cote d'lvoire, Ecuador, Mexico, Morocco,
Nigeria, Peru, Philippines, Uruguay, Venezuela, and Yugoslavia;
the World Bank adds Costa Rica and Jamaica to complete the list
of Highly Indebted Countries.

13

Trade statistics provide another indication of the economic
recovery and growth potential in debtor countries.

The value of

exports sold by the major debtors rose by 12% in 1988 and is
expected to continue to rise (by 8%) in 1989.

The value of

imports for the group increased by 10% in 1988, and projections
show that it will continue to rise at that rate in 1989.

Some progress has been made in recent years in easing the
external debt burden of the major debtors.

The major debtors'

aggregate ratio of debt to Gross Domestic Product fell in 1988
and is expected to continue its decline in 1989.

The group's

debt/exports ratio has dropped by 11% since reaching its peak
in 1986.

Furthermore, the ratio of debt service to exports in 1988
stood 18% below its 1982 level, and the IMF projects that this
indication of the ability of debtors to service their debt
will continue to show improvement in 1989.

Debtor countries

have been able to make this progress in reducing their debt
service burden through continued improvement in export
performance —

despite rising interest rates, which have tended

to cause an increase in debt servicing obligations.

The

aggregate interest/export ratio for the fifteen shows similar
improvement, although the 1987 and 1988 figures are heavily
influenced by Brazilian interest arrears and repayment of those
arrears.

14
The experiences of several countries that have in general
adopted and implemented strong reform programs is illustrative
of the progress achieved in promoting long-term growth and
reduced debt burdens in the major debtors.

Chile, for example, has undertaken intensive policy
reforms. These reforms reach across the Chilean economy,
promoting greater efficiency and competitiveness. Chile has
the most open investment regime in Latin America. Reforms in
other areas have yielded particular progress in rehabilitating
the financial and corporate sectors and liberalizing the trade
regime. Because of these and other adjustments in its economic
management, Chile has benefitted from real growth exceeding 5
percent for the past three years. Inflation has also been
reduced to a very low level. The country's debt/equity swap
programs have also reduced its existing external obligations by
almost $6.5 billion.

Colombia is one of the most successful adjusters in Latin
America and has avoided any formal debt rescheduling during the
region's debt crisis. Colombia carried out far-reaching
structural reforms in 1985 and 1986 under IMF "enhanced
surveillance," while simultaneously undertaking reforms in its
trade and agricultural sectors. The country has subsequently:
reduced its fiscal deficit to less than 3 percent of GDP in
1988; reformed its tax system to increase equity, efficiency,
and collections; and increased its international competitiveness

15
through a more liberal foreign trade and exchange rate system.
The reward has been GDP growth averaging over 5% in the 1986-88
period.

Since 1982, Mexico has been pursuing a reform program that
emphasizes trade liberalization and includes public enterprise
reforms, reductions in and better targeting of food and credit
subsidies, greater receptivity to foreign investment, and tax
reform. In further efforts to stabilize the economy, Mexico
adopted in December 1987 an Economic Solidarity Pact, followed
by the Pact for Stabilization and Economic Growth in 1988.
These programs have significantly reduced inflation from its
recent high levels. Mexico has also engaged in extensive
privatization, reducing the number of state-owned enterprises
by over 50%, although much remains to be done to improve the
efficiency of remaining parastatals. Earnings from nontraditional exports, moreover, have increased substantially in
response to efforts to diversify exports. However, declining
oil prices have impeded the benefits in terms of growth that
Mexico should be experiencing as a result of its sweeping
reform program.

Adjustment efforts have also helped Morocco to increase
exports, eliminate its current account deficit in 1988, and
limit inflation to a moderate level. Structural reforms
underway include measures to liberalize Morocco's foreign trade
and price regimes, rehabilitate the financial sector, and

16
improve public enterprise management. Although Morocco suffered
a slowdown in GDP growth in 1987, the economy achieved a healthy
level of growth in 1988, and its future prospects are quite
positive.

The Philippines has also taken on a serious reform
program. The tax system has been restructured; trade
liberalization has significantly opened the economy; the
financial sector has undergone restructuring; and a program to
privatize government-owned assets has begun. The Philippines
has subsequently experienced GDP growth well above the average
for the major indebted countries. In order to sustain growth,
current reforms need to be continued, and further efforts need
to be made in areas such as exchange rate policy.

However, despite accomplishments to date, we must
acknowledge that serious problems and impediments to a successful
resolution of the debt crisis remain. Clearly, in many of the
major debtor nations, growth has not been sufficient. Nor has
the level of economic policy reform been adequate. Capital
flight has drained resources from debtor nations' economies.
Meanwhile, neither investment nor domestic savings has shown
much improvement. In many cases, inflation has not been brought
under control. Commercial bank lending has not always been
timely. The force of these circumstances has overshadowed the
progress achieved. Despite progress, prosperity remains out of
reach for many.

17
The growth of per capita gross national product (Table 2)
provides one indicator of the impact of economic growth on
national populations. However, equity4 might be better measured
by looking at how an economy distributes the benefits of economic
growth. Because distribution of economic benefits and income
within a country is determined by domestic policies (and
politics), economic equity is not an issue easily addressed by
adjustment programs. Nonetheless, by attempting to disassemble
distortions in economies, such as subsidies that
disproportionately benefit the middle classes, adjustment
programs do tackle some distribution issues. For instance, the
removal of price ceilings on agricultural goods affords farmers
a better opportunity to profit from their goods and provides
more realistic incentives to production. Some strides can also
be made by the Bank through poverty alleviation and other
development initiatives. However, the responsibility for
equitable growth rests with each country.

The overall sustainability and equity of growth achieved
by individual debtor countries is difficult to determine. As
reforming economies experience sequential years of significantly
positive growth, they become more likely to succeed in sustaining
a healthy level of growth over the long term. Much depends,
however, on the continuation of good economic policies.

4

H.R. 464 5 directs the Secretary to describe debtor
countries' success in achieving sustainable and equitable
growth as measured by criteria such as per capita income.

18
In attempting to draw overall conclusions about the drain
of debt servicing on debtor economies, some analysts have used
net financial transfer figures to assess the amount of capital
developing countries are exporting to the industrial world.
However, calculation of these variables has been a source of
controversy in the field of international economics and
finance.

Some sources confine these terms to the parameters of

international financial markets. They define net flows (i.e.,
net lending or net disbursements) as actual disbursements less
principal repayments, while describing net transfers as net
disbursements less interest payments — which will, of course,
reflect a substantial negative outflow.

One such calculation

estimated net transfers on long-term debt to the 17 Highly
Indebted Countries at approximately $-11 billion in 1987.

Other analysts (the Organization for Economic Cooperation
and Development (OECD), for example) look more carefully at the
economic significance of these terms. Such analysis reveals
that net financial transfers are intended to identify the
resources available to a national economy to expand domestic
consumption and investment beyond the level of national
output.5

As a result, data prepared by the OECD and others

include official development assistance (ODA) and private
investment in a developing economy as contributors to the
concept.

5

Organization for Economic Cooperation and Development,
Development Cooperation. 1988, pp. 52-55.

19
Table 3 illustrates the method used by the OECD for
calculating net resource flows, which serve as a guideline for
deriving net financial transfer estimates. These figures
represent flows to all developing countries. It should be
noted that Sub-Saharan African countries tend to receive more
ODA than do major debtor nations and that some of the Asian
countries make more substantial negative transfers abroad
without overburdening their economies. Nevertheless, the OECD
calculation of net resource flows offers some indication of the
discrepancies involved with differing definitions. While total
resource flows to developing countries have declined in the
1980s, they remain positive: approximately $89.1 billion in
resources flowed to the developing world in 1988, according to
the OECD. Drawing from these figures, the OECD has calculated
net financial transfers (Table 4). The OECD estimate of net
financial transfers to Latin America in 1987 is negative $4
billion, compared to the negative $11 billion figure cited above.

The remaining point to be made about the flow of financial
resources is that neither net inflow nor net outflow can be
definitively labelled beneficial for developing countries.
While the inflow of financial resources to a developing country
can allow it to expand consumption and experience greater
investment, the existence of inflows is not necessarily a
positive indicator for the country's economy and its potential
for sustained growth. Large positive inflows in the late
1970s and early 1980s, for instance, portended financial and

20
economic trauma for many developing countries in the following
years because of their inability to service fully the large
debt component of these flows.

On the other hand, the flow of

financial resources out of a developing country —
South Korea is now experiencing —

like that

can indicate that the economy

is highly productive and reflects a normal process in which a
country moves from a net debtor to a net creditor position.

Debt Reduction

Debt reduction offers a potentially powerful tool for
debtor nations to redress negative capital flow problems.

A

number of Highly Indebted Countries have pursued debt reduction
with their commercial bank creditors via market mechanisms.
These options include debt/equity swaps and other debt
conversions, exit bonds, cash buybacks, and debt exchanges.
Such voluntary debt reduction measures have already achieved
substantial success in reducing both debt and debt service
burdens.

During the past four years, various voluntary debt reduction
techniques have reduced by more than $26 billion the external
debt that the 15 major debtor countries owed to commercial
banks.

As shown in Table 5, nearly half this reduction was

from debt/equity swaps ($12.5 billion).

In addition, commercial

banks have undertaken some $7 billion in private debt
restructurings (primarily in Mexico) and over $6 billion in

21
other types of swaps, including informal conversions and the
1988 Mexican debt/bond exchange.

The vast bulk of these

arrangements ($26 billion) have been made in the past two
years, with more than $18 billion in 1988 alone.

The most recent example of negotiated debt reduction is
found in the financial package agreed by Brazil and its
commercial bank creditors.

This package was the first to combine

substantial new money with significant debt reduction,
illustrating that these two financial techniques are not mutually
exclusive.

The package includes $5.2 billion in new money to

support Brazil's economic program, including structural reforms,
to mid-1989.

The debt reduction component of the program

allows larger banks to improve, through exit bonds, the risk
profile of their portfolios while eliminating future commitments
to new money or restructuring arrangements.

In the Brazilian

package, each bank was allowed to acquire up to $15 million in
exit bonds, bearing interest of six percent per year.

The maximum amount of exit bonds provided for in this
program was $5 billion.

Initially, bank analysts estimated

that these exit bonds, along with other debt reduction
provisions and existing conversion programs, had the potential
to reduce Brazil's external debt by more than $18 billion (net)
between 1988 and 1993.

If it were to take full advantage of

this opportunity, Brazil could save $5 billion on future interest
payments.

22
However, in recent months Brazil has suspended its relending
program for one year and its debt-equity swap program on a more
temporary basis. If these suspensions continue, they could
delay debt reduction under this program. Nevertheless, the
program clearly underscores the ability of debtors and commercial
banks to work out agreements with diversified new money and
debt reduction components. Linkages to the World Bank and IMF
continue to offer important mechanisms for facilitating such
agreements.

23
SECTION IV: Suggestions for Strengthening the Current Approach

The Administration has undertaken a major review of the
international debt situation in order to assess progress and
shortcomings of the current strategy. Our review reaffirmed
the viability of the key principles of that strategy:
o Growth is essential to easing debt problems;
o Economic reforms are necessary to achieve such growth;
o Debtor nations have an ongoing need for external
financial resources; and
o Solutions to debt problems must be pursued on a caseby-case basis.

On the other hand, the review confirmed that serious
problems and impediments to a successful resolution of the debt
crisis remain. In many debtor nations, growth has not been
sufficient, nor has economic policy reform been adequate.
Capital flight continues to drain resources from debtor
countries' economies, and neither investment nor domestic
savings have shown much improvement. Furthermore, while some
progress has been made in reducing countries' debt through market
mechanisms, the pace of debt reduction has been constrained by
the sharing and negative pledge clauses in commercial bank
agreements.

As a result of these ongoing problems and shortcomings of
the current approach, we have concluded that additional measures
are needed to address international debt problems.

24
In developing new ideas to confront this situation, several
objectives have framed our thinking.

Experience has shown us

that financial resources are scarce, and we feel that they need
to be used more effectively.

In addition, we strongly believe

that the international financial institutions should retain
central roles in the debt strategy.

Measures must also be

taken to preserve their financial integrity and to minimize
the cost or contingent shift in risk to creditor governments
and taxpayers.

At the same time, our review has convinced us

that the international community must encourage debt and debt
service reduction, while continuing to recognize the importance
of new lending.

As a result of our review of debt problems, we have made
specific suggestions about how debt problems might be better
addressed.6

First and foremost, the international financial

institutions should continue to promote
financial support —

—

through advice and

economic policy reforms.

Revitalized new

investment, strengthened domestic savings, and the return of
flight capital should receive particular emphasis, since progress
in these areas can help countries to finance their own growth.
We hope that the Bank will use available tools, specifically
SALs and SECALs, to promote policies that encourage direct
investment and bring flight capital home.

Such adjustment and

revitalization of debtor economies through World Bank and IMF
6

These ideas were presented by Secretary Brady in a
speech before the Brookings Institution and Bretton Woods
Committee, March 10, 1989.

25
programs should also continue to serve as a catalyst to new
financing.

Further steps need to be taken, however, to mobilize more
effective and timely financial support from the creditor
community. In brief, commercial banks need to work with debtor
nations to agree on a broader range of alternatives for financial
support, including both debt and debt service reduction and new
lending mechanisms. To facilitate the debt reduction process,
constraints on diversified forms of financial support need to
be relaxed. In particular, the negotiation of a general waiver
of the sharing and negative pledge clauses for each performing
debtor could permit debt reduction negotiations between debtors
and banks which choose to pursue this alternative to go
forward. Such waivers might have a three-year life, to
stimulate debt reduction within a relatively short time period.
We expect these waivers to accelerate the pace of debt reduction,
passing the benefits directly to the debtor nation.

Other steps will also be necessary to address debtor
countries' financing needs. New lending will be encouraged as
creditworthiness improves and differentiations are made between
new money and old. Efforts will also be made to provide more
timely and flexible financial support, while maintaining the
close association between economic performance and external
financial support.

26
The World Bank and IMF can support and encourage the debt
reduction process by redirecting a portion of the funds which
they currently have available. Negotiation of debt or debt
service reductions should remain in the marketplace, rather
than under the management of the international financial
institutions. However, specific measures can be taken to
promote debt reduction arrangements. For instance, the World
Bank and IMF could redirect a portion of their policy-based
loans for use to support specific transactions. These could
include financing to collateralize debt-for-bond exchanges
with a significant discount on outstanding debt, or to replenish
foreign exchange reserves following a cash buyback.

The World Bank and IMF could also provide additional
financial support to back a portion of interest on transactions
involving a significant reduction of principal or a major
reduction in interest rates.

These suggestions for a greater World Bank role in
facilitating debt reduction are fully consistent with the
intent of Congress as expressed in H.R. 4645. Discussions of
these ideas are underway with other creditor governments and
have been initiated with other World Bank Executive Directors.
The details of our suggestions for strengthening the current
debt strategy will have to be worked out through further
consultations in the IMF and World Bank with other creditor and
debtor governments, and with commercial banks.

27
It is our hope that these ideas for revitalizing the debt
strategy will receive the support and attention of the
international community and that all parties will move forward
to facilitate progress in addressing debt problems.

TABLE 1
AGGREGATE PERFORMANCE IN THE FIFTEEN MAJOR DEBTORS

1981

1982

1984

1985

1986

1987

1988

1989

2.3

3.8

3.8

2.5

1.5

3.4

123.4

118.8

99.4

112.5

126.2

136.3

80.4

78.2

78.7

86.1

94.7

105.2

271.7

289.6

347.9

336.7

308.3

293.7

Debt/GDP 37.8 42.3 46.5

46.0

46.0

47.4

49.7

47.2

44.9

Debt service/ 38.9 49.8 39.5
exports

39.9

38.8

43.3

34.6

41.0

38.8

Interest service/ 22.7 30.9 29.2
exports

29.3

28.5

27.9

21.5

26.1

25.2

GDP Growth (%) 0.1 -0.5 -2.7
Export Values 127.0 112.2 111.1
($ billion)
Import Values 133.6 108.2 82.8
($ billion)

1983

RATIOS, in percent:
Debt/exports 202.4 267.8 290.8

** Entries for 1988 are estimated; entries for 1989 are projected.
SOURCE: International Monetary Fund, World Economic Outlook, October 1988

TABLE 2
GNP PER CAPITA
In U.S.
Dollars

Real growth rate
(percent}

1986

1987

1980-87

2360

2370

-1.9

0.2

510

570

-5.4

0.3

Brazil

1830

2020

1.0

1.5

Chile

1310

1310

-1.8

3.6

Colombia

1260

1220

0.6

3.4

Costa Rica

1510

1590

-0.9

0.5

700

750

-3.0

-5.9

Ecuador

1130

1040

-1.9

-7.9

Jamaica

870

960

-2.5

4.5

1900

1820

-1.6

3.0

Morocco

580

620

0.5

-1.3

Nigeria

700

370

-5.0

-7.7

1150

1430

-1.1

5.9

560

590

-3.3

3.1

Uruguay

1920

2180

-2.3

4.4

Venezuela

3850

3230

-2.3

0.0

Yugoslavia

2300

2480

0.0

-2.1

Argentina
Bolivia

Cote d'lvoire

Mexico

Peru
Philippines

Source:

The World Bank Atlas 1988

1986-87

TABLE 3
TOTAL NET RESOURCE FLOWS TO DEVELOPING COUNTRIES
Current $ billion

1979

1980

1981

1982

1983

1984

1985

1986

1987

I. OFFICIAL DEVELOPMENT
FINANCE (ODF)

36.9

45.1

46.6

44.0

41.8

47.1

48.5

56.2

59.3

Official Development
Assistance (ODA)

31.1

37.3

37.9

33.7

33.3

34.4

36.9

44.4

48.1

5.8

7.8

8.7

10.3

8.5

12.7

11.6

11.8

11.2

13.5

17.0

17.2

13.6

7.4

7.1

4.6

-0.3

-0.7

54.0

66.1

74.5

58.4

48.0

33.5

30.9

26.1

30.5

13.4

11.2

17.2

12.8

9.9

11.4

6.7

12.2

20.0

Other ODF
II. TOTAL EXPORT CREDITS
III. PRIVATE
Direct

FLOWS
Investment

Int'l Bank

Lending

35.9

49.0

52.0

37.6

34.1

17.4

13.6

5.2

5.0

Total Bond

Lending

X

1.5

1.5

5.0

1.1

1.0

4.8

1.6

0.5

2.7

2.0

1.8

0.7

0.6

1.1

2.9

3.8

1.5

Grants by Non-governmenta 1
2.0
Organizations

2.4

2.0

2.3

2.3

2.6

2.9

3.3

3.5

104.4

128.2

138.3

116.0

97.2

87.7

84.0

82.0

89. 1

X

2.6

6.2

12.5

5.4

0.8

-1.4

-4.7

Other

Private

TOTAL NET RESOURCE
(I+II+III)

FLOWS

Related data:
Use of IMF credit, net

Note:

6. 1

1987 data are provisional

SOURCE: Organization for Economic Cooperation and Development, Development Issues. 1988, p. 47.

