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CREDIT WHERE CREDIT IS DUE Address By Delos C. Johns P r e s i d e n t , F e d e r a l R e s e r v e Bank of St. Louis Before The Louisville Chapter, A m e r i c a n Institute of Banking Seelbach Hotel, L o u i s v i l l e , KentuckySaturday Evenings May 22, 1954 CREDIT WHERE CREDIT IS DUE I should like to begin m y a d d r e s s this evening by giving c r e d i t w h e r e c r e d i t i s due. When I r e c e i v e d your p r e s i d e n t ' s g r a c i o u s invitation some weeks ago, I had not a m o m e n t ' s hesitation in accepting it. It i s a p r i v i l e g e to honor you who, by giving of your own free t i m e and energy, add so much to your p e r s o n a l capital, t h e r e b y adding also to the human r e s o u r c e s and thus the total r e s o u r c e s of the banking institutions which you r e p r e s e n t . T h e r e i a little question, of c o u r s e , that your AIB work, if you see it through, will be r e w a r d i n g . None of us can escape the sense of satisfaction which c o m e s with the capacity to r e l a t e our job and the work of our institution to the complex economic world about u s . Nor can I a g r e e with a c e r t a i n Spanish p h i l o s o p h e r , (Unamuno), that all knowledge m u s t have an object other than the p l e a s u r e of acquiring knowledge for i t s own s a k e . We may wish to l e a r n some things m e r e l y for the t h r i l l of a c q u i r - ing new v i s t a s , and not simply to complete our fund of knowledge nor to achieve s o m e p r a c t i c a l end. It h a s nonetheless been my o b s e r v a t i o n that s e r i o u s attention to furthering o n e ' s education does bring m a t e r i a l r e w a r d s , Many of my acquaintances who w e r e unable to complete their f o r m a l academic training have made g r e a t s u c c e s s e s in banking in l a r g e p a r t b e c a u s e they w e r e able to p u r s u e such p r o g r a m s a s the Louisville Chapter of AIB i s affording you. Nothing about an individual i m p r e s s e s me m o r e than a willingness to forego p l e a s u r e s for the sake of l o n g - r u n i m p r o v e m e n t . It i s not e a s y . After a d a y ' s work at a p l a c e of b u s i n e s s , night work i s o n e r o u s , and f o r m a l a c a d e m i c effort may s o m e t i m e s s e e m not worth the c a n d l e . It is h a r d to forego an evening of r e l a x a t i o n and - 2 e n t e r t a i n m e n t in favor of h o u r s in a dingy c l a s s r o o m . Whatever the r e w a r d s that lie in some distant future, it t a k e s strength of c h a r a c t e r and a genuine loyalty to o n e ' s bank to bring about the s a c r i f i c e s which you have made and a r e making. Credit i s indeed due you 9 and I believe in bestowing c r e d i t where c r e d i t i s due. But I a m s u r e you did not gather h e r e this evening to h e a r me say nice things to you about y o u r s e l v e s . I a s s u m e your p u r p o s e in exposing y o u r s e l v e s to my a r t l e s s speech w a s to h e a r a d i s c u s s i o n of a worth while topic in the field of money and b a n k ing. Therefore^ the subject of my a d d r e s s this evening i s no idle play on w o r d s . I wish to talk with you s e r i o u s l y and as fully as a brief t i m e will p e r m i t about s o m e b r o a d p r i n c i p l e s by which^ in today's economy,, we give c r e d i t in the financial sense w h e r e c r e d i t i s due. When one f i r s t e x a m i n e s the m e c h a n i s m by which c r e d i t is allocated in an economy, it may s e e m that the b u s i n e s s of d e t e r m i n i n g who shall r e c e i v e c r e d i t is a function of the c o m m e r c i a l banks alone. Indeed, in the s h o r t - t e r m s e c t o r s of the c r e d i t m a r k e t the c o m m e r c i a l banks a r e the major s u p p l i e r s of funds. As we shall p r e s e n t l y s e e , however, both s u p p l i e r s of l o n g - t e r m funds and the F e d e r a l R e s e r v e S y s t e m have their p a r t s to play in deciding how c r e d i t shall be allocated and, if need b e , rationed. But the c o m m e r c i a l banks a r e so i m p o r t a n t in this r e g a r