TABLE 4
NET FINANCIAL TRANSFERS
Current $ billion

1979

Average
1980-82

1983

1984

1985

1986

1987

Sub-Saharan Africa

12

12

10

8

10

13

16

North Africa and Middle East

16

9

5

7

8

6

4

Asian LICs

10

12

12

14

17

17

22

Other Asia

5

6

9

1

-3

-2

-2

28

30

-8

-8

-15

-10

-4

7

8

-2

5

3

3

-2

78

77

27

27

20

27

34

Western Hemisphere
Other and adjustments*
TOTAL DEVELOPING COUNTRIES

* Europe, Oceania, unallocated and other adjustments
SOURCE: OECD, Development Cooperation, 1988, p. 53.

TABLE 5
DEBT REDUCTION BY CATEGORY. 1985-88

Debt/Equity Swaps

$12.5 bn

Private Debt Restructuring 7.0 bn
Repatriation of Flight Capital
via Swaps (Chile)

2.1 bn

Informal Debt Conversions 5.0 bn
Debt/Bond Swap (Mexico) 1.1 bn
Cash Buybacks (Bolivia and Chile) 0.6 bn
TOTAL $28.3 bn

SOURCE:

Treasury estimates

DEPARTMENT OF THE TREASURY

Report to the Congress
on
A Limited Purpose Allocation of
Special Drawing Rights for the
Poorest Heavily Indebted Countries

March 1989

DEPARTMENT OF THE TREASURY

Report to the Congress
on
A Limited Purpose Allocation of
Special Drawing Rights for the
Poorest Heavily Indebted Countries

March 1989

TABLE OF CONTENTS

Page
PART ONE:

Introduction

1

PART TWO:

The Role and Use of the SDR

1

PART THREE

A Limited Purpose SDR Allocation for
the Poorest Countries

4

PART FOUR:

Other SDR Proposals

7

PART FIVE:

IMF and Other Actions to Address the
Needs of the Poorest Countires

10

Conclusion

12

PART SIX:

A LIMITED PURPOSE ALLOCATION OF
SPECIAL DRAWING RIGHTS FOR THE
POOREST HEAVILY INDEBTED COUNTRIES

PART ONE: INTRODUCTION
Section 3123 of the Omnibus Trade and Competitiveness Act
of 1988 (Pub. L. 100-418, 102 Stat. 1107) requires the Secretary
of the Treasury, in consultation with the directors and staff of
the International Monetary Fund and such other interested
parties as the Secretary may determine to be appropriate, to
conduct a study of the feasibility and efficacy of reducing the
international debt of the poorest of the heavily indebted
countries through a one-time allocation by the International
Monetary Fund of limited purpose Special Drawing Rights. The
legislation also requires the Secretary to submit a report
containing the findings and conclusions of the study, together
with recommendations, to the Banking Committees of the House and
Senate and the Senate Foreign Relations Committee. This report
is being submitted in fulfillment of the requirements of Section
3123.
Part Two of the report provides relevant background on the
origins, purposes, and characteristics of the Special Drawing
Right (SDR). Part Three examines the proposal for a limited
purpose SDR allocation for the poorest countries. Other SDR
related proposals to address the problems of developing
countries are reviewed in Part Four, while alternative measures
to respond to the special situation of the poorest countries are
considered in PART
Part TWO:
Five.THESummary
conclusions
ROLE AND
USE OF THEand
SDR
recommendations are contained in the final Part.
Origin and Procedures
The SDR was created in 1969, by an amendment of the IMF
Articles of Agreement to supplement then existing international
reserve assets, primarily dollars and gold, as a means of
assuring adequate global liquidity and a supply of official
reserve assets unrelated to the balance of payments position of
any one country or the vagaries in the supply of gold for
official use due to production in a limited number of countries
and competing private demand for gold. A subsequent amendment
of the Articles of Agreement in 1978, broadened the role for the
SDR by requiring Fund members to collaborate among themselves
and with the Fund to make the SDR the "principal reserve asset
in the international monetary system."

-2-

The Articles provide that SDRs may be allocated only to
member countries that agree to participate in the arrangement
(at present all IMF members are participants). The IMF and
other designated official entities are permitted to hold and use
SDRs in operations and transactions but may not obtain SDRs
through allocation. In addition, there is no provision in the
Articles for private entities to receive or hold SDRs.
The IMF Articles specify that decisions to allocate or
cancel SDRs must satisfy the following criteria:
In all its decisions with respect to the allocation or
cancellation of Special Drawing Rights the Fund shall seek
to meet the long-term global need, as and when it arises,
to supplement existing reserve assets in such a manner as
will promote the attainment of its purposes and avoid
economic stagnation and deflation as well as excess demand
and inflation in the world.
Decisions to allocate SDRs are made by the IMF Board of
Governors, based on a recommendation by the IMF Managing
Director and concurred in by the Executive Board, and require an
85-percent special majority vote of the total voting power.
Thus, the United States, with over 19 percent of the IMF's
voting power, can veto decisions with respect to an allocation
of SDRs. Since 1969, the IMF has allocated a total of 21.4
billion SDRs, including SDR 9.4 billion in the period 1970-72
and SDR 12 billion between 1979-81.
Allocations are made to participants in proportion to their
shares in IMF quotas. A member has a right to use its SDRs to
acquire currencies to meet a balance of payments financing or
reserve need but may not do so solely for the purpose of
changing the composition of its reserves. In addition, the IMF
has authorized certain voluntary SDR transactions among members
and designated holders, including the IMF, without the
requirement of a balance of payments financing need.
The IMF has developed special procedures to ensure that
members will be able to use their SDRs to acquire currencies.
Thus, members with strong balance of payments and reserve
positions are designated to acquire SDRs in exchange for "freely
usable currencies" (U.S. dollars, German marks, British pound
sterling, Japanese yen, and French francs) from countries
needing to use their SDRs. In designating countries to receive
SDRs, the IMF seeks to promote a balance of holdings among
participants. In any event, no country is required to accept
SDRs beyond the point where its holdings exceed three times the
amount of net cumulative SDR allocations that have been made to
it. The country may, however, agree voluntarily to hold SDRs in
excess of its acceptance limit. The Articles also provide that
a member using SDRs may be required to reconstitute its SDR
holdings so that the average daily balance of its holdings over

-3-

a specified period exceeds a specific proportion of its
allocations. At present, however, the IMF, under existing
authority, has reduced the reconstitution requirement to zero
although this may be changed by a 70-percent majority vote.
SDRs are valued on the basis of the market exchange rates
for a basket of five currencies (the same freely usable
currencies noted above) weighted broadly to reflect their
relative importance in international trade and finance. The
weights for the currencies in the basket are as follows: the
U.S. dollar is 42 percent; the German Deutsche mark 19 percent;
the Japanese yen 15 percent; and the French franc and British
pound sterling 12 percent. The value of one SDR was
approximately $1.32 at the end of February 1989. Since 1972,
the SDR has served as the IMF's official unit of account.
Countries participating in the IMF's SDR Department are
obligated to pay charges (interest) to the Fund on the
cumulative allocations made to them and simultaneously receive
interest on their holdings of SDRs. thus, members holding SDRs
in excess of their cumulative allocation receive net interest
payments from the IMF, while members with SDR holdings below
their cumulative allocation must pay net charges to the Fund.
Such charges and interest are payable quarterly in SDRs at an
interest rate equal to the weighted average of short-term
interest rates in the five countries whose currencies comprise
the SDR exchange rate basket. This interest rate, at the end of
February 1989, was 8.25 percent per annum.
U.S. Legislative Authority and Restrictions
The Special Drawing Rights Act of 1968 (Pub. L. 90-349, 82
Stat. 188) authorizes U.S. participation in the SDR arrangement
and provides that SDRs allocated by the IMF or otherwise
acquired by the United States are resources of the Treasury
Department's Exchange Stabilization Fund (ESF). The legislation
also authorizes the Secretary of the Treasury to issue Special
Drawing Right certificates, in such form and in such
denominations as he may determine, to the Federal Reserve
against SDRs held by the ESF in exchange for dollars. Such
certificates may be issued only for the purpose of financing ESF
purchases of SDRs or other exchange stabilization operations.
The amount of certificates issued and outstanding shall at no
time exceed the value of SDRs held against the SDR certificates.
At the end of February 1989, SDR certificates totaling $5.0
billion were outstanding. Legislation approving U.S.
participation in the 1983 increase in IMF quotas (Pub. L.
98-181) requires the Secretary of the Treasury to consult with
the Congress at least 90 days prior to a U.S. vote in support of
an SDR allocation.

-4-

The United States has used its SDRs for various purposes
over the years, including: to pay a portion of its IMF quota
increases in 1980 and 1983; to acquire foreign exchange in 1978
and in 1987 for use in foreign exchange market operations; and
to make payments of net SDR charges to the IMF. At the end of
February 1989, the United States held SDR 7.2 billion,
equivalent in value to $9.5 billion, or about SDR 2.3 billion in
excess of the total amount allocated to the United States. The
U.S. SDR holdings represent roughly 25 percent of U.S. non-gold
international reserve assets.
U.S. Budgetary and Financial Effects
Allocations, purchases, and sales of SDRs do not have a
direct budget impact although they may affect Treasury's
financing requirements. Thus, allocations to the United States
involve an increase in ESF assets and liabilities by an equal
amount. Purchases of SDRs for dollars reduce the ESF's cash
balances and can increase the Treasury's public borrowing
requirements, although the ESF may also finance such purchases
through the issuance of SDR certificates to the Federal Reserve.
Sales of SDRs have normally been for the purpose of acquiring
foreign currencies; such sales do not immediately affect the
Treasury's domestic borrowing requirements, although subsequent
sales of the foreign currencies (for dollars) result in an
inflow of cash to the Treasury which reduces the Treasury's
borrowing requirements.
The U.S. transactions in SDRs affect the Federal budget
through their impact on the financial position of the ESF. The
net cash profit or loss of the ESF is recorded as a positive or
negative net outlay, respectively, in the Federal budget.
Interest earned on SDR holdings, and charges paid on U.S.
allocations of SDRs all affect the financial position of the
ESF, as does
movement
in the PURPOSE
value ofSDR
theALLOCATION
SDR against the
PARTthe
THREE:
A LIMITED
dollar.
FOR THE POOREST COUNTRIES
The proposal in Section 3123 for a one-time allocation of
SDRs to reduce the international debt of the poorest countries
provides that:
o The allocation be made without regard to the quota
established for the poorest countries under the Articles
of Agreement of the Fund;
o Limited purpose SDRs be used only to repay official debt
of the poorest countries to official creditors (i.e.,
governments and multilateral financial institutions).

-5-

o

The allocation of limited purpose SDRs to the poorest
countries not be treated as an allocation on which such
countries must pay interest to the Fund; and

o The use of limited purpose SDRs by the poorest countries
to repay official debt be treated as an allocation of
regular Special Drawing Rights to the creditor.
The proposal is designed to facilitate debt reduction on a
generalized basis for the poorest countries. Such debt reduction
would be financed through unconditional money creation rather
than by direct budgetary means. As such, it raises fundamental
issues relating to the balance between financing and economic
adjustment in dealing with debt problems, the use of a monetary
reserve asset rather than budgetary resources for debt reduction,
legal and procedural issues related to the SDR, and the direct
benefits and costs to the United States.
Financing/Adjustment Balance
A basic principle of the international debt strategy is that
debt problems must be considered on a case-by-case basis and that
lasting solutions can only be achieved through the adoption of
comprehensive growth-oriented economic policies, supported by
appropriate external finance. In this context, the IMF plays a
central role by promoting sound economic policies in individual
countries, catalyzing international finance on behalf of these
efforts, and providing its own limited conditional resources.
The proposal for a limited purpose SDR allocation would represent
a major departure from this approach by treating the poorest
developing countries as a group and providing financing
regardless of economic performance.
As noted earlier, the present SDR represents a form of
unconditional financing which may be used without regard to the
countries' economic policies and performance. While the
additional resources would ease debt service pressures on
countries seeking to put their economic house in order, it would
have a similar effect on those countries pursuing unsound
policies. By failing to differentiate between good and bad
performers, the proposal could reduce incentives for the poorest
countries to adopt the economic reforms which represent the only
lasting solution to the debt problem.
It would be extremely difficult to limit such a proposal to
the poorest countries. For example, middle income debtors have
substantially larger amount of debt outstanding and face
difficult economic adjustment needs. They would undoubtedly seek
similar treatment, resulting in a much larger SDR allocation.

-6-

Monetary Character of the SDR
SDRs have become an accepted international monetary reserve
asset in large measure because participants are assured of being
able to use them to meet their balance of payments financing
needs. Moreover, countries have been willing to accept and hold
SDRs because of the financial characteristics of the instrument.
The proposal for a limited purpose SDR would affect both the
liquidity and financial characteristics of the SDR and thus the
monetary character of the instrument.
Under the proposal, the debtors world repay official debt
with SDRs but incur no interest cost in the use of the SDRs. At
the same time, creditors which acquired the SDRs would treat them
as allocated SDRs on which they must pay interest. In effect,
creditors would be paying interest to themselves on the SDRs
which they receive as debt repayments. Thus, creditors receiving
limited purpose SDRs would earn no net interest whereas they
would earn net interest on SDRs acquired from a regular
allocation. Moreover, to the extent that creditors received
limited purpose SDRs, their need for and willingness to acquire
SDRs through other transactions could diminish. This could
reduce the liquidity of outstanding SDRs and possible support for
future allocations to meet a global need to supplement reserve
assets.
Legal Aspects
A limited purpose allocation of SDRs to repay official debt
would require amendment of the IMF Articles of Agreement, a
process that in the past has taken several years to achieve. As
noted previously, under the IMF's Articles, SDRs are to be
allocated in proportion to IMF quotas; the limited purpose SDR
allocation proposal specifies that the allocation be made without
regard to the IMF's quota structure. Amendment of the Articles
of Agreement would require an 85-percent special majority vote -the same majority required for decisions on an SDR allocation —
of the Fund's membership. While there is widespread sympathy for
the plight of the poorest countries, it is not clear that the
necessary majority could be mobilized. Indeed, discussions in
the IMF Executive Board of similar proposals for use of the SDR
indicate a wide divergence of views.
As noted above, many middle and upper-income developing
countries with large outstanding stocks of official and private
debt would have a vested interest in seeking SDR allocations as a
form of debt relief. They might be expected to oppose such
treatment for the low-income developing countries unless they
were treated similarly. Several industrial countries,
particularly those with large net SDR holdings, have also
objected strongly to the use of a monetary reserve asset for debt
relief since this, as already discussed, could impair the
liquidity of their SDR holdings and raise fundamental questions
about the monetary character of the SDR.

-7-

Furthermore, it is unlikely that the process of amending the
IMF Articles of Agreement could be limited to the SDR issue.
Over the years, a wide range of proposals have been advanced that
would alter fundamentally the role and functioning of the IMF.
The negotiating process would be long and difficult, possibly
requiring several years. The end result might well be an IMF
that is no longer able to serve its key role in the international
monetary system and as a cornerstone of U.S. foreign economic
policy.
Impact on the United States
A limited purpose SDR allocation to repay official debt of
the poorest countries would have a number of budgetary and
financial effects on the United States.
The poorest developing countries owe about $100 billion to
official creditors, of which about $10 billion is to the
U.S. government. The repayment of debt owed the U.S.
government in advance of maturity would increase current
revenues relative to future income. This would reduce
Treasury's borrowing requirements and interest costs.
However, exchanging an interest bearing asset (LDC debt)
for a non-interest bearing asset (limited purpose SDRs)
would reduce revenue. The overall impact on the budget
would depend on the interest rates involved.
As noted earlier, SDRs account for about 25 percent of U.S.
international reserve assets (excluding gold). Any
reduction in the liquidity of the SDR could adversely
affect the ability of the U.S. to mobilize its reserve
assets to meet a balance of payments financing need and/or
for foreign exchange market operations.
The United States is the largest member of the IMF and has
the highest SDR acceptance limit. Over time, the U.S.
would be expected to acquire the largest share of the SDRs
allocated for use in retiring official debt.
PART FOUR: OTHER SDR PROPOSALS
Proposals to use the SDR for purposes other than
supplementing existing reserve asset have been a subject of
continuing discussion in the IMF for more than 20 years. More
recently, they have been an integral part of the consultations
and negotiations regarding a possible SDR allocation where
proposals similar to those described in the preceding section
have been advanced. This section of the report focuses on the
general question of an SDR allocation and other proposals for
special purpose SDRs.

-8-

The Current Debate over an SDR Allocation
The IMF Articles of Agreement require the Fund to review
periodically the possible need for an SDR allocation. Before
making a proposal, the Managing Director is required to consult
with members to ascertain whether there is broad support among
participants for the proposals. In recent years, the necessary
consensus on an allocation has not emerged due to fundamental
differences on whether the criteria for an allocation specified
in the Articles of Agreement have been met (i.e., a long-term
global need to supplement existing reserve assets).
Those supporting an allocation have made several points.
They contend that under present international monetary
arrangements, countries must often rely on borrowings from
private financial markets to satisfy their liquidity needs. In
their view, these markets are an inherently unstable source of
international liquidity. An allocation of SDRs could provide
countries with a source of international liquidity not subject
to the uncertainties of the private markets. An allocation
would reduce the cost of acquiring reserves through current
account adjustments by providing reserves that might otherwise
only be acquired through a reduction of imports. According to
proponents, an allocation would also be in keeping with the aim
of making the SDR the "principal reserve asset in the
international monetary system."
Opponents of an SDR allocation respond with the following
considerations. In their view, the international financial
markets have proved capable of meeting the liquidity needs of
creditworthy countries. Indeed, the only countries that have
experienced difficulties in satisfying their reserve needs,
according to traditional statistical measures, have been the
capital-importing countries with recent debt-servicing problems.
This suggests that the criteria specified in the Articles for an
allocation — in particular the long-term global need to
supplement existing reserve assets — are not now being met.
Furthermore, problems relating to a lack of access to private
markets should be addressed through the use of conditional
sources of liquidity associated with economic, financial, and
structural policy reforms by debtor countries, rather than
through the creation of unconditional liquidity such as an SDR
allocation.
SDR Allocations to Promote Development Objectives
During the negotiations leading to the creation of the SDR,
and subsequent discussions in the 1970s on reform of the
international monetary system, a number of proposals were
advanced for an "SDR aid-link" which would facilitate resource
transfers to developing countries through non-budgetary means by
allocating SDRs to them in excess of their shares in IMF quotas.
More recently, the Group of 24 — a body of Finance Ministers
and Central Bank Governors representing the developing nations
— has renewed these calls.

-9-

The proposals for an SDR "aid-link" have not received wide
support among creditor governments for several reasons. These
countries believed that the use of the SDR in this manner would
be inconsistent with the criteria for an allocation specified in
the Articles of Agreement and incompatible with the objective of
preserving the status of the SDR as a reserve asset. While
recognizing the need to increase resource transfers to
developing countries, creating SDRs, an international money, for
this purpose was considered potentially inflationary and an
undesirable precedent.
Furthermore, such "back door" means of financing foreign
assistance that circumvented legislative prerogatives and normal
budgetary processes were considered inappropriate and
undesirable. In this connection, an SDR allocation for
developmental purposes might not result in a net increase in
resource flows if, as was likely, other foreign assistance
financing was curtailed. Finally, there was concern that use of
the SDR for resource transfers would politicize decisions on
allocation and use, thereby diminishing the flexibility
necessary to preserve the monetary function of the SDR.
"Conditional" SDR Allocations
In recent years, there have been a number of proposals to
allocate SDRs for use in connection with formal IMF adjustment
programs as a means of responding to concerns that unconditional
SDR financing could undermine incentives to implement needed
economic reforms. In some proposals, the allocated SDRs would
augment regular IMF resources, while in others the SDRs would be
used for specific purposes such as facilitating the
securitization and reduction of LDC debt to private commercial
banks.
The proponents of proposals to allocate SDRs to augment IMF
financing of economic adjustment programs argue that it would
provide an alternative to financing an IMF quota increase, which
would not involve use of budgetary resources or lengthy
legislative approval, as well as a means of fostering the role
of the SDR in the system. Concerns have been expressed,
however, that decisions to augment IMF resources should be
reached on their own merits, independent of considerations
relating to the SDR. (Discussions are currently underway on a
possible increase in IMF quotas but no decisions have been
reached.) Moreover, it was feared that allocating SDRs for this
purpose would erode the role of the IMF as a quota-based
institution and create a precedent that could upset the careful
checks and balances between debtors and creditors built into
current IMF arrangements (e.g., voting power, weighted
majorities on key issues). Furthermore, since many creditor
governments, including the United States, would require
legislative approval to provide a grant or loan of SDRs to the
IMF, the purported benefits in expediting decisions on IMF

-10-

resource increases would be illusory. Finally, the real
resource commitments which the United States and other creditor
countries would be undertaking could increase substantially,
since their obligation to accept SDRs would rise by a multiple
of the amounts allocated and could exceed significantly the
commitments arising from a comparable increase in quota
subscriptions.
More recently, proposals have been made to use SDR
allocations to guarantee interest payments on new bonds issued
by LDC debtors, which would be exchanged for discounted
commercial bank claims. According to such proposals, a fund
would be created in the IMF and financed through an SDR
allocation in which developed countries would set aside their
share of an SDR allocation for use by developing countries.
Heavily indebted middle-income countries would be eligible to
use this facility, provided that they were implementing IMF
approved adjustment programs.
Since the SDR cannot be used or held by private entities,
such proposals would require that the developed countries
provide currencies in exchange for SDRs to the LDC debtor or to
the IMF to make required payments to commercial banks. In
effect, creditor governments would be providing the same
currency resources to facilitate debt reduction that would have
been provided if IMF quota resources were used. In such
circumstances, the real issue is whether the IMF should be used
to assist in debt reduction and whether its quota resources are
adequate for this purpose.
PART FIVE: IMF AND OTHER ACTIONS
TO ADDRESS THE NEEDS OF THE
POOREST COUNTRIES
The international community, including the IMF, has
recognized increasingly the severe economic problems facing the
poorest countries and their special financial needs. In recent
years, the IMF has taken a number of steps to address this
problem. In addition, creditor governments have initiated new
programs to provide debt relief on highly favorable terms for
the poorest countries.
In 1986, the IMF established the Structural Adjustment
Facility (SAF) to provide balance of payments assistance on
concessional terms to the poorest countries. Under the SAF, an
eligible member could draw up to 63.5 percent of its quota over
a 3-year period. SAF loans are extended at an interest rate of
0.5 percent per annum with repayments taking place in ten equal
semiannual installments, beginning 5-1/2 years and ending
10 years from the date of disbursement.

-11-

The creation of the SAF represented a milestone in the
IMF's approach to dealing with the economic and balance of
payments problems of the low-income countries. Its
establishment reflected the growing recognition that the
longer-term structural economic problems facing the low-income
countries could not readily be resolved through traditional IMF
programs, which rely on short-term financing at market-related
rates of interest. Instead, comprehensive growth-oriented
measures needed to be developed to tackle structural impediments
to growth and correct protracted balance of payments
disequilibria.
This approach also recognized that a coordinated effort by
the IMF, World Bank, and bilateral donors was essential to
catalyze concessional resources for and to promote comprehensive
growth-oriented reforms in these countries. To this end, the
IMF and World Bank intensified their collaboration through the
establishment of the Policy Framework process. Under this
process, members eligible to use the SAF would develop a
medium-term Policy Framework Paper (PFP), outlining a 3-year
structural adjustment program. The PFP is developed jointly by
the staffs of the IMF and World Bank and contains an assessment
of the social impact of the proposed policy measures as well as
the country's financing needs and possible sources of financing,
including those from the SAF and World Bank.
In connection with the 1987 Venice Summit, IMF Managing
Director Michael Camdessus proposed a significant expansion in
the resources of the SAF. In response to this proposal, the
Enhanced Structural Adjustment Facility (ESAF) was established
in December 1987. The resources for the ESAF are being provided
by a group of industrial and developing countries which have
agreed to lend about SDR 6 billion to a special IMF trust and
provide contributions to an interest subsidy account to enable
the trust to extend financing with a concessional interest rate.
Access under the ESAF will be determined for individual
countries on a case-by-case basis with respect to their balance
of payments need and the strength of their adjustment effort.
Total access on average is intended to be around 150 percent of
quota over the 3-year period of the ESAF program, and maximum
access is 250 percent of quota. This ceiling may be extended in
exceptional circumstances up to a maximum of 350 percent of
quota.
At the end of February 1989, 30 SAF and ESAF arrangements
were in place with commitments totaling SDR 2.3 billion. Of
these 30 arrangements, 23 represented programs with Sub-Saharan
African nations. A number of new ESAF arrangements are expected
to be put in place in the coming months.

-12-

The PFP process is having the desired catalytic effect in
support of growth-oriented reforms. In addition to the amounts
committed by the Fund, the World Bank, for its part, agreed to
earmark $3 to 3 1/2 billion of the $12.4 billion of the Eighth
Replenishment of the International Development Association (IDA)
for adjustment programs related to PFPs. Furthermore, the Bank
has extended over the 1986-88 period, $3.9 billion in adjustment
lending to the 30 countries with PFPs. Substantial donor
support is also being catalyzed through co-financing, in
particular for Sub-Saharan Africa under the Special Program of
Assistance. Donor co-financing for IBRD Fiscal Years 1988-90 in
Sub-Saharan Africa is projected to total $12.5 billion under IDA
and IBRD operations.
Furthermore, at the 1988 Toronto Summit, the Heads of State
or Government of the seven Summit countries agreed to ease the
debt servicing burdens of the poorest countries undertaking
internationally supported adjustment programs. The Paris Club
has recently completed work in implementing the Toronto Summit
Declaration. It has established a framework of comparability,
under which concessional debt will be rescheduled at
concessional interest rates over 25 years, including 14 years'
grace. On non-concessional debt, creditors may choose from
several options to reduce the debt service burden: 1) write-off
one-third of debt service due, with the remainder rescheduled
over 14 years with 8 years' grace; 2) reduce interest rates by
3.5 percentage points, or by half if the original rate is less
than 7 percent, with repayment taking place over 14 years with 8
years' grace; and 3) reschedule at market-based rates over 25
years with 14 years grace.
To support these international efforts on behalf of the
low-income countries, especially Sub-Saharan Africa, the
Administration is submitting a request, as part of the FY 1990
budget, for authorization and appropriation of a $150 million
contribution by the United States to the ESAF Interest Subsidy
Account. A modest U.S. contribution to the ESAF represents a
very cost effective means of promoting economic reforms and
political stability in many countries of key importance to the
United States. The resources
which
the ESAF can bring to bear
PART SIX:
CONCLUSION
in these countries is many times the amount being provided by
the United States to the facility or through U.S. bilateral
Major programs.
changes in international monetary arrangements since
assistance
the SDR was created in 1969 — particularly the movement towards
a generally floating multiple currency system and the evolution
of large globally integrated private capital markets — have
affected the basic rationale for the SDR. Nevertheless, the SDR

-13-

continues to play an important role in the international
monetary system as a liquid international reserve asset. In an
effort to expand the role of the SDR under present international
monetary arrangements and to deal with LDC debt problems, a
number of proposals have been advanced to use the SDR to promote
development objectives, facilitate debt relief, and/or
facilitate adoption of growth-oriented adjustment programs.
The economic and financial problems facing the developing
nations, particularly the poorest, are a serious concern of the
United States and the international community. A number of
steps have been taken, and there is scope for additional action.
In this connection, however, the use of a monetary reserve asset
such as the SDR has a number of drawbacks.
o The provision of unconditional financing through a
generalized use of the SDR could undermine adjustment
incentives and contribute to an increase in inflationary
pressures.
o Use of the SDR to provide aid to the poorest countries
could weaken the liquidity of the instrument and its
usefulness as a monetary reserve asset.
o A reduction in the usefulness of the SDR as a monetary
reserve instrument could adversely affect the liquidity
of U.S. reserve assets.
Consequently, it is unlikely that the 85-percent majority
necessary to amend the IMF Articles of Agreement to provide for a
special purpose SDR allocation could be obtained.
The international community, including the IMF, has taken a
number of steps to address the pressing economic needs of the
low-income countries. These measures seek to promote on a
case-by-case basis economic reforms, supported by external
financing or terms that reflect the specific needs of the poorest
countries. The creation of the IMF's Enhanced Structural
Adjustment Facility (ESAF) represents an important new initiative
for this purpose.
A U.S. contribution to the ESAF represents a highly cost
effective means of assisting the poorest countries while avoiding
the potential problems of SDR-related proposals. For this
purpose, the fiscal 1990 budget request provides for a U.S.
contribution to the ESAF Interest Subsidy Account of $150 million

•<*•

o

CM
CO
CO
to

federal financing b a n k .

0)

0)
CD

WASHINGTON, D.C. 20220

a.

March 16, 19 89

FOR IMMEDIATE RELEASE

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Secretary, Federal Financing
Bank (FFB), announced the following activity for the month
of August 1988.
FFB holdings of obligations issued, sold or guaranteed
by other Federal agencies totaled $149.8 billion on
August 31, 1988, posting a decrease of $0.1 billion from
the level on July 31, 1988. This net change was the result of
an increase in holdings of agency debt of $83.0 million, and a
decrease in holdings of agency-guaranteed debt of $210-3 million
There was no significant change in holdings of agency
assets. FFB made 59 disbursements during August.
Attached to this release are tables presenting FFB
August loan activity and FFB holdings as of August 31, 1988.

NB-183

CO
CO
• < *

eg

co

CO
lO
CD
LL
li.

Page 2 of 4

FEDERAL FINANCING BANK
AUGUST 1988 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

32,900,000.00
9,245,000.00
60,000,000.00
673,000.00

11/08/88
11/17/88
11/29/88
12/01/88

7.267%
7.382%
7.696%
7.704%

156,000,000.00
173,000,000.00
310,000,000.00
27,000,000.00
10,000,000.00
124,000,000.00
230,000,000.00
75,000,000.00
220,000,000.00
38,000,000.00
162,000,000.00
219,000,000.00
82,000,000.00
132,000,000.00
115,000,000.00
260,000,000.00

8/08/88
8/11/88
8/15/88
8/17/88
8/18/88
8/19/88
8/22/88
8/19/88
8/26/88
8/25/88
8/29/88
8/31/88
9/01/88
9/06/88
9/06/88
9/12/88

7.249%
7.181%
7.260%
7.340%
7.340%
7.340%
7.355%
7.355%
7.370%
7.407%
7.407%
7.613%
7.692%
7.692%
7.666%
7.666%

8/25/14
9/01/13
9/01/13
11/30/94
8/25/14
9/01/13
8/25/14
9/01/13

9.331%
9.182%
9.260%
8.215%
9.471%
9.523%
9.525%
9.549%

AGENCY DEBT
NATIONAL CREDIT UNION ADMINISTRATION
Central Liquidity Facility
Note #469
+Note #470
Note #471
Note #472

8/4
8/18
8/30
8/30

$

TENNESSEE VAT.TEV AUTHORITY
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance

#926
#927
#928
#929
#930
#931
#932
#933
#934
#935
#936
#937
#938
#939
#940
#941

8/2
8/5
8/8
8/11
8/11
8/11
8/15
8/15
8/19
8/22
8/22
8/26
8/29
8/29
8/31
8/31

GOVERNMENT - GUARANT^T) THANS
DEPARTMENT OF DEFENSE
Foreign Military Sales
Greece 17
Greece 16
Greece 16
Morocco 10
Greece 17
Greece 16
Greece 17
Greece 16

+rollover

8/1
8/3
8/8
8/10
8/11
8/22
8/22
8/29

6,142,189.20
2,624,775.34
11,225,000.00
10,885,287.16
1,673,432.00
3,175,197.34
3,575,250.00
714,210.25

INTEREST
RATE
(other than
semi-annual)

Page 3 of 4

FEDERAL FINANCING BANK
AUGUST 1988 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

$ 1,985,985.09
5,000,000.00
1,615,000.00
126,421.08
1,370,285.00
199,619.99
9,000,000.00
207,000.00

8/02/93
8/03/92
8/16/93
10/03/88
8/15/94
1/15/89
9/01/89
2/15/89

8.649%
8.723%
8.981%
7.175%
9.079%
7.860%
8.430%
7.976%

8.836% arm.
8.913% arm.
9.183% arm.

513,000.00
196,000.00
3,686,000.00
769,000.00
3,810,000.00
350,000.00
101,000.00
2,004,000.00
2,533,000.00
5,591,000.00
386,000.00
20,000.00
2,500,000.00
7,920,000.00
64,000.00
149,000.00
825,000.00
477,000.00
5,000,000.00

1/03/17
1/03/17
10/01/90
1/03/17
10/01/90
10/01/90
1/02/18
1/02/90
1/02/90
1/03/17
1/03/17
8/11/90
1/03/23
10/01/90
1/03/22
12/31/15
1/03/23
1/03/17
10/01/90

9.313%
9.313%
8.472%
9.250%
8.731%
8.725%
9.322%
8.489%
8.489%
9.456%
9.456%
8.771%
9.517%
8.847%
9.500%
9.559%
9.551%
9.535%
8.884%

9.207%
9.207%
8.384%
9.145%
8.638%
8.632%
9.216%
8.401%
8.401%
9.347%
9.347%
8.677%
9.406%
8.751%
9.390%
9.447%
9.440%
9.424%
8.787%

8/01/03
8/01/08
8/01/08

9.177%
9.215%
9.215%

11/30/88

7-700%

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
Community Development
Mayaguez, PR
*Long Beach, CA
* Rochester, NY
San Juan, PR
*Alhambra, CA
Montgomery County, PA
Detroit, MI
Newport News, VA

8/1
8/1
8/4
8/9
8/15
8/15
8/17
8/29

9.285% arm.
8.608% arm.

RURAL ELECTRIFICATION ADMINISTRATION
>N
*Tex-La Electric #208A
*Tex-La Electric #208A
Kamo Electric #209
*Tex-La Electric #208A
*Allegheny Electric #175A
*Wolverine Power #101A
New Hampshire Electric #270
*Wolverine Power #182A
*Wolverine Power #183A
*Wabash Valley Power #104
*Wabash Valley Power #206
*Wabash Valley Power #206
Contel of Kentucky #254
Associated Electric #328
Brazos Electric #144
*Wolverine Power #191
Tel. util. of E. Oregon #256
*Wabash Valley Power #206
Tri-State Electric #250

8/1
8/1
8/5
8/8
8/10
8/10
8/10
8/10
8/10
8/11
8/11
8/11
8/12
8/24
8/24
8/26
8/29
8/29
8/30

SMALL BUSINESS ADMrNISTRATION
State and Local Development Company Debentures
Dev. Corp. of Middle Georgia
N.E. Louisiana Industries Inc.
Pioneer Country Dev. Inc.

8/10
8/10
8/10

265,000.00
172,000.00
42,000.00

TENNESSEE VALLEY AUTHORITY
Seven States Energy Corporation
+Note A-88-11 8/30

*maturity extension

671,038,262.21

qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.

Page 4 of 4
FEDERAL FINANCING BANK HOLDINGS
(in millions)
Net Change
Program
August
Agency Debt:
$
Export-Import Bank
NCUA-Central Liquidity Facility
Tennessee Valley Authority
U.S. Postal Service
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.
DOE-Geothermal Loan Guarantees
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
Rural Electrification Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
$
TVA-Seven States Energy Corp.
DOT-Section
•figures may 511
not total due to rounding
DOT-WMATA
+does not include capitalized interest
sub-total*
grand total*

31. 1988
1 1 ,226. 2
118. 1
1 7 , 114. 0
592.
2
5,

Julv 3 1 . 1988
$

11,226.2
95.2
17,054.0
5,592.2

8/1/88 -8/31/88

$

FY '88 Net Change
10/1/87-8/31/88

-023.0
60.0
-0-

$ - 1 ,2 3 7 . 3
6- 8
728. 0
2
3
8
.8
1,

3 4 , 650. 6

33,967.6

83.0

736. 3

59, 464. 0
79- 3
96. 4
-0,071.
2
4,
15. 8

59,674.0
79.3
96.4
-04,071.2
16.1

-210.0
0.0
0.0
-0-0-0.3

" 5 ,,545. 0
-4. 7
-5. 9
- 0 .,7
-170.,0
- 3 ..8

,726.,7
63 ,

63,936.9

-210.3

- 5 ,r 7 3 0 ..0

18,r 584..2
4,,940.,0
50,.0
321,.8
-02,,037,.0
387,.5
32 .6
26 .6
898 .8
1 ,758 .9
19 ,224 .8
670 .7
874 .3
1 ,999 .7
48 .3
177 .0

18,556.5
4,940.0
50.0
321.0
-02,037.0
387.5
32.6
26.6
949.4
1,758.9
19,206.0
675.5
879.6
1,986.1
48.5
177.0

27.7
-0-00.9
-0-0-0-00.0
-50.6
-018.8
-4.8
-5.3
13.6
-0.2
-0-

-579..8
-050..0
- 2 ..4
- 3 0 ,.6
- 3 7 ,.3
-8 .0
-0 .5
-0 .6
90 .2
-29 .4
-1 ,972 .1
-69 .9
-25 .5
176 .0
-7 .1
-18-

52 ,032 .1

52,032.1

0.0

-2 ,447 .1

-127.3

$ "7 ,440 .8

149 ,809 .3

$

149,936.6

$

TREASURY NEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
CONTACT: Office of Financing
202/376-4350
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS

FOR IMMEDIATE RELEASE

March 20, 1989

UBRMK.RSOHSSW

,~ ?of 13-week bills and for $7,200 million
Tenders for $7,228 million
of 26-week bills, both to be issued on
March 23, 1989, were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing
June 2 2 , 1989
Discount Investment
Rate
Price
Rate 1/

Low
High
Average
a/ Excepting 2
b/ Excepting 2
Tenders at the
Tenders at the

9.00% b/
8.98%a/
9.32%
97.730
9.56%
95.450
9.01%
9.35%
97.722
9.05%
9.62%
95.425
9.00%
9.34%
97.725
9.04%
9.60%
95.430
tenders totaling $220,000.
tenders totaling $195,000.
high discount rate for the 13-week bills were allotted 13%.
high discount rate for the 26-week bills were allotted 5 3 % .
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
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

26-week bills
maturing September 21, 1989
Discount
Investment
Rate
Rate 1/
Price

Accepted

30,325
23,588,070
23,635
36,975
150,150
29,710
2,303,850
41,125
8,600
44,030
41,315
884,395
250,255

30,325
$
6 ,355,770

$27,432,435

$7 ,228,325

: $21,881,960

$7,200,300

$24,452,770
1,010,285
$25,463,055

$4 248,660
1,010,285
$5 ,258,945

: $17,672,160
:
725,200
: $18,397,360

$2,990,500
725,200
$3,715,700

1,917,280

1,917,280

:

1,800,000

1,800,000

52,100

52,100

:

1,684,600

1,684,600

$27,432,435

$7 ,228,325

: $21,881,960

$7,200,300

$

23,635
36,975
63,150
29,710
200,740
22,425
8,600
44,030
31,315
131,395
250,255

$

27,040
18,768,725
18,520
27,500
40,085
:
33,850
1,762,375
28,065
8,240
40,915
28,390
:
927,655
:
170,600

s
:
:

$

27,040
6,404,475
18,520
27,500
40,085
33,850
88,875
21,125
8,240
40,915
18,390
300,685
170,600

An additional $1,600 thousand of 13-week bills and an additional $314,800
thousand of 26-week bills will be issued to foreign official institutions for
new cash.
1/ Equivalent coupon-issue yield

NB-I34

TREASURY NEWS

papartment of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
March 21, 1989

CONTACT

Bob Levine
202/566-2041

<>%o:si5z10

ADDRESS BY DR. DAVID C. MULFORD
:> 7J
TEMPORARY ALTERNATE GOVERNOR FOR THE UNITED STATES OF AMERICA 8
bip
AT THE THIRD PLENARY SESSION
AHl,^
INTER-AMERICAN DEVELOPMENT BANK
IN AMSTERDAM

I vane co thank the Government of Che Netherlands and Che people of
Amsterdam for the very warm welcome ve have received in this beautiful and
historic cicy. I also wane Co offer my congratulations co Governor Ruding
on his election as Chairman of che Board of Governors of our Bank.
Ladies and gentlemen, there is a wave of change sweeping across
Latin America. Its results may be difficult co discern as ve continue Co
vrescle vith che debt problem. But, it is clear chat che men and women of
Latin America vho are nov in responsible policy positions are introducing
nev policies and chose policies are changing cheir countries.
Debe remains a dominant issue in Latin- America today. It
preoccupies Heads of Stace, Finance Ministers, Central Bank Governors,
businessmen, bankers, che media, and che population in general. The debt
problem La also a great challenge Co che Unieed States because ve are your
friend, as well as your largest trading partner. Latin America's standard
of living, your commitment Co democracy, and your ulcimate resolution of
che debc problem are all high priorities for che United States. Ve share
a deep common interest. And therefore ic is highly desirable that the
Inter-American Development Bank -- our Bank -- make its particular
contribution co resolving Latin America's debc problems.
This same wave of change has nov reached che Inter-American
Development Bank itself.
A year ago, at our meeting in Caracas, I
encouraged President Iglesias to begin building a new consensus chat could
support an expanded IDB. enabling ic co become a more important player in
promocing sustainable groweh in Latin America. Today, in Amseerdam, I
offer him my congratulations and appreciation.
After years of discussion and some difficult negotiations, we are
now close to agreement wich other major shareholders on che essential
elements of a replenishmenc vhich vould transform che IDB. If important
remaining issues can be resolved, che Bank's resources vould increase by
over $26 billion. Its four year lending program vould reach $22.5 billion,
and policy-based lending would become a reality. The replenishment, once

NB-185

f"5 • «

'S3

- 2 -

settled, vould be significant not only for the Latin American and the
Caribbean borrowers of the Bank but also for the United States. Our
participation in this single replenishment vould amount to nearly $9
billion, raising the total financial contribution of the United States to
the Bank co over $25 billion. This is a measure of the importance that
the new Administration attaches to the Bank and to its mission.
We are all now looking forward vith considerable hope and
expectation co che Bank taking up the challenge.
The replenishment,
coupled with institutional and operating reforms vill position the IDB to
assume broader responsibilities. It vill have the opportunity to make a
more significant contribution to the Inhabitants of our hemisphere, It
will be doing so in a world economic environment marked by many positive
features.
Global Economic Developments and Prospects
Maintaining a supportive macroeconomic environment in the industrial
countries has been a cornerstone of our collective efforts.
A balanced assessment of the performance of the industrial nations
vould conclude that our macroeconomic performance in recent years has been
impressive. While one could perhaps argue that this or that element of
the picture has not been fully satisfactory, the positive aspects are
clear:
economic expansion in the industrial countries is now into its
seventh consecutive year; inflationary pressures have been kept in check;
and world trade flows have expanded robustly.
We should not ignore che creraendous resilience chat our economies
showed in che wake of the financial market turbulence in lata 1987.
Contrary to widespread expectations ac che cime, Induscrlal country grovth
picked up strongly last year, pulling vorld trade grovth up about 9
percent.
Our cask nov Is to continue to build on the firm foundation we have
laid.
The next few years vill surely be challenging, as the past fev
years have been. Sustaining growth, resisting inflation, and bolstering
trade must remain the principal objectives for the industrial countries
and the LDCs as well. I am confident chat ve vill meet these challenges.
The United States has played a central role in constructing this
foundation and vill continue to play an important part in further efforts.
Our casks are several. First, we need to sustain growth. We anticipate
real growth in the 3.0 percent range through 1990, which would be the
eighth consecutive year of expansion. Second, we need to keep the lid on
inflation.
Some recent statistics in the U.S. point to some price
firming, but the general economic data are mixed with no clear and
compelling evidence that Inflationary forces are rising.
12. The third key cask for the United States is to continue to make
progress tn reducing our Federal budget deficit. The Administration has

- 3 -

made a clear commitment to meet the deficit targets laid out by the
Gramm-Rudman process and negotiations are in progress at this time.
Finally, we need to continue reducing U.S. trade and current account
imbalances. Last year, 1988, ve made substantial progress and ve look for
more progress this year.
Strengthening the Debt Strategy
In the world environment, as seen from Latin America, the debt
problem casts its long shadow over the landscape.
Sunday I spoke of
Secretary Brady's recent proposals for strengthening the international
debt strategy. Although important progress has been made in recent years,
che Bush Administration recognizes that the debt difficulties facing
developing nations of the Western Hemisphere remain a serious global
problem.
Our suggested approach builds upon the basic principles chat have
guided international efforts in recent years. It recognizes the central
importance of stronger growth, economic policy reforms, external financial
support, and a case-by-case approach to individual nations' problems.
Our proposals vould maintain a central role for the IMF and World
Bank within the debt stracegy in encouraging dabcor policy reforms and
catalyzing financial support.
This is because the heart of the problem
is still the reform of economic policies to produce key structural changes
and sustained economic performance. While ve recognize the continuing need
for nev lending from commercial banks, we need to place stronger emphasis
on new investment flows and the repatriation of flight capital as
alternatives to over-reliance in recent years on private bank loans. To
this end, we vould encourage che IMF and World Bank to vork vith debtor
nacions to focus on specific measures to improve the investment climate
and to encourage the return of flight capital in addition to promoting
vital macroeconomic and structural reforms.
The initiative for structural reform and a sound investment climate
must come from vithin each debtor nation. This is a difficult issue for
many nations in Latin America as elsevhere. But experience shows that
where reforms are made, economic results help resolve non-economic
problems.
In any case, che problems that must be faced in order co
accomplish reform are not so difficult as those that result from
stagnation and decline.
In developing our new proposals we have borne in mind particularly
Chose countries which have made important reforms, as veil as those that
are villing to commit their policies and energy co major reform efforts.
In short, there needs to be light at the end of the tunnel.
We believe it is necessary to place greater emphasis on
international efforts to achieve more rapid and broadly based voluntary
debt reduction and debt service reduction. This will improve prospects
for stronger growch especially where countries have already made important

- 4 -

reforms in their economies and stand poised co benefit from their past
sacrifices.
The U.S. proposals visualize redirecting and increasing available
IMF and World Bank resources -- from their current capital stock -- to
support debt and debt service reduction transactions agreed in the market
by debtor nations and commercial banks.
This concept involves an
important shift in focus away from the present practice of using official
resources in ways that, in effect, increase a debtor nations' stock of
debc and ultimately its debt service burden.
Debtor nations which wish to engage in a debt reduction program
should develop policy reform programs with the IMF and World Bank, as a
condition for access to financial support for debt reduction. At the same
time, commercial banks and debtors should negotiate general waivers
covering such areas as che sharing and negative pledge provisions in
existing commercial bank agreements.
These waivers, which we have
suggested might have a life of three years, could come into effect whan
IMF and World Bank disbursements become Available, thus making it possible
for multiple transactions between a debtor and the banks to reduce debt
and debc service.
Once a general waiver has been agreed upon, a portion of IMF
financing and World Bank policy-based loans could be made available co
support debt reduction operations. The set-aside amounts could operate as
standby credits to collateralize discounted debt/bond agreements or to
replenish debtor reserves following cash buybacks during the period of che
waiver.
For debcor nations vhich have negotiated agreements to reduce the
stock of debt, the IMF and World Bank could also make available support
for interest payments on a rolling basis for a limited period.
Such
support could be available for debt restructurings or exchanges which
involve either a substantial discount of principal or a major reduction in
interest rates.
In addition to the measures to facilitate reduction of commercial
bank debt, the Paris Club should continue providing support through
rescheduling based on debtor performance, with agreement contingent upon
an IMF standby program or extended financing program (EFF). Key creditor
countries might also seek to assure continued access to official export
credit support for debtor nations adopting Fund and World Bank programs.
We would encourage creditor nations to review regulatory,
accounting, and cax provisions with a view to reducing or eliminating
impediments to debt reduction, where those exist, while of course
maintaining che safety and soundness of the financial system.
Creditor
countries that are in a position co do so should provide financial support
to this effort.

- 5 -

We are noc proposing these ideas as immediate alternatives to the
current process of direct negotiations between debtors and creditors.
Rather, we are suggesting that new approaches and emphasis should be
phased Into ongoing discussions between these parties in order to avoid
any interruptions in their orderly relations.
The process might work in the following way. Each debtor nation
would work out with its commercial bank creditors a range of debt and debt
service reduction instruments as a central element of meeting the debtor's
financing needs.
Debtors and their creditors could choose any number of debc
reduction mechanisms.
Debt reduction transactions, for example, might
include: the offer of specific instruments (such as debt/bond exchanges)
to all commercial banks; cash buybacks up to a maximum amount; and/or the
negotiation of specific
debt/equity or non-collateralized
interest
reduceIon instruments with individual banks.
An integral part of che approach vould be for debtor nations engaged
in debt reduction to maintain viable debt/equity swap programs, vhich can
make a substantial concribucion to debt reduction and already has done so
in several important
countries.
Provisions vhich permit
domestic
nacionals Co engage in such transactions could also contribute to the
repatriation of flight capital, as we have seen already in the case of
Chile.
Debc reduction transaction *T* n°f- «vp#r.r.Ad to cover all the
financing needs of debtor countries. Additional nev financing commitments
will also be needed -• in the form of concerted lending, club loans by a
group of banks, or a range of trade, investment, or other credits from
individual banks. In some cases, this might involve a differentiation of
new loans from old debt.
Repatriation of flight capital and new
investment are other potential sources of finance. It is hoped that the
combination of these resources vill enable debtor nations to finance their
needs and to meet their obligations on a timely basis. The IMF should
continue to monitor progress, and each country should report on a regular
basis Co che IMF and Che World Bank on progress in ics negotiations vith
commercial banks.
Taken together, these proposals represent a basis on which ve can
vork together to revitalize the current debt strategy. This will require
broad international support and cooperation between creditor and debtor
governments, the commercial banking community, and the international
financial institutions. Japan has already expressed their strong support,
including a willingness to provide supportive financing, and a number of
other creditor and debtor nations have responded favorably to the general
approach vhich ve have outlined.
We look forward to discussing these proposals in the coming weeks
and especially at the spring meetings of the IMF and World Bank. We
believe the proposals we have outlined, including efforts to stimulate

- 6 -

broader voluntary debt and debc service reduction, provide substantial
benefits for debtor nations In the form of more manageable debt service
obligations, smaller and more realistic financing needs, stronger economic
grovch, and higher standards of living for their people.
The Inter-American Development Bank
Turning once again co the IDB, President Iglesias has already begun
to create a stronger institution vhich can address the very serious
problems of our Latin American and Caribbean member countries.
His
efforts to chart a course for the Bank have been impressive and he well
deserves our praise for the leadership he has displayed and for his
perseverance.
He also needs the support of our governments and this
includes more Chan che provision of capital.
We muse help define the Bank's mission and sharpen its focus. The
recent task force reports, prepared at the President's Initiative, address
key organizational and operational Issues.
We strongly encourage all
members co work cooperatively and enthusiastically with the President and
vith Management to implement the changes that vill be necessary to
transform the Bank. This may be a difficult process because there are
some differences between member countries. However, I am certain that ve
will find constructive ways to deal with our various points of view.
Indeed, ve must do so ... if we want to help Latin America and the
Caribbean ... and ve muse do so, if ve want a strong IDB.
The Bank needs co be in a position to encourage its borrowers to
adopt policies that improve economic performance, stimulate new foreign
investment, increase domestic savings, and encourage the repatriation of
flight capital. Private sector initiatives and che development of market
based economies should be emphasized. Specific policy measures designed
to help achieve these objectives should be an Integral part of the Bank's
lending operations.
Environment
The IDB's treatment of environmental issues must improve. This is
an area of global importance of concern to us all. The Bank's assessment
of che environmental impact of projects and programs that it helps to
finance is critical. Over the past year, Che Bank has made continued
progress in providing Graining Co its permanent staff on the importance of
environmental Issues. Seminars have been held on issues such as reservoir
silting, shoreline conservation, and biodiversity issues in Latin America.
The Bank Is emphasizing environmentally-beneficial projects and providing
technical assistance aimed at Improvements in watershed management and
riverine systems in Ecuador and Colombia.
We applaud these and other
initiatives the Bank has taken to promote environmental issues.
More needs to be accomplished, hovever, on organizational and
staffing changes to produce effective environmental assessment procedures.
The Bank needs a senior envtronraencal line unit vith a clear mandate, and

- 7-

with the strong, consistent support from President Iglesias to participate
fully in project identification, preparation and appraisal. I strongly
recommend chat the President's Committee on the Environment take the lead
in evaluating and distributing information on the environmental assessment
of the Bank's projects and programs.
Conclusion
And finally, Mr. Chairman, a closing note. The extensive and
protracted negotiations to replenish the Bank's resources continue to be
near completion. We need to settle the last remaining issues as soon as
possible.
The Bank needs to recover its momentum and to adjust its
priorities. The first priority surely must be to move ahead with an
expanded Bank that can address Latin America's most urgent challenges.
Thank you very much.

TREASURY NEWS

Department of the Treasury • Washington, D.C. • Telephone
CONTACT: Office of-Financing
202/376-4350

FOR RELEASE AT 4:00 P.M.
March 21, 1989
TREASURY'S WEEKLY BILL OFFERING f 3 ° "•
The Department of the Treasury, by this public notice, Invites
tenders for two series of Treasury bills totaling approximately
$14,400 million, to be issued March 30, 1989.
This offering
will provide about $125
million of new cash for the Treasury, as
the maturing bills are outstanding in the amount of $14,28 5 million.
Tenders will be received &t Federal Reserve Banks and Branches and
at the Bureau of the Public Debt, Washington, D. C. 20239, prior to
1:00 p.m., Eastern Standard time, Monday, March 27, 1989.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
December 29, 1988, and to mature June 29, 1989
(CUSIP No.
912794 SG 0), currently outstanding in the amount of $7,3 57 million,
the additional and original bills to be freely interchangeable.
182-day bills (to maturity date) for approximately $7,200
million, representing an additional amount of bills dated
September 29, 1988, and to mature September 28, 1989 (CUSIP No.
912794 SL 9), currently outstanding in the amount of $9,419 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 March 30, 1989.
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 $1,57 8 million as agents for foreign
and international monetary authorities, and $3,405 million for their
own account. Tenders for bills to be maintained on the book-entry
NB-186
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).

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
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.

TREASURY NEWS

2041

Department of the Treasury • Washington, D.c. • Telephone
' ' •'!•« R 3 1

M 5310

FOR IMMEDIATE RELEASE

March 22, 1989

•**B a
TML:

Monthly Release of U.S. Reserve Assets
The Treasury Department today released U.S. reserve assets data
for the month of February 1989.
As indicated in this table, U.S. reserve assets amounted to
$49,373 million at the end of February, up from $48,190 million in
January.

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

End
of
Month

Total
Reserve
Assets

Gold
Stock 1/

Special
Drawing
Rights 2/3/

Foreign
Currencies

48,190
49,373

11,,056
11.,061

9,388
9,653

18, 324
19,,306

1/

Reserve
Position
in IMF 2/

1989
Jan.
Feb.

,422
9,
9,,353

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.

NB-187

TREASURYNEWS
Otportment of the Treasury • Washington, D.C. • Telephone 566-2041
! !D t
l L !V

FOR I M M E D I A T E R E L E A S E

Lib,' -rt-j. -A,0H 55
March 2 2 t

1939

•i£f? n

Steven W. Broadbent
Appointed Deputy Assistant Secretary
for Information Systems

Secretary of the Treasury Nicholas F. Brady today announced the
appointment of Steven W. Broadbent to serve as Deputy Assistant
Secretary for Information Systems, effective March 13, 1989. In
that capacity, Mr. Broadbent will serve as the principal advisor
to the Assistant Secretary for Management on Information Systems
issues.
Previously, Mr. Broadbent was associated with AT&T in a variety
of sales, sales management, and network operations positions from
1982 to 1989.

A native of New Jersey, Mr. Broadbent now lives in Washington,
D.C. where he is active in the United States Naval Reserve.

NB-188

TREASURYNEWS
Department of the Treasury •:• » Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE
March a, 1989

'-y^'xi.
J

• v:Cj
r 7 7

--CONTACT:

LARRY BATDORF
{101) 566-2041

— 'X

^ 61

A --- *u -

3tP;. R 7 , .

U.S.-SPAIN INITIAL DRAFT INCOME TAX TREATY
The Treasury Department today announced that a proposed
Convention for the Avoidance of Double Taxation of Income and the
Prevention of Fiscal Evasion between the United States and Spain
was initialled in Washington on March 16, 1989.
The draft
Convention and an accompanying Protocol will be transmitted to
the appropriate authorities for approval and signature. Details
of the texts will remain confidential until signed and submitted
for ratification.
The proposed Convention provides rules for the taxation at
source of business profits, employment income, and investment
income, including reduced rates of tax at source on dividends,
interest, and royalties. It takes into account changes in U.S.
tax law introduced by the 1986 Tax Reform Act, such as the branch
tax; and it provides for administrative cooperation and the
limitation of treaty benefits to prevent "treaty shopping".
Once signed, the proposed Convention and Protocol will be
submitted
to the Senate
for its advice and consent to
ratification. The Convention and Protocol will enter into force
on ratification and will apply prospectively.
It is hoped that
the new treaty will be ratified before the end of 1989.
o 0 o

NB-189

TREASURYNEWS

Department of the Treasury • Washington, D.c. • Telephone 566-2
'-^ ?• •'

FOR RELEASE AT 4:00 P.M.
March 22, 1989

H"P

• rib »

CONTACT:

Office of Financing
202/376-4350

B 8 55 /IN %B
vErArUHLK .

TREASURY TO AUCTION 2-YEAR AND 4-YEAR NOTES
TOTALING $16,750 MILLION
The Treasury will auction $9,250 million of 2-year notes
and $7,500 million of 4-year notes to refund $16,527 million
of securities maturing March 31, 1989, and to raise about $225
million new cash. The $16,527 million of maturing securities
are those held by the public, including $2,151 million currently
held by Federal Reserve Banks as agents for foreign and international monetary authorities.
The $16,750 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 prices of accepted competitive tenders.
In addition to the public holdings, Federal Reserve Banks,
for their own accounts, hold $2,322 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.
Details about each of the new securities are given in the
attached highlights of the offerings and in the official offering
circulars.
oOo
Attachment

NB-190

HIGHLIGHTS OF TREASURY OFFERINGS TO THE PUBLIC
OF 2-YEAR AND 4-YEAR MOTES TO BE ISSUED MARCH 31, 1989
March 22, 1989
Amount Offered to the Public ... $9,250 million
$7,500 million
Description of Security:
Term and type of security
2-year notes
4-year notes
Series and CUSIP designation ... Series X-1991
Series N-1993
(CUSIP No. 912827 XH 0)
(CUSIP No. 912827 XJ 6)
Maturity date
March 31, 1991
March 31, 1993
Interest Rate
To be determined based on
To be determined based on
the average of accepted bids
the average of accepted bids
Investment yield
To be determined at auction
To be determined at auction
Premium or discount
To be determined after auction To be determined after auction
Interest payment dates
September 3 0 and March 31
September 3 0 and March 31
Minimum denomination available . $5,000
$1,000
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%
Accepted in full at the averNoncompetitive tenders
Accepted in full at the aver- age price up to $1,000,000
age price up to $1,000,000
None
Accrued interest payable
by investor
None
Payment Terms:
Full payment to be
Payment by non-institutional
submitted with tender
investors
*. . Full payment to be
Acceptable for TT&L Note
submitted with tender
Option Depositaries
Payment through Treasury Tax
and Loan (TT&L) Note Accounts .. Acceptable for TT&L Note
Acceptable
Option Depositaries
Deposit guarantee by
Wednesday, March 29, 1989,
designated institutions
Acceptable
prior to 1:00 p.m., EST
Key Dates:
Receipt of tenders
Tuesday, March 28, 1989,
prior to 1:00 p.m., EST
Friday, March 31, 1989
Settlement (final payment
Wednesday,
March 29, 1989
due from institutions):
a) funds immediately
b) available
readily-collectible
to the Treasury
check ... Wednesday,
Friday, March
March
31,29,
1989
1989

TREASURYNEWS^
Department of the Treasury • Washington, D.c. • Telephone sss-2041

Embargoed For Release Until Delivery
Expected at 1:00 p.m. EST

TESTIMONY BY JAMES H. FAIJ,. Ill
ACTING DEPUTY ASSISTANT SECRETARY
FOR DEVELOPING NATIONS
DEPARTMENT OF THE TREASURY
BjBFORJSJEBE
HOUSE FOREIGN AFFAIRS SUBCOMMITTEE OM
ASIAN AND PACIFIC AFFAIRS
(March 7, 1989)
Introduction
Mr. Chairman:
I am pleased to have the opportunity to testify before this
Subcommittee today on the Philippines. Since you have expressed
particular interest in the Philippines debt situation, I vould
like to comment in some detail on the magnitude and composition
of the Philippines debt and on its debt servicing burden.
I would also like to provide the Treasury Department's views
on the proposed Multilateral Assistance Initiative (MAI). Let me
state that the Treasury Department supports the MAI's key
objectives of preserving and strengthening democracy in the
Philippines, reinforcing the government's economic restructuring
efforts, and assuring a firm basis for sustained, noninflationary grovth. We are fully committed to working vith the
Congress and ths rest of the Executive Branch in an effort to
ensure its success.

- 2 The Philippines Debt Situation
External Debt - At the end of 1988, the Philippines external
debt totalled an estimated $28.2 billion, equivalent to 74% of
its Gross National Product (GNP). The Philippines scheduled debt
service (i.e., before deferrals of principal and interest payments
through rescheduling) vas equal to an estimated 49% of its exports
of goods and services. Later on in this testimony, I vill compare
these percentages vith those of other major middle-income debtors.
The Philippines has benefited from a substantial rescheduling
of amortization and interest payments. The International Monetary
Fund (IMF) estimates that, since 1985, the Philippines has deferred
$4.8 billion in amortization payments due to commercial banks and
about $2 billion of principal and interest payments to official
bilateral creditors through the Paris Club. Total deferrals in
1985-1988 amounted to $6.8 billion, or 38% of payments of principal
and interest scheduled in that period.
In 1988 alone, the Philippines deferred $832 million in
payments due to its commercial bank creditors and another
$376 million to Paris Club creditors.
Thus, the Philippines
actual debt service payments in 1988 (after debt rescheduling)
accounted for an estimated 3 5% of its exports of goods and
services. This represents a deferral of debt service equal to
about 14% of its exports of goods and services in that one year.
Composition of External Debt - According to the latest
available data (for September 1987), about 85% of the Philippines
total external debt vas medium- and long-term (including debt to
the IMF) and 15% vas short-term. (See Table 1.)
o About $15 billion, or 54%, vas owed to commercial
banks, including $11.5 billion in medium- and long-term
debt.
o Suppliers credits accounted for an additional
$2.2 billion, or 8%. The bulk of this ($1.6 billion)
had maturities of more than one year.
o Nearly $5 billion, or 18%, vas medium- and long-term
debt to multilateral institutions. More than half of
this vas owed to the World Bank, vith the balance
split fairly evenly betveen the IM? and Asian
Development Bank.
o About $4.4 billion, or 16%, vas medium- and long-term
debt to or guaranteed by official bilateral creditors,
such as the U.S. Government.
Debt to the United States - As of June 1988, the Philippines
debt to the U.S. Government totalled somewhat mora than

- 3 $1.1 billion. The Export-Import Bank vas the largest U.S.
government creditor, vith $479 million outstanding, followed by
AID, vith $311 million outstanding. (See Table 2.)
The U.S. Government had also guaranteed an additional
$1 billion in loans and insurance on behalf of Philippine debtors
as of June 1988. The Export-Import Bank was the largest U.S.
Government guarantor, vith $652 million in contingent liabilities,
folloved by 0PIC, vith $325 million in guarantees and insurance.
The Philippines debt to U.S. commercial banks vas estimated
at about $4.2 billion as of September 1988.
Domestic Debt - At the end of 1987, Philippine national
government bonds outstanding (excluding those held by the monetary
authorities) vere estimated at $8 billion, or about 23% of GNP.
Information on the maturity structure and yields of these bonds
is not available.
The national government's total interest payments, hovever,
on both domestic and foreign debt rose sharply from 9% of its
current outlays and net lending in 1983 to 27% in 1987. As a
percentage of GNP, such interest payments increased from 1.3% in
1981 to 5.2% in 1987. Most of this increase resulted from the
government's groving reliance on domestic, rather than foreign,
financing for the fiscal deficit and from the high interest rates
that prevailed during that time. The government's assumption of
the domestic and foreign debt service obligations of the
government non-financial institutions also played an important
part in this increase.
The Philippines Debt Burden: An Assessment
Given the debt and debt service indicators that I have
described, the question arises as to vhether the Philippines can
afford to incur additional debt, particularly additional external
debt. In other vords, vill the Philippines be able to continue
to service the debt that it already has, let alone additional
debt?
In general terms, the ansver to both of these questions is,
"It depends." Barring unforeseen, adverse external events such
as a sharp increase in international interest rates or in the
price of petroleum, a sudden drop in international commodity
prices, or a rise in trade barriers in the Philippines principal
export markets, the Philippines ability to take on and service
additional debt depends largely on the government's continued
commitment to, and succass in, implementing economic reform and
restructuring and on President Aquino's enlightened leadership in
this rsgard.

4
We are confident that President Aquino's leadership and the
government's strong commitment to economic reform and
restructuring vill continue to contribute to diversification and
grovth of the Philippines exports, to significant real grovth of
the Philippines economy, and to an easing of the Philippines debt
burden.
Thanks in large part to the Philippines reneved commitment
to sound economic management, its economic progress in the past
three years has been impressive, compared particularly vith
performance in the early 1980s. As I shall describe later, this
has already contributed to an easing of the Philippines debt
burden.
Cumulative real GNP grovth since the beginning of 1986
exceeds 15%, compared vith a cumulative decline of 6% in 19811985. Inflation, vhich reached 26% and 51% in 1983 and 1984,
respectively, was reduced to an average of 5.2% annually in
1986-1988. Export volume grev 36% in 1986-1988, compared vith a
28% cumulative decline in 1981-1985. Imports also grev
substantially in volume terms, but the current account deficits
shrank significantly nonetheless.
The one major area vhere performance has been less positive
is the fiscal deficit. Although the consolidated public sector
deficit dropped to an average of 4.5% of GNP in 1986-1988,
compared vith 7.1% in 1981-1985, the fiscal deficit of the
national government vorsened. The latter increased from an
average of 2.8% of GNP in 1981-1985 to 3.7% in 1986-1988. The 6%
real effective appreciation of the peso in 1988 is another
disturbing factor.
As the Philippine authorities focus on their economic policy
reform priorities for the future, particular attention should be
devoted to:
o avoiding an overvalued exchange rate that discourages
exports and encourages excessive import consumption;
o adopting additional fiscal and monetary reforms that
encourage savings and investment;
o furthering trade liberalization efforts that increase
the economy's efficiency;
o continuing to liberalize lavs and administrative
procedures to give added impetus to foreign investment;
and
o restoring momentum to the government's privatization
program.

5 In assessing the veight of the Philippines debt burden,
hovever, and its ability to service nev debt, it is helpful to
consider issues other than the Philippines macroeconomic and
structural policy. For example, it is useful to consider: 1) the
Philippines debt burden ratios, particularly compared vith those
of other countries; 2) its 1989 debt service needs; 3) the
Philippines prospects for additional debt relief; 4) net capital
flovs and reflovs to the Philippines; 5) the Philippines debtequity svap program; and 6) other programs that could help reduce
its debt service burden.
The Philippines Debt Ratios - We have already revieved some
basic debt ratios for the Philippines, namely external debt as a
percentage of GNP and debt service as a percentage of exports of
goods and services. There is no doubt that these ratios indicate
a heavy debt burden. It should be noted, hovever, that other
major developing country debtors have even heavier debt burdens
by some measures.
Table 3 illustrates hov the Philippines external debt compares
vith that of five other countries. For example, in 1988:
o In terms of external debt as a percentage of GNP, the
Philippines ranked third vith a ratio of 74%, compared
vith 88% for Chile and 91% for Venezuela.
o The Philippines ranked fifth in terms of outstanding
external debt as a percentage of annual exports vith a
ratio of 270%, compared vith more than 500% for
Argentina, about 325% for Brazil and Mexico, and 288% for
Venezuela.
o In terms of debt service payments of principal and
interest (before rescheduling) as a percentage of exports
of goods and services, the Philippines ranked third
vith a ratio of 49%, compared vith 93% for Argentina
and 55% for Chile.
o Finally, the Philippines ranked fifth in terms of
interest payments as a percentage of exports vith a
ratio of 23%, compared vith 42% for Argentina, 30% for
Brazil, and 28% for Mexico.
It should also be noted that the Philippines key debt ratios
have begun to ease, in part because it has been able to restore
real GNP grovth and expand exports without nev commercial bank
borrowing sines 1987. After having risen to 93% of GNP in 1986,
the Philippines external debt as a percentage of GNP has declined
once again to roughly its 1983 level. The ratio of debt service
to exports of goods and services has also improved slightly.

- 6 These debt ratios should continue to improve. By 1992,
midvay through the proposed Multilateral Assistance Initiative,
it is expected that the Philippines debt vill have dropped by
another 11 percentage points to 63% of GNP. It is also expected
that the debt service ratio vill have dropped significantly — by
14 percentage points before rescheduling and by 5 percentage
points after rescheduling.
1989 Debt service Requirements - The Philippines 1989
scheduled debt service requirements are projected at $5.3 billion,
including $2.6 billion in interest payments, of vhich
approximately 60% are due to commercial banks, and $2.7 billion
in principal payments. Offsetting capital inflovs from bilateral
creditors and multilateral institutions should total $2 billion,
to vhich should be added some $750 million in grants from bilateral
donors, including the United States. At this time, it is difficult
to predict vhat nev capital flovs from commercial banks might
occur in 1989 to offset the Philippines interest payments to them.
Prospects for Additional Debt Relief - The Philippines 1987
restructuring agreement vith the commercial banks provides for
the deferral of an additional $4.6 billion in maturities falling
due in 1989-1994. Additional debt relief from official bilateral
creditors via the Paris Club is also likely if the Philippines
obtains and adheres to an IMF Extended Financing Facility
arrangement.
In 1989, the additional deferrals of principal and interest
resulting from such private and official arrangements could total
veil over $1 billion.
Net Capital Flovs - Given the Philippines projected debt
service requirements, offsetting nev official grants and other
capital flovs, and possible additional debt relief, the Philippines
is currently projected to have a negative capital flow of
$1.1 billion on debt-related transactions in 1989.
It should be noted, hovever, that this does not reflect a
negative "aid" flov. The amount of this negative capital flow is
somevhat less than the Philippines projected interest payments to
the commercial bardcs. Thus, the negative flov in debt-related
transactions that is currently projected reflects the fact that
ve have not made an explicit assumption about the amount of nev
commercial bank lending in 1989. This negative flov does not
result from an imbalance in official bilateral and multilateral
assistance. Such official assistance has, in fact, increased
substantially since the restoration of Philippine democracy.
In any event, this particular measure of capital flovs is
not very meaningful. It overlooks other sources of finance, such
as foreign investment inflovs, suppliers credits, short-term

- 7

capital flovs, and private remittances that are available and
that can be stimulated through appropriate policies.
Indeed, the question of vhether net debt-related capital
flovs are positive or negative tends to divert attention from the
more important issue of vhether such inflovs are being used to
pay for consumption or to finance productive investments vithin a
sound policy framevork. As the case of Korea demonstrates,
negative net capital flovs are not necessarily incompatible vith
sustained economic grovth.
Debt-Eouitv Svaos - Debt-for-equity svaps have proven
to be an effective vay of reducing a country's stock of debt and
debt service burden, vhile increasing the amount of nev productive
investments.
The Philippines svap program generally vorks in the folloving
fashion:
o An investor, foreign or domestic, purchases a debt
obligation in the secondary market at a discount
determined by the market.
o The investor then trades the debt instrument vith the
public or private debtor through the Central Bank,
receiving in return its full face value in local
currency, minus any fees or other charges.
o The investor uses the local currency to make an equity
investment in an existing business concern or to finance
a nev investment in the country.
The investor benefits from a favorable effective exchange
rate, due to having received the full local currency value of a
debt purchased at a discount, minus fees and other charges. The
debtor, vhether public or private, benefits from being relieved
of an obligation denominated in foreign exchange. Finally, the
country benefits from investment that maintains or generates
additional employment, production, and possibly exports.
The Philippines introduced its debt-equity svap program in
August 1986. As of September 1988, approved svaps totalled
$485 million, only 28% of the $1.7 billion in applications
received. This relatively modest amount results from certain
limitations imposed on the program by the Philippine government:
o First, in late 1987 the Central Bank increased fees
and other requirements that have the effect of capturing
part of the secondary market discount and obliging the
investor to import foreign exchange over and above the
amount required to purchase the debt obligation in the
secondary market. These fees and requirements

- 8 -

substantially reduce the benefits of the debt-equity
svap program for the investor.
o Second, in early 1988, the Central Bank established a
cap of $180 million in annual conversions of Central
Bank debt in order to control the associated Central
Bank credit expansion and dampen vhat vere seen to be
the resulting inflationary pressures. I vill take
issue vith this concern later in this testimony.
There is no corresponding limit on conversions of
private sector debt, vhich do not result in credit
expansion. Fev private sector debtors, hovever, are
able to obtain the necessary peso counterpart. Thus,
little private sector debt is being converted.
o Third, in early 1988, the Central Bank also published
criteria that guide its approval or disapproval of
applications for debt conversions. Preference is given
to: a) nev investments, as opposed to equity investments
in existing facilities; b) investments that are laborintensive, generate employment, and located in regions
not yet heavily industrialized; c) activities vhere at
least 80% of production is for export; and d) export
products that are nev and not subject to foreign quotas.
Although it is not necessary to satisfy all of
these criteria, they limit the program's flexibility
and attractiveness unnecessarily. Restrictions on the
investor's ability to repatriate profits also diminish
ti.ie program's attractiveness.
In our judgment, there is ample scope for expanding the
Philippines debt-equity svap program. The primary obstacle to
such expansion is probably the Central Bank's cap on conversions
of its debt. While I acknovledge the Central Bank's concern
about the inflationary impact of such conversions, I vould point
out that the annual cap of $180 million under the debt-equity
svap program is equal to about only 3% of the Philippines broad
money supply.
Furthermore, concerns about the inflationary impact of debtequity conversions can be addressed in other vays, as they have
been in other countries. For example, more active open market
sales of public sector securities could help sop up the liquidity
created by the debt conversions. Greater restraint on the
government's current expenditures to reduce the fiscal deficit
that conversions
resulting from
from debt
the
could Finally,
also helpI vould
offset note
the credit
expansion resulting
privatization
of
public
sector
entities
have
no
impact
on
the
conversions.

- 9
money supply, yet boost government revenues. A Business
International report puts the equity book value of these
enterprises at $31.6 billion in the Philippines.
There is potential for a more active Philippines debt-equity
svap program in terms of aiding the Philippines to reduce its
debt service burden, sustain an investment-led economic recovery,
and generate additional employment and exports. This is all the
more the case, given the entrepreneurial bent and diligence of
the Philippine people.
The success of Chile's debt conversion program hints at the
magnitude of the potential of debt conversion in the Philippines.
Chile's programs have resulted in svap agreements totalling
$6 billion since their inception in 1985, vhile inflation rates
have declined substantially. The resulting annual debt service
savings could reach $600 million.
Debt Reduction - The Philippines is interested in developing
additional debt reduction instruments to supplement its debtequity svap program. It has broached this subject vith its
commercial banks creditors as part of its preliminary discussions
about a 1989-1990 financing package. At this stage, hovever, it
is difficult to speculate on vhat form a debt reduction program
might take or on the savings that might result.
This said, I should like to add that the Treasury Department
vould support a voluntary, "market-oriented debt reduction program
for the Philippines if it vishes to pursue one. Indeed, ve stand
ready to consult vith the Government of the Philippines, if it so
desires, vhen it is ready to explore such a program in cooperation
vith its commercial bank creditors.
The Multilateral Assistance Initiative
I vould nov like to turn to the proposed Multilateral
Assistance Initiative for the Philippines (MAI). The Treasury
Department shares the vievs expressed by others here today as to
the importance of nurturing and strengthening the rebirth of
democracy of the Philippines. We concur that achieving sustained,
non-inflationary grovth is essential to attaining this vital
objective. We recognize that the Philippines vill need additional
capital inflovs over the next fev years to support its economic
restructuring and lay an enduring foundation for continued grovth.
We are also in complete agreement that bilateral donors,
multilateral institutions, and private creditors and investors
alike all have an important role to play in responding to a
strengthened Philippine economic reform effort vith increased
levels of financing.
The MAI is intended to facilitate cooperation among bilateral
donors, multilateral institutions, and private lenders and

- 10 investors. It vill seek to stimulate additional capital flovs in
a vay that fosters further economic reform in the Philippines.
Thus, the MAI can make an important contribution to the task of
achieving sustained non-inflationary grovth.
The Treasury Department has played an integral role in the
Executive Branch's deliberations and in consultations vith other
donors and the multilateral institutions to help refine the MAI's
objectives and the implementing procedures.
Measuring the Success of the MAI - Economic grovth and
development, the improvement of living standards, and the
preservation of democracy are tasks that vill continue in the
Philippines beyond the expected duration of the extraordinary
effort that the MAI represents. Thus, the success of this
international initiative cannot be measured solely by vhether the
Philippines has achieved a certain level of per capita income or
eliminated the communist insurgency. Although these objectives
are vital, the best measure of the MAI's success vill be vhether
the Philippines is able to sustain economic development and
continue to improve living standards vithout further need for
concerted, extraordinary official assistance.
Achieving Success - The key to achieving success, therefore,
is implementation of the Philippines own economic reform and
restructuring program. Developed by the Government of the
Philippines vith the endorsement and support of the bilateral
donors and multilateral institution.*, this program must create
the economic policy framevork and conditions needed to stimulate
the Philippine private sector, repatriate flight capital, attract
foreign investors, diversify and expand exports, and restore the
Philippines creditvorthiness and access to international capital
markets.
Economic Reform and Restructuring Needs - The Philippines
economic reform and restructuring effort is already veil under
vay. Trade liberalization, tariff reform, privatization, the
elimination of monopolies, tax return and liberalization of the
investment regime have already been initiated to open the economy
to foreign competition, attract foreign capital and technology,
stimulate the Philippine private sector to play a greater role in
a more market-oriented economy, and generate additional fiscal
revenues.
we hope that the Philippines policy priorities in the future
vill focus on the following seven areas:
o In fiscal policy, the major challenge is to reduce the
fiscal deficit vhile also increasing investment
expenditures. Although MAI financing vill help support
a higher level of investment, vage restraint and
structural reforms, including further tax reform to

- 11
eliminate non-economic exemptions and improve compliance,
vill be required to sustain higher investment over the
long-term.
Monetary policy has been constrained by the need to
fight inflation and has resulted in high exchange and
interest rates that inhibit private investment, exports,
and production from reaching higher levels of grovth.
Successful fiscal adjustment and a major expansion of
productive capacity, supported by the MAI, vill of
themselves lessen inflationary pressures and allow
monetary policy to become more responsive to the needs
of investment, export production, and grovth.
Faster privatization or market-reorientation of remaining
public sector firms vould assist the process of fiscal
adjustment, increase the scope for private sector
initiative, and improve economic efficiency.
The benefits of the debt-eouitv svap program to the
Philippines economy are currently limited by an
unnecessarily restrictive quota on annual svap
operations, fees, and performance and capital
requirements. Removing these restrictions vould
stimulate greater svap activity and help reduce the
burden of interest payments on the fiscal budget and
stimulate greater investments and employment generation.
Despite considerable liberalization to date, Philippine
investment policy still retains features of an outmoded import-substitution model. Licensing and
registration requirements for establishment of foreign
investments and for importation of necessary capital
and equipment need to be further simplified. D£ facto
prohibitions that sxist on foreign investment in many
manufacturing sectors need to be abolished, along vith
performance and local content requirements.
Progress in trade policy to date has been particularly
commendable, notably in the reduction of coverage of
quantitative restrictions to only 10% of total imports
and in the leadership that President Aquino has shovn
in refusing to increase maximum tariff rates above 50%.
Further import liberalization and efforts to avoid
overvaluation of the peso are indispensable to improve
economic efficiency, dampen inflationary pressures,
encourage investment in the labor-intensive tradable
goods sector that is the most likely solution to the
underemployment problem, and improve the Philippines
international creditvorthiness.

- 12
o

Financial sector policy has been directed at the
important tasks of disposing of non-performing assets,
restructuring the major government development banks,
and privatizing smaller government-ovned banks. In the
period ahead, plans being developed vith the World Bank
to reform the commercial banking system need to be
implemented and additional steps taken to privatize the
larger government-ovned banks and develop the
Philippines equities market.
Supporting Economic Reform and Restructuring - The recovery
of the Philippine economy in the past tvo years attests to the
competence and dedication of the Philippines economic policymakers and to the effectiveness of reforms implemented to date.
The Philippines cooperative relations vith the IMF and World
Bank have contributed greatly to the success of its reforms and
to the process that has begun to restore international
creditvorthiness.
We expect that the same constructive spirit vill prevail in
the Philippines relations vith the multilateral institutions as
it continues to develop and implement its economic reform program.
Discussions betveen the Government of the Philippines and the IMF
are proceeding on an Extended Financing Facility credit. This
three-year arrangement vill help provide the underlying
macroeconomic and structural framevork for the Philippines economic
program. The Philippines discussions vith the World Bank — and
vith AID -- on structural and sectoral policies are also expected
to contribute to the formulation of the Philippines economic
program.
At this critical juncture, the United States and other
bilateral donors can strengthen the hand of reform-oriented
policy-makers in the Philippines by linking use of their MAI
assistance to implementation of economic, structural, and
administrative reforms. Tovards this end, the Philippines
commitment to continued reform and its visible achievement of
specific reform objectives should be a primary factor in
determining the Administration's future budget requests for the
MAI and the subsequent use of appropriated funds.
Our future budget requests should also be guided by an
annual reassessment of the Philippines financing requirements and
capital flovs likely to be available from other sources. Too
little financing could restrict the Philippines ability to sustain
adequate real GNP grovth and achieve the objectives of the MAI.
Excessive financing from official sources, hovever, could reignite
inflationary pressurss. Moreover, it vould influence the
commitment to, and limit the scope for, action by Philippine
policy-makers to expand the debt-equity svap program, maintain an
appropriate exchange rate, and adopt needed fiscal, tax, and
trade policy reforms. As a rssult, the prospects for stimulating

13 the private capital flovs that are essential to the success of
the MAI vould be greatly reduced.
Pole of Debt Reduction in the M^\ - A voluntary, marketoriented debt reduction program could further the objectives of
the MAI, for example, by aiding the process of fiscal adjustment
and freeing resources for investment.
The MAI's emphasis on supporting economic restructuring in
the Philippines should facilitate the Philippines ability to vork
out a voluntary, market-oriented debt reduction program vith its
commercial bank creditors. As the restructuring process unfolds,
it is expected that the Philippines export earnings vill increase,
along vith investment, remittances, and other capital inflovs.
These resources vould enhance the Philippinee ability to pursue a
variety of debt reduction arrangements vith its commercial bank
creditors.
I should like to reiterate that the Treasury Department is
ready to consult as desired vith the Government of the Philippines
on possible approaches to debt reduction.
Conclusion
The MAI represents an historic opportunity in international
cooperation. At stake is the strengthening of an important,
strategic ally vhose efforts to restore democracy, renew economic
grovth, and improve living standards are an inspiration the vorld
around. The Treasury Department velcomes the opportunity to
continue vorking vith the Congress, our Executive Branch
colleagues, our international partners, and the Government of the
Philippines to ensure the success of this important initiative.
Attachments
Table 1 - Composition of Philippine Debt
Table 2 - Composition of Philippine Debt to the United States
Government
Table 3 - Indicators of Comparative External Debt Burden

Table 1
THE PHILIPPINES
eoMPoaition of External Debt 1/
(U.S. $ Millions)
Mediumand
Long-

Isrm
Commercial Banks
Other Financial Institutions

11.541

2A1

ShortIa£B

lO^Ll

3.57Q

ILJjj,

11

366

52A

2.157

Suppliers 2/

1.581

Multilateral Institutions

4.951

4.951

World Bank
Asian Development Bank
IMF
Official Export Credit
U
Agencies

2,609
1,096
1,246

2,609
1,096
1,246

1.443

1.443

Other Bilateral V

2^10.

Z*21&

Japan
United States

2,070
568

2,070
568

850

850

Other
TOTAL

21*421

27.798

4.1*7

V
Data as of September 1987; source * IMF
2/
Not guaranteed by official export credit agencies
y
Guarantees/insurance on non-concessional credits
y
Concessional terms
M—orandm
o Debt to commercial banks (as reported to the Bank for
International Settlements) stood at $12.3 billion as of
September 1988.
o Debt to U.S. banks (as reported to the Federal Reserve
Board) totalled $4.2 billion as of September 1988.
March 6, 1989

Table 2

Debt to U.S. Cov^rT^n* 1/
(U.S. $ Millions)
Direct Credits
Under Foreign Assistance and
Related Acts
Loans

1,141,7
311,7
310.5

OPIC-Investment Support
Arms Export Control Act
Agricultural Trade Development
And Assistance
Currency Loans
Long-term Dollar Sales
Export Import Bank
Commodity Credit Corporation

Guarantees and Insurance
Under Foreign Assistance, and
Related Act! (OPIC-Investment Support)

1.2
154.3
157

f

5

0.5
157.0
479.2
39.0

981.3
325.4

Commodity Credit Corporation
Export Import Bank

V

$5212

oata am of June 30, 1988
March 6, 1989

Tab I • 3
SIX MAJOR DEBTORS
Trends in Key Economic Indicators

COP
Count r y

A v t r a ge
1982-35

Growth

(%>

1987

I ?84

Inflation
I ?88

Avtrtji
1982-85

Argtntin*
S r ati 1
Chili
Itxi : o
P~\ i L i p p m t i

*»52
I 87
22
71
23
10

Vinit'jt>i

Exports
ountr y
Argent m i
Sr 4 s 1 i
Chi 1 t
Met 1co
Phi 1 i p p i n t s
VtmtuiU

Av•r 491
1982-85
8
23
3
23
5
IS

0
7
8
4
0
4

(?

A r g e n t 1na
3r411 1
Chi 1 e
Me 11 co
Phi.1ppinet
Venezuela

Average
1912.13
72
42
93
37
73
109
Debt

Country
A r g e n t 1na
Br a x ; 1
Chile
Me 11 co
Ph 1 i 1 pp m i l
Venezuela

p

I n d r n t

1984

1987

1988

4
22
4
17
4
8

4 2
24 2
5 2
22 2
5 7
10.0

8
33
7
23
4
10

9
4
2
3
8
4

Oebt/GDP
Country

billions)

Ratio

31
43
42
37
24
23

(%)

1987

1988

74
39
1 13
78
72
73

78
37
103
73
83
90

70
33
88
58
73
91
<%>

1984

1987

1988

101
74
77

104
74
97

144
88
37

93
37
33

43
49
74

49
90
94

42
31
34

44
47
38

Average
1982-83
433
337
349
317
309
198

47
40
31
33
24
32

:3 1
228
22
1 32
4
40

1988
300
581
; i
i 2 8
8
25

Ratio

1987

1/

1988

51
32
27
27
24
22

42
30
22
28
23
24

Ratio

(%> 2

1984

1987

1988

348
439
379
424
330
313

470
423
303
341
303
287

312
321
214
328
271
288

1/

Projection

1/ Ratio to eiportf of goods and services prior to debt relief
2/ R a t i o to e i p o r t f of g o o d s and s e r v i c e *
100/CON

1987

Payment!

Oebt/Eiports

Ratio

Average
1982-83

90
1 45
1 7
84
1
1 3

Avtrtat
1982 -85 1984

7
0
I
0
8
S

1984

Service

1984

<%>

TREASURY NEWS
Department of the Treasury
Washington, D.c. • Telephone 566-204!
' v COM•5310
RELEASE

CONTACT:

March 27, 1989
ClfARTHtN7 '

Office of Financing
202/376-4350

-!.£A?JK1

TREASURY OFFERS $15,000 MILLION
OF 17-DAY CASH MANAGEMENT BILLS
The Department of the Treasury, by this public notice, invites
tenders for approximately $15,000 million of 17-day Treasury bills
to be issued April 3, 1989, representing an additional amount of
bills dated October 20, 1988, maturing April 20, 1989 (CUSIP No.
912794 RU 0 ) .
Competitive tenders will be received at all Federal Reserve
Banks and Branches prior to 1:00 p.m., Eastern Standard time,
Thursday, March 30, 1989. 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 bills acquired through "when issued" trading, futures,
NB-191

- 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 Monday, April 3, 1989.
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.

TREASURYNEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
;;0M 5310
CONTACT:
Office of Financing
FOR IMMEDIATE RELEASE
. f,
202/376-4350
March 2 7 , 1989
RESULTS OF TREASURY'S WEEKLY BILL AUCTIONS
DEPAKlh
Tenders for $7,221 million of 13-week bills and for $7,204 million
of 26-week bills, both to be issued on March 30, 1989,
were accepted today,
RANGE OF ACCEPTED
COMPETITIVE BIDS:

13-week bills
maturing
June 29, 1989
Discount Investment
Rate
Price
Rate 1/

Low
Hi

8h
Average
a/ Excepting 3
b/ Excepting 5
Tenders at the
Tenders at the

26-week bills
maturing September 28, 1989
Discount Investment
Rate
Rate 1/
Price

9.05%£/
9.39%
97.712
9.10% W
9 67%
95 399
9.11%
9.46%
97.697
9.15%
9 73%
95 374
9.10%
9.44%
97.700
9.12%
9 69%
95 389
tenders totaling $80,000.
tenders totaling $6,615,000.
high discount rate for the 13-week bills were allotted 68%.
high discount rate for the 26-week bills were allotted 11%.

TENDERS RECEIVED AND ACCEPTED
(In Thousands)
Location
Received
tAccepted
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

$
32,985
22,253,705
23,630
74,410
61,365
46,770
1,046,690
53,215
9,655
48,655
42,510
939,910
413,275

32,985
$
6 ,347,010
23,630
60,410
44,765
46,130
46,690
28,315
9,655
48,655
32,510
86,910
413,275

$25,046,775

Accepted

37,245
16,799,440
24,725
40,455
42,410
40,630
993,150
43,905
13,685
63,945
43,105
1,126,850
514,380

$
37,245
5,300,440
24,725
40,455
42,395
40,630
373,650
36,125
13,685
63,945
38,655
677,460
514,380

$7 ,220,940

. $19,783,925

$7,203,790

$21,968,230
1,219,435
$23,187,665

$4 142,395
1 219,435
$5 361,830

$15,825,775
:
1,171,750
: $16,997,525

$3,245,640
1,171,750
$4,417,390

1,705,210

1 705,210

:

1,700,000

1,700,000

153,900

153,900

:

1,086,400

1,086,400

$25,046,775

$7 220,940

: $19,783,925

$7,203,790

Equivalent coupon-issue yield.

NB-192

Received
$

TREASURY NEWS
iportment of the Treasury • Washington, D.C. • Telephone 566-2041
.-../.iY.ROai-1 5J10

i'Cf''A.~ . M L t { .

\.>.z'C\\~

Text as Prepared
Embargoed for Release Upon Delivery
Expected at 8:15 a.m. CST
Remarks by
The Secretary of the Treasury
Nicholas F. Brady
Dallas Chamber of Commerce
Sheraton Park Central Hotel
Dallas, Texas
Tuesday, March 28, 1989
It is a pleasure to be here today to talk to you about an
issue of great mutual concern—the crisis in the Savings and Loan
industry.
I am here today to report to you that the Bush
Administration has acted swiftly and forcefully to resolve the
crisis. Just eighteen days after his Inauguration President Bush
announced a comprehensive plan to resolve the current problems in
the Savings and Loan industry and to assure that the industry
will be a strong, viable part of our nation's banking system in
the future.
As the Treasury Department formulated the solution, we were
guided by the President's directive to fix it now, fix it right
and fix it for good. Our plan meets these requirements. Our
plan addresses the current and long-term financial needs of the
Savings and Loan industry. But it does not stop there. It also
confronts the equally great need for substantial statutory and
administrative reforms that will ensure that the industry can
never again be driven into this kind of crisis. These reforms
are absolutely essential to the future success of the S&L
industry.
Let me stress, our plan is not a bailout. It is the
fulfillment of the Federal Government's commitment to
depositors. The plan relies on a combination of industry and
taxpayer funds. We require that the industry provide as much
financial support as is possible and still emerge a healthy
competitive industry, once the insolvent S&Ls are taken care of.
The President has sent to the Congress legislation that will
NB-193
provide the necessary financing and enact the required reforms.

2
It is a truly comprehensive package—the draft legislation is 330
pages long.
The analysis that backs it up is just as
comprehensive and contains more numbers than the Dallas phone
book.
We are working with Congress for rapid passage of the
legislation.
Part of our plan—the administrative action—is already
underway.
Since the President made his announcement in
February, the FDIC has taken charge of over 100 insolvent S&Ls.
This is a very important step. The damage that insolvent S&Ls
cause extends far beyond their clients and their local
communities.
Insolvent institutions pay unrealistic interest
rates to attract depositors, forcing solvent institutions to meet
these rates to attract customers.
Consequently, the cost of
deposits is pushed to economically unsound levels for all
institutions.
We cannot permit this to continue.
FDIC
stewardship of insolvent S&Ls is a critical step, but the process
can not be completed until Congress has passed and sent to the
President the funding package that will enable the FDIC to
complete the resolutions.
Let me assure you, during this interim period insured
depositors remain fully protected, basic customer services have
not changed, and each institution's employees continue to conduct
the normal day to day operations of the institution.
These
thrifts are open, with deposits backed by the federal government,
and ready to do business with their customers.
Despite the FDIC's swift action we continue to witness
record withdrawal of funds from the S&L industry. And we will
continue to see withdrawals as long as our plan is not enacted
into law.
The consequence of inaction affects us all.
As
deposits fall, revenues from
insurance premiums—required to
reduce the taxpayers burden—also fall. For every day of delay
in enacting the President's legislation,
the cost to the
taxpayers increases. Currently, the cost of the solution is $20
million per day.
Clearly it is in everybody's interest to have
the Bush plan become law.
This is how we calculate the financing. The cost of the
resolutions of insolvent S&Ls undertaken in previous years by
FSLIC totals $40 billion.
The cost of resolving currently
insolvent S&Ls, as well as ones which may become insolvent during
the next three years, is $50 billion. This $90 billion is to be
provided by an equitable, and somewhat complex system of
government funding and industry contributions.
Some have suggested that the resolution of the crisis would
be expedited by a one-time, lump-sum appropriation of the
necessary funds by the government.
I strongly disagree. The
taxpayers did not create this problem—there is no reason why
they should have to shoulder the full burden of solving it. In
addition to government funds, our plan requires the commitment of

3
S&L industry funds, which will finance the principal and pay a
substantial portion of the interest on the $50 billion to be
raised in the financial markets.
There is another reason not to try to force the taxpayer to
absorb the full brunt of the financing: the intent and integrity
of the Gramm-Rudman process—a process whose existence is owed in
great part to the wisdom and courage of a Senator from this
state.
Gramm-Rudmam dictates that if the government does not
meet voluntarily the mandated spending targets by a specified
date, automatic, across-the-board spending cuts will be invoked.
Concentrating this financial burden solely in this year's budget
would mean that we would far exceed the Gramm-Rudman deficit
reduction target.
If we were to concentrate the financing for
the S&L solution solely in this year's budget, we would sidestep
this process. This would completely, and unnecessarily, render a
sham the essential budgetary discipline of Gramm-Rudman. And it
is important that we do not make a mockery of Gramm-Rudman. It
is not only the law of the land, it is the wheelhorse of the
fiscal discipline that will drive our deficit down. Meeting its
deficit reduction targets is very important to the continued
vitality of our economy.
Furthermore, it is important to our international economic
standing that we meet and maintain the Gramm-Rudman deficit
reduction procedure.
Our foreign trading partners are very
concerned about our ability to bring down the federal deficit,
they are knowledgeable about our legislative system, and they are
watching carefully to see if we keep our commitments. If we fail
to honor Gramm-Rudman the effect on the financial markets could
be to raise government borrowing rates.
And if these rates
increase by as little as ten basis points, the effect would be to
overwhelm any cost savings achieved from having the U. S.
Treasury directly borrow the funds to pay the cost of the S&L
solution.
Finally, if we open up the issue of exemptions to
Gramm-Rudman, the one sure consequence will be delay in the
passage of this legislation. We can not afford delay. If the
debate over alternate financial plans takes even three weeks, the
cost to the taxpayer goes up by $500 million. For all these
reasons, the Bush financing plan is the best realistic approach
to solving the S&L issue.
In addition to the financing required to solve current
problems, our plan calls for an additional $33 billion over the
next ten years to handle any future insolvencies and to put S&L
deposit insurance on a sound footing.
We will create a new
Savings Association Insurance Fund whose funding will come from a
combination of industry deposit insurance premiums and taxpayer
funds. While most public and press commentary has centered on
the $90 billion figure for insolvent S&Ls, we feel that the $3 3
billion
the S&Ls isindustry
just ascontinues
important,
to because
be a prominent
it will and
helprobust
ensureplayer
that

4
in our financial system.
We are absolutely committed to the
future of the S&L industry.
And we've put money behind that
commitment.
However, this goal cannot be attained by a strengthened
insurance fund alone.
Our reform package will play an
indispensable role in achieving our goal.
In the past the Savings and Loan industry was treated like
an undisciplined junior partner in our financial system; we
demanded less and tolerated more. It had less regulation, lower
capital requirements and less rigorous accounting rules.
Frankly, many of them abused the freedom given to them. This
must no longer be the case—the S&L industry has come of age. It
is time for it to meet the standards demanded of a mature,
sophisticated industry, standards that will ensure that it never
again finds itself in the situation it currently faces.
The
events of the 1980's demonstrate that the goals of the regulator
as an industry advocate and insurer inherently conflict.
Our
plan removes this conflict of interest by separating the FSLIC
from the Federal Loan Home Bank Board and attaching it to the
FDIC. This will create a strong, independent insurer with the
over-arching mission to protect depositors and to maintain the
integrity of the deposit insurance fund.
Our plan also requires that thrifts operate under the same
accounting standards as commercial banks. And the plan gives
regulators the tools to move quickly against any type of
investment or other operating practices which they view as unsafe
or unsound.
Some have suggested that the higher capital requirements
will force out of business otherwise healthy S&Ls.
This is
highly unlikely. The industry is in better capital shape than
many believe.
First, fifty percent of all solvent S&Ls today
meet the six percent capital standard. Second, while the solvent
S&Ls would need $64 billion of capital to meet the six percent
standard, today they already have $55 billion, or eighty-five
percent of what they need. Third, the capital standard is not a
make it or be liquidated standard. If a thrift has a realistic
business plan and shows real progress toward reaching the
standard, federal regulators have the authority to extend the
time period for reaching the standard.
Finally, agreements
already reached between thrifts and their federal regulator to
provide a longer period of time to reach the capital objective
will be honored under the new system.
Our plan also requires that the thrift industry be subject
to stricter regulations concerning the type of investments an S&L
can make. It also increases the safety and soundness standards
for the industry.

5
We are also going to clean out the fraud in the industry.
We want the S&L industry restored to and worthy of the esteem it
enjoyed from the public in the days when Jimmy Stewart was an
American hero for operating a Savings and Loan. Our plan adds
new enforcement authorities, and increases dramatically funding
for law enforcement staff and prosecutions.
Approximately $50
million per year will be authorized for three years for the
Justice Department to fund a new national program to search out
financial institution fraud.
Maximum civil penalties will be
raised to $1,000,000 per day, and maximum criminal penalties to
20 years in prison, with mandatory minimum sentencing.
Most owners and operators of Savings and Loan banks are
honest, hard-working people.
We owe it to them to remove the
taint placed on the industry. And with your help and support, we
will.
We in Washington are aware that people in Texas are
concerned that federal officials will "dump" real estate held by
insolvent S&L's on the local market. Congressman Steve Bartlett
and Senator Phil Gramm have raised these concerns with us. They
have forcefully represented your views.
We understand the
potential destructive effects on the local economies of wholesale
dumping.
Let me assure you that we intend to proceed very
carefully with real estate sales.
The government also has a
vested interest in avoiding dumping and receiving the best
possible price for the real estate. Every possible consideration
will be given to the local circumstances; decisions will be
evaluated and made with the best interests of everyone involved
taken into consideration.
Without a doubt, the Savings and Loan crisis is a large and
very difficult problem to solve.
The Bush Administration has
wasted no time in acting decisively to construct a far-reaching,
long-lasting solution to the crisis. We did not act alone, we
consulted widely—with industry experts, business leaders and
members of Congress, in particular, with Chairman Henry Gonzalez
of the House Banking Committee and Senator Don Riegle, Chairman
of the Senate Banking Committee. We have no pride of authorship,
we took good ideas wherever we found them and we believe this
plan is the best result of our collective wisdom. Our proof lies
in the fact that no one else has come forth with an alternative
plan.
However, the favorite Washington pastime of criticizing
the President's plan without constructive alternatives has begun.
These critiques call to mind the words of Teddy Roosevelt, who
said:
it is not the critic who counts—not the man who point out
how the strong man stumbled or where the doer of deeds could
have done better.
The credit belongs to the man who is
actually in the arena...who strives violently...and spends
himself in a worthy cause
so that his place shall never be
with those cold and timid souls who know neither victory nor
defeat. (Pause.)

6
Or, as General George S. Patton said:
A good plan, violently executed now, is better than a
perfect plan next week.
Our plan has the support of the federal regulators—the
Federal Reserve, the FDIC, the Federal Home Loan Bank Board and
the Comptroller of the Currency. Many in Congress also support
it. Now we need your support. I ask you to join with me and
President Bush in calling on Congress to pass our legislation
now, so that we can return the S&L industry to its previous
vitality and stature. America needs a strong S&L industry, and
we need your help to make it strong—working together we can
achieve our goal.

TREASURY JMEWS
Department of the Treasury • Washington, D.C. • Telephone 566-2041
» ^ i Vf.ROCM 5blO

FOR RELEASE AT 4:00 P.M.
March 28, 1989

VjR?:3

8i
Office of Financing
» :c , CONTACT: 202/376-4350

CePARTHLM'

TREASURY'S WEEKLY BILL OFFERING
The Department of the Treasury, by this public notice, invites
tenders for two series of Treasury bills totaling approximately
$14,400 million, to be issued April 6, 1989.
This offering
will result in a paydown for the Treasury of about $650
million, as
the maturing bills are outstanding in the amount of $15,054 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 3, 1989.
The two series offered are as follows:
91-day bills (to maturity date) for approximately $7,2 00
million, representing an additional amount of bills dated
July 7, 1988,
and to mature July 6, 1989
(CUSIP No.
912794 SH .8 ), currently outstanding in the amount of $16,747 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $7,200 million, to be dated
April 6, 19 89,
and to mature October 5, 1989
(CUSIP No.
912794 SZ 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 6, 1989.
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 $ 1,976 million as agents for foreign
and international monetary authorities, and $4,497 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)
NB-194

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'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

TREASURYNEWS

Department of the Treasury • Washington, D.c. • Telephone 566-20
S?c5M5fDIi««RELEASE L^/-.tf.R00M^ACTs
M r c n 28
' 1989
M/5R 3P 8 ^ *M

0ffice of

Financing
•"•
202/376-4350

rn

q
RESULTS.OF AUCTION OF 2-YEAR NOTES

«f* 07hi«?eparn-nt °! ^he TreasurY has accepted $9,269 million
or $27,18. million of tenders received from the public for the
2-year notes, Series X-1991, auctioned today. The notes will be
issued March 31, 1989, and mature March 31, 1991.
The interest rate on the notes will be 9-3/4%. The range
« ,^?? ep ? d c o m P e t i t i v e bids, and the corresponding prices at the
9-3/4% rate are as follows:
Yield Price
Low
9.84%*
99.840
Hi n
9
9.88%
99 769
Average
9.87%
99.'787
•Excepting 5 tenders totaling $75,000.
Tenders at the high yield were allotted 50%.
TENDERS RECEIVED
AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
78,030
$
78,030
New York
23,535,180
7,525,170
56,580
Philadelphia
56,580
129,585
114,585
Cleveland
127,340
111,840
Richmond
87,965
82,315
Atlanta
1,549,855
643,010
Chicago
149,895
109,370
St. Louis
55,300
55,300
174,310
171,560
Minneapolis
56,045
48,545
Kansas City
1,078,555
168,055
Dallas
104,395
104,395
San Francisco
$27,183,035
$9,268,755
Treasury
Totals
The $9,26 9 million of accepted tenders includes $1 800
million of noncompetitive tenders and $7,469 million of competitive tenders from the public.
^
In addition to the $9,269 million of tenders accepted in
the auction process, $1,230 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $i son million
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturinq
securities.
^
NB-195

TREASURYNEWS
Department of the Treasury • Washington, D.c. • Telephone 566-2041
FOR IMMEDIATE RELEASE CONTACT: Office of Financing
March 29, 1989
UG^URY. RO0.-! 23 '

202/376-4350

RESULTS OF AUCTION OF'4-YEAR NOTES
l>:i iRTMU

"' '

The Department of the Treasury has accepted $7,510
million
of $ 26,086 million of tenders received from the public for the
4-year notes, Series N-1993, auctioned today. The notes will be
issued March 31, 1989, and mature March 31, 1993.
The interest rate on the notes will be 9-5/8%. The range
of accepted competitive bids, and the corresponding prices at the
9-5/8% rate are as follows:
Yield
Price
Low
9,.69%
99..789
9..70%
99..756
High
9..70%
99..756
Average
Tenders at the high yield were allotted 48%.
TENDERS RECEIVED AND ACCEPTED (In Thousands)
Location
Received
Accepted
Boston
$
66,159
$
64,159
New York
22,828,070
6,292,103
Philadelphia
43,215
43,215
Cleveland
91,676
91,676
Richmond
84,017
63,872
Atlanta
73,985
70,385
Chicago
1,296,707
266,538
St. Louis
104,142
78,965
Minneapolis
52,388
52,387
Kansas City
132,351
132,336
Dallas
42,792
37,687
San Francisco
1,233,020
279,300
Treasury
37,142
37,142
Totals
$26,085,664
$7,509,765
The $7,510 million of accepted tenders includes $1,419
million of noncompetitive tenders and $6,091 million of competitive tenders from the public.
In addition to the $7,510 million of tenders accepted in
the auction process, $710 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities. An additional $822 million
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturing
securities.

NB-196

TREASURYNEWS
ppartment of the Treasury • Washington, D.c. • Telephone 566-2041
on
i"£PARTM:M ;

FOR IMMEDIATE RELEASE

March 30, 1989

Desiree Tucker Sorini
Appointed Deputy Assistant Secretary
for Public Affairs
Secretary of the Treasury Nicholas F. Brady today announced the
appointment of Desiree Tucker Sorini to serve as Deputy Assistant
Secretary for Public Affairs. Ms. Sorini will serve as the
principal advisor to the Assistant Secretary for Public Affairs
and Public Liaison on communicating Treasury policies and
programs to the American public through the print and electronic
media.
Prior to joining Treasury, Ms. Sorini had been Director of Public
Affairs at the International Trade Administration in the
Department of Commerce since 1986. From 1984 to 1986 she served
as Press Secretary to Ambassador Clayton Yeutter during his
tenure as United States Trade Representative. Previously, Ms.
Sorini had been Special Assistant to the Director of the Women in
Development Conference; Director of Fundraising for Tucker and
Associates; and a marketing representative with the Xerox
Corporation.
Ms. Sorini graduated in 1980 from Colorado State University with
a bachelor of arts degree in Communications. She and her
husband, Ronald Sorini, reside in Washington, D.C.

NB-197

TREASURYNEWS
lepartment of the Treasury • Washington, D.c. • Telephone 566-2041
Ll»:p;t ^Y, R O O M 5310
SEFA.WHtf:.

•

>, i _ _

FOR IMMEDIATE RELEASE March 30, 1989

Sarah M. Hildebrand
Appointed Deputy Assistant Secretary
for Public Liaison
Secretary of the Treasury Nicholas F. Brady today announced the
appointment of Sarah McCray Hildebrand to serve as Deputy
Assistant Secretary for Public Liaison, effective March 20, 1989.
Ms. Hildebrand will serve as the principal advisor to the
Assistant Secretary for Public Affairs and Public Liaison on
communicating Treasury policies and programs to American
businesses, consumers, and to state and local governments.
Before joining Treasury, Ms. Hildebrand had been Director of
Congressional Affairs at the International Trade Administration
in the Department of Commerce since 1987. Previously, she had
served as a Congressional Liaison Officer at the Commerce
Department and in managerial and organizational capacities in The
White House and campaign politics. She came to Washington in the
late 70's as a Legislative Assistant to Representative Dan
Lungren of California.
She received a bachelor of arts degree from The College of
William and Mary in Economics and Government in 1978 and was
named to Outstanding Young Women of America the same year.
Ms. Hildebrand, a native of Evansville, Indiana, now resides in
Alexandria, Virginia, with her husband, Bruce Hildebrand.

NB-198

TREASURY NEWS
department of the Treasury • Washington, D.c. • Telephone 566-2041

Text as Prepared l-J $5 ^."f '53
Embargoed for Release Upon Delivery
Expected at 1 p.m. EST

B£p

A*TMtM o? .

Remarks by
The Secretary of the Treasury
Nicholas F. Brady
Greater New York Savings Bonds Committee
Plaza Hotel
New York, New York
March 30, 1989
Good afternoon and thank you for the opportunity to be with
you today for the annual kickoff of the Savings Bond campaign.
Thanks also to John B. Carter, President and Chief Executive
Officer, The Equitable Financial Companies, for serving as 1989
Chairman for Greater New York. This is one of the most important
geographic area campaigns in the nation. It has the greatest
concentration of companies offering their employees the payroll
savings plan.
Thanks to each of you for being here and joining the ranks
of volunteers in the 1989 Savings Bonds campaign effort.
Particular gratitude is due to the men and women on the dias, who
- year in and year out - have given the Savings Bonds program
the tremendous support of their time and talents. These
volunteers have been instrumental in the success of the Savings
Bonds program not only in New York but, to a great extent,
throughout the rest of corporate America as well.
U.S. Savings Bonds make a significant contribution to
financing the national debt. Because they are held on average
about twice as long as marketable securities (approximately 7
years vs. 3.5 years), they provide a stable, reliable source of
income to the government.
U.S. Savings Bonds are a more cost effective way for the
Treasury to finance debt than are marketable securities. For
every billion dollars sold, it is estimated that the Treasury
NB-199

2
(and thus U.S. taxpayers) saves $70 million. By selling over 7
1/4 billion dollars in bonds last year alone, this program saved
the taxpayers over one-half billion dollars in financing costs.
Savings Bonds are also a major positive factor in
encouraging saving and increasing the savings rate of Americans.
They are easy to buy and widely available through the payroll
savings plan offered by tens of thousands of companies and
financial institutions.
In a time when increasing the nation's savings rate is among
the Administration's highest priorities, the Savings Bonds
program provides an important avenue for saving, particularly for
the small saver. The payroll savings plan, which we are here to
support, is the vehicle to those savings.
The reason for the bond program's continuing and growing
success is that Savings Bonds are a good deal for everyone.
They are exempt from state or local income taxes, a
particular advantage here in New York, and federal tax on the
interest can be deferred until the bonds are cashed or mature.
Savings Bonds are safe — backed by the full faith and
credit of the United States. And because they are registered
securities, they can be replaced if lost, stolen or destroyed.
Next year the program gains another benefit, the "College
Savings Bonds," that will enhance the effectiveness of Savings
Bonds as a means for parents to save for the education of their
children by exempting the earned interest from federal income tax
when the bonds are used to pay for the costs of a higher
education.
I urge all of you to support the payroll savings bonds in
your companies. It is an opportunity for your company to offer a
quality benefit to your employees. Savings Bonds are both good
for your employees and for our country.
Now I would like to turn to some other issues that are
important to our country — ones that President Bush is
determined to face forthrightly. The President has told each of
us in the Cabinet that he wants us to face the issues squarely
and to solve the problems facing our country.
For us at the Treasury, this has meant tackling some of the
biggest financial problems ever to face our nation.
First of all, the President has come forward with a budget
that will meet the Gramm-Rudman deficit reduction targets
without increasing taxes. Some predicted his budget would be
called "dead on arrival", but no one is saying that now. The

3
President's budget is forming the basis for serious negotiations
with the Congress.
We also have succeeded in changing the way Washington looks
at the word "cut". In the past, budget discussions have been
predicated on a baseline that is last year's budget adjusted
upward for inflation and new entrants to programs. Any decline
from that level, even though the resulting spending would still
be higher than last year's, was termed a "cut".
Now, in doing your family budget, it would be nice if you
could automatically increase spending to cover inflation and a
new child, but you can't, and neither can the federal government.
So we're conducting this year's budget negotiations with last
year's spending level as the baseline.
It is still too early to know exactly how the budget
negotiations will come out, but I do know this: We will meet the
Gramm-Rudman target of a deficit below $100 billion next year,
one way or another. We will do so because we must. Our hopes
for continued, non-inflationary growth depend on it. And our
developed and developing country partners in the world economy
are depending on us to do it.
The second big issue we have tackled is Third World debt.
This is perhaps the most difficult of all the economic problems,
because it is so large and because a "made in America" solution
just isn't possible. Too many countries are involved for that.
Nevertheless, we have put forward some important new ideas
for revitalizing our international debt strategy. We believe
that progress can be made in addressing and reducing the problem
by shifting the focus of our efforts in the direction of debt
reduction. We will continue the fundamental principles of the
current approach — advising economic reforms and encouraging
growth in debtor nations. But this new emphasis will help reduce
the overall debt burden, rather than adding to it, as we have
been doing year after year.
Finally, I want to turn to a topic of immediate concern to
all of us: the crisis facing the savings and loan industry.
The Bush Administration has acted swiftly and forcefully to
resolve the crisis. Just eighteen days after his Inauguration
President Bush announced a comprehensive plan to resolve the
current problems in the Savings and Loan industry and to assure
that the industry will be a strong, viable part of our nation's
banking system in the future.
As the Treasury Department formulated the solution, we were
guided by the President's directive to fix it now, fix it right
and fix it for good. Our plan meets these requirements. Our

4
plan addresses the current and long-term financial needs of the
Savings and Loan industry. But it does not stop there. It also
confronts the equally great need for substantial statutory and
administrative reforms that will ensure that the industry can
never again be driven into this kind of crisis. These reforms
are absolutely essential to the future success of the S&L
industry.
The President has sent to the Congress legislation that will
provide the necessary financing and enact the required reforms.
It is a truly comprehensive package—the draft legislation is 330
pages long. The analysis that backs it up is just as
comprehensive and contains more numbers than the Manhattan phone
book. We are working with Congress for rapid passage of the
legislation.
Part of our plan—the administrative action—is already
underway. Since the President made his announcement in
February, the FDIC has taken charge of over 100 insolvent S&Ls.
This is a very important step. Insolvent institutions pay
unrealistic interest rates to attract depositors, forcing solvent
institutions to meet these rates to attract customers.
Consequently, the cost of deposits is pushed to economically
unsound levels for all institutions.
FDIC stewardship of
insolvent S&Ls is a critical step, but the process can not be
completed until Congress has passed and sent to the President the
funding package that will enable the FDIC to complete the
resolutions.
Let me assure you that during this interim period insured
depositors remain fully protected. The thrifts remain open,
ready to do business with their customers, wit deposits fully
backed by the federal government.
Despite the FDIC's swift action we continue to witness
record withdrawal of funds from the S&L industry. And we will
continue to see withdrawals as long as our plan is not enacted
into law.
For every day of delay in enacting the President's
legislation, the costs to the taxpayers increase. Currently,
the cost of the solution is $20 million per day.
Clearly it is
in everybody's interest to have the Bush plan become law and
become law soon.
This is how we calculate the financing. The cost of the
resolutions of insolvent S&Ls undertaken in previous years by
FSLIC totals $40 billion. The cost of resolving currently
insolvent S&Ls, as well as ones which may become insolvent during
the next three years, is an additional $50 billion. This $90
billion is to be provided by an equitable, and somewhat complex
system of government funding and industry contributions.
Some have suggested that the resolution of the crisis would

5
be expedited by a one-time, lump-sum appropriation of the
necessary funds by the government. I strongly disagree. The
taxpayers did not create this problem—there is no reason why
they should have to shoulder the full burden of solving it. In
addition to government funds, our plan requires the commitment of
S&L industry funds, which will finance the principal and pay a
substantial portion of the interest on the $50 billion to be
raised in the financial markets to solve the problem.
There is another reason not to try to force the taxpayer to
absorb the full brunt of the financing: the intent and integrity
of the Gramm-Rudman process. Concentrating this financial burden
solely in this year's budget would mean that we would far exceed
the Gramm-Rudman deficit reduction target. This would
completely, and unnecessarily, render a sham the essential
budgetary discipline of Gramm-Rudman.
And it is important that we do not make a mockery of GrammRudman. It is not only the law of the land, it is the
wheelhorse of the fiscal discipline that will drive our deficit
down. Meeting its deficit reduction targets is very important to
the continued vitality of our economy and to our international
economic standing. Our foreign trading partners are very
concerned about our ability to bring down the federal deficit;
they are knowledgeable about our legislative system, and they are
watching carefully to see if we keep our commitments.
If we fail to honor Gramm-Rudman the effect on the financial
markets could be to raise government borrowing rates. And if
these rates increase by as little as ten basis points, the effect
would be to overwhelm any cost savings achieved from having the
U. S. Treasury directly borrow the funds to pay the cost of the
S&L solution.
Finally, if we open up the issue of exemptions to GrammRudman, the one sure consequence will be delay in the passage of
this legislation. We can not tolerate delay. If the debate over
alternate financial plans takes even three weeks, the cost to the
taxpayer goes up by $500 million. For all these reasons, the
Bush financing plan is the best realistic approach to solving the
S&L issue.
In addition to the financing required to solve current
problems, our plan calls for an additional $33 billion over the
next ten years to handle any future insolvencies and to put the
S&L deposit insurance fund on a sound basis. We will create a
new Savings Association Insurance Fund whose funding will come
from a combination of industry deposit insurance premiums and
taxpayer funds. We are absolutely committed to the future of the
S&L industry. And we've put money behind that commitment.
However, this goal cannot be attained by a strengthened

6
insurance fund alone. Our reform package will play an
indispensable role in achieving our goal.
In the past the Savings and Loan industry was treated like
an undisciplined junior partner in our financial system; we
demanded less and tolerated more. It had less regulation, lower
capital requirements and less rigorous accounting rules. This
must no longer be the case—the S&L industry has come of age. It
is time for it to meet the standards demanded of a mature,
sophisticated industry, standards that will ensure that it never
again finds itself in the situation it currently faces.
The events of the 1980's demonstrate that the goals of the
regulator as an industry advocate and insurer inherently
conflict. Our plan removes this conflict of interest by
separating the FSLIC from the Federal Loan Home Bank Board and
attaching it to the FDIC. This will create a strong, independent
insurer with the over-arching mission to protect depositors and
to maintain the integrity of the deposit insurance fund.
Our plan also requires that thrifts operate under the same
accounting standards as commercial banks. And the plan gives
regulators the tools to move quickly against any type of
investment or other operating practices which they view as unsafe
or unsound.
Some have suggested that the higher capital requirements
will force out of business otherwise healthy S&Ls. This is
highly unlikely. The industry is in better capital shape than
many would have you believe. First, fifty percent of all
solvent S&Ls today meet the six percent capital standard.
Second, while the solvent S&Ls would need $64 billion of capital
to meet the six percent standard, today they already have $55
billion, or eighty-five percent of what they will need. Third,
the capital standard is not a "make it or be liquidated"
standard. If a thrift has a realistic business plan and shows
real progress toward reaching the standard, federal regulators
have the authority to extend the time period for reaching the
standard.
Without a doubt, the Savings and Loan crisis is a large and
very difficult problem to solve.
The Bush Administration has
wasted no time in acting decisively to construct a far-reaching,
long-lasting solution to the crisis. We did not act alone; we
consulted widely — with industry experts, business leaders and
members of Congress. We took good ideas wherever we found them
and we believe this plan is the best result of our collective
wisdom. Our proof lies in the fact that no one else has come
forth with an alternative plan. However, the favorite
Washington pastime of criticizing the President's plan without
constructive alternatives has begun. These critiques call to
mind the words of Teddy Roosevelt, who said:

7
It is not the critic who counts — not the man who points
out how the strong man stumbled or where the doer of deeds
could have done better. The credit belongs to the man who
is actually in the arena ... who strives ... and spends
himself in a worthy cause — so that his place shall never
be with those cold and timid souls who know neither victory
nor defeat.
Or, as General George S. Patton said:
A good plan, violently executed now, is better than a
perfect plan next week.
Our plan has the support of the federal regulators—the
Federal Reserve, the FDIC, the Federal Home Loan Bank Board and
the Comptroller of the Currency. Many in Congress also support
it. Now we need your support. I ask you to join with me and
President Bush in calling on Congress to pass our legislation
now, so that we can return the S&L industry to its previous
vitality and stature. America needs a strong S&L industry, and
we need your help to make it strong — working together we can
achieve our goal.

TREASURY NEWS

lapartment of the Treasury • Washington, D.c. • Telephone 56
LIBRARY. ROOM 5310
FOR IMMEDIATE RELEASE
March 30, 1989

CONTACT:

Office of Financing
202/376-4350

MftR 3i 8 ss ,;H "B9
DEr-\Ft7MEKT Cl V.

RESULTS OF TREASURY'S AUCTION
OF 17-DAY CASH MANAGEMENT BILLS
Tenders for $ 15,106 million of 17-day Treasury bills to
be issued on April 3, 1989, and to mature April 20, 1989, were
accepted at the Federal Reserve Banks today. The details are
as follows:
RANGE OF ACCEPTED COMPETITIVE BIDS
Discount Investment Rate
Rate
(Equivalent Coupon-Issue Yield)
Low 9.63% 9.81% 99.545
High
9.65%
Average
9.64%

Price

9.84%
9.81%

99.544
99.545

Tenders at the high discount rate were allotted 6%.
TOTAL TENDERS RECEIVED AND ACCEPTED
BY FEDERAL RESERVE DISTRICTS
(In Thousands)
Location
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco
TOTALS

Received

Ac:cepted
$

$

72,878,000
---

1,000
--

6,605,000
-----

1,490,000
$80,974,000

—

15,,003,000
-----

91,200
--—
--

12,000
$15,, 106,200

An additional $400,000 thousand of the bills will be issued
to foreign official institutions for new cash.

NB-200

federal financing bank
March 31, 1989

FEDERAL FINANCING BANK ACTIVITY
Charles D. Haworth, Secretary, Federal Financing
Bank (FFB), announced the following activity for the month
of September 1988.
FFB holdings of obligations issued, sold or guaranteed
by other Federal agencies totaled $146.2 billion on
September 30, 1988, posting a decrease of $3.7 billion from
the level on August 31, 1988. This net change was the result
of decreases in holdings of agency debt of $251.6 million,
in agency assets of $900.2 million, and in agency-guaranteed
debt of $2,507 million. FFB made 43 disbursements during
September.
During fiscal year 1988, FFB holdings of obligations
issued, sold or guaranteed by other Federal agencies posted
a net decrease of $11,099 million from the level on
September 30, 1987. This change was the result of decreases
in agency assets of $6,630.2 million and in agency guaranteed
debt of $4,954.1 million. Holdings of agency debt increased
by $484.7 million.
The Omnibus Budget Reconciliation Act of 1987 authorized
rural electric borrowers to prepay up to $2.0 billion of their
Rural Electrification Administration-guaranteed loans from the
FFB, without premium or penalty, using REA-guaranteed private
market financings. Pursuant to this Act, FFB received
prepayments of $2.0 billion in FY 1988. FFB suffered an
associated loss of $473 million.
The Continuing Appropriations Resolution for 1988 allowed
FFB borrowers under foreign military sales (FMS) guarantees
to prepay at par their debt with interest rates of 10 percent
or higher. Pursuant to this Resolution, FFB received FMS
prepayments of $2.5 billion in FY 1988. FFB suffered an
associated loss of $814 million.
Attached to this release are tables presenting FFB
September loan activity and FFB holdings as of
September 30, 1988.
NB-201

.
CD

m

co

co

*>

s 2

WASHINGTON, D.C. 20220

FOR IMMEDIATE RELEASE

CD
CO

Page 2 of 4

FEDERAL FINANCING BANK
SEPTEMBER 1988 ACTIVITY

BORROWER

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

19,000,000.00

9/01/98

9.180%

9.077% qtr.

260,000,000.00
274,000,000.00
249,000,000.00
224,000,000.00
233,000,000.00
230,000,000.00
19,000,000.00
124,000,000.00

9/16/88
9/19/88
9/23/88
9/26/88
10/01/88
10/01/88
10/03/88
10/03/88

7.574%
7.638%
7.527%
7.502%
7.559%
7.586%
7.697%
7.653%

DATE

AGENCY DEBT
EXPORT-IMPORT BANK
Note #74

9/1

$

TENNESSEE VATTFV aTTTHORTTY
Advance
Advance
Advance
Advance
Advance
Advance
Advance
Advance

#942
#943
#944
#945
#946
#947
#948
#949

9/6
9/12
9/16
9/19
9/23
9/26
9/28
9/30

AGENCY ASSETS
Rural Electrification Adminiatration - Certificates of Beneficial Ownership
Certificate #28 9/30 68,000,000.00 12/31/88 7.664%

GOVERNMENT - GUARANTEED IPANS
DEPARTMENT OF HOUSING AND URBAN DEVFT/^yFyT
Community Development
•Brownsville, TX 9/1 326,450.25

9/01/89

8.410%

8.587% ann.

10/01/90
1/02/90
1/02/90
1/03/17
1/03/17
10/01/90
12/31/15

8.607%
8.355%
8.355%
9.085%
9.085%
8.484%
9.099%

8.516%
8.270%
8.270%
8.984%
8.984%
8.396%
8.998%

PTTPAT. FTFr;iHlJr'lCAnON ADMINISTRATION
New Hampshire Elec. #270
•Wolverine Power #182A
•Wolverine Power #183A
•Wabash Valley Power #206
•Wabash Valley Power #104
Old Dominion Elec. #267
Alabama Electric Coop. #287

•maturity extension

9/7
9/9
9/9
9/12
9/12
9/15
9/19

386,000.00
2,170,000.00
2,686,000.00
1,805,000.00
5,055,000.00
2,408,000.00
4,380,000.00

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Page 3 of 4

FEDERAL FINANCING BANK
SEPTEMBER 1988 ACTIVITY

BORROWER

DATE

AMOUNT
OF ADVANCE

FINAL
MATURITY

INTEREST
RATE
(semiannual)

INTEREST
RATE
(other than
semi-annual)

12/31/19
10/01/90
10/01/90
1/02/90
1/02/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
10/01/90
12/31/18

9.259%
9.248%
8.660%
8.660%
8.410%
8.410%
8.649%
8.654%
8.650%
8.650%
8.655%
8.654%
8.655%
8.655%
8.655%
8.655%
8.655%
8.650%
8.654%
8.660%
9.176%

9.154%
9.143%
8.568%
8.568%
8.323%
8.323%
8.557%
8.562%
8.558%
8.558%
8.563%
8.562%
8.563%
8.563%
8.563%
8.563%
8.563%
8.558%
8.562%
8.568%
9.073%

9/01/03
9/01/08
9/01/08

9.073%
9.116%
9.116%

12/30/88

7.713%

PTTP&T, FTFCTRIFICAnON ADMINISTRATION (continued)
Brazos Electric #230 9/29 $ 1,000,000.00 1/03/23
Brazos Electric #332
9/29
2,359,000.00
Tex-La Electric Coop. #329
9/30
2,037,000.00
Kamo Electric Coop. #209
9/30
6,145,000.00
•Wolverine Power Supply #182A
9/30
4,003,000.00'
•Wolverine Power Supply #183A
9/30
4,905,000.00
•Colorado Ute-Electric #8A
9/30
7,750,568.80
•Colorado Ute-Electric #78A
9/30
2,385,329.68
•Colorado Ute-Electric #78A
9/30
1,031,398.38
•Colorado Ute-Electric #78A
9/30
3,194,017.12
•Colorado Ute-Electric #203A
9/30
7,537,000.00
•Colorado Ute-Electric #96A
9/30
3,066,000.00
•Colorado Ute-Electric #297
9/30
6,345,673.20
•Colorado Ute-Electric #276
9/30
1,668,848.48
•Colorado Ute-Electric #297
9/30
4,079,985.36
•Colorado Ute-Electric #297
9/30
1,276,512.22
•Allegheny Elec. Coop. #304
9/30
247,000.00
•United Power Assoc. #86A
9/30
1,239,545.43
•Basin Electric #87A
9/30
19,085,714.32
•Wabash Valley Power #206
9/30
295,000.00
•Chugach Electric #257
9/30
585,000.00
SMALL BUSINESS ADMINISTRATION
State and Local Develccroent Onrr^pY nptv»ntures
Mahoning Valley Econ. Dev. Corp. 9/7 108,000.00
Quaker State CDC Inc.
9/7
231,000.00
Metropolitan Growth & Dev. Corp. 9/7
271,000.00

TENNESSEE V & T J E V ATTmnRTTY
Seven States Energy Corporation
Note A-88-12 9/30

•maturity extension

807,705,721.13

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U O Q O O O Q U O O Z Q C C I

TREASURYNEWS _
lepartntent of the Treasury • Washington, D.c. • Telephone 56S-2041
FOR RELEASE AT 12:00 NOON
March 31, 1989

CONTACT:

Office of Financing
202/376-4350

TREASURY'S 52-WEEK BILL OFFERING
EH I1

The Department of the Treasury, by this public notice, invites
tenders for approximately $9,000
million of 364-day Treasury bills
to be dated April 13, 1989,
and to mature April 12, 1990
(CUSIP No. 912794 TZ 7 ). This issue will result in a paydown for
the Treasury of about $50
million, as the maturing 52-week bill
is outstanding in the amount of $ 9,062 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 6, 1989.
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 13, 1989.
In addition to the
maturing 52-week bills, there are $ 14,724 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 $ 1,959 million as agents for foreign
and international monetary authorities, and $ 6,433 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 $ 360
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
be submitted on Form PD 5176-3.
NB-2 0 2

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
the Public Debt.
10/87

Ilmswy DepiiimWOBm
Z°,mt5°m- T-easury Building
lu. Pennsylvania Ave N W
Washington, D.C. 20220

•BMMOTV

•—w^mummmimmm

U.S. TREASURY LIBRARY

1 003166"