d that we m u s t pause f i r s t to reflect on their r o l e . It is to the c o m m e r c i a l banker that the b u s i n e s s f i r m seeking s h o r t - t e r m c r e d i t n o r m a l l y c o m e s for accommodation. Upon the c o m m e r c i a l banker falls the r e s p o n s i - bility of deciding in each c a s e whether or not that p a r t i c u l a r demand for c r e d i t is - 3 worthy and should be satisfied. At this point it may be well to r e c a l l that the t r u e concept of c r e d i t w o r t h i n e s s is dual; it is actually two concepts rolled into one. A c r e d i t i s worthy in one sense if the g r a n t o r can r e a s o n a b l y expect fulfillment of the specified t e r m s of r e p a y m e n t . C r e d i t i s worthy in another sense if it will enable the b o r r o w e r to make a contribution to the community and the nation. No banker is likely to neglect the r e s p o n s i b i l i t y which is his in the f i r s t s e n s e . He may make m i s t a k e s of judgment about the r i s k s involved, but he will not often be unmindful of these r i s k s . It is t r u e that in t i m e s of easy money and continuously r i s i n g p r i c e s - when inflation i s the o r d e r of the day and its end is not yet in sight the concept of c r e d i t w o r t h i n e s s in the sense of collectibility tends to become d i m m e r and d i m m e r . In such t i m e s money i s easy to come by and collection p r o b l e m s a r e the l e a s t of a b a n k e r ' s w o r r i e s . On the other hand, in t i m e s of falling economic activity, the t h r e a t grows daily m o r e r e a l that some b o r r o w e r s may not be able to m e e t their obligations a s they fall due. B a n k e r s a r e then likely to take a l e s s o p t i m i s t i c view of the g e n e r a l outlook for b u s i n e s s and p r i c e s , and applications for loans a r e m o r e carefully s c r e e n e d . B a n k e r s a r e hi;.man, notwithstanding o c c a s i o n a l r u m o r s to the c o n t r a r y , and their attitudes a r e likely to reflect the tempo of the time s o Now for the other b r a n c h of our dual concept of c r e d i t w o r t h i n e s s . The t r a d i - tional duty of the b a n k e r , p e r h a p s h i s highest duty, has been to make such allocations of the c r e d i t at his disposal as will b e s t s e r v e society. w i s d o m , and courage a r e r e q u i r e d to a g r e a t d e g r e e . This is w h e r e judgment, When available c r e d i t h a s some l i m i t , the b a n k e r ! s t a s k of selection and allocation c a l l s for p r i v a t e s t a t e s m a n ship of the highest o r d e r . But when money is so e a s y that t h e r e is m o r e than enough - 4 c r e d i t for all at going r a t e s , the n e c e s s i t y to make h a r d and often unpleasant decisions recedes. Under such c i r c u m s t a n c e s the second of,our twin concepts of c r e d i t w o r t h i n e s s , like the f i r s t , b e c o m e s l e s s o p e r a t i v e . J u s t a little over t h r e e y e a r s ago we r e t u r n e d to a m o r e n o r m a l money c l i m a t e , something different than obtained for n e a r l y a decade during and after World War 11. Since the spring of 1951, when the F e d e r a l R e s e r v e System c e a s e d to convert a u t o m a t ically, at or above p a r ? the Government s e c u r i t i e s of banks into r e s e r v e s , c o m m e r c i a l b a n k e r s have operated under the old r u l e s of the g a m e . It has not always been p o s s i b l e to a c c o m m o d a t e all c r e d i t demand which m e e t s only the f i r s t t e s t of c r e d i t w o r t h i n e s s ( r e a s o n a b l e expectation of repayment),, The banker had at those t i m e s to r e s u r r e c t and refurbish h i s p o w e r s of selection; he again faced the opportunity and the r e s p o n s i bility to see that sound c r e d i t d e m a n d s w e r e supplied in o r d e r of p r i o r i t y of contribution to community and nation and, of c o u r s e , to see that unsound d e m a n d s w e r e denied. In other w o r d s , the banker had to r e t u r n to the traditional dual concept of c r e d i t w o r t h i n e s s and govern himself accordingly 0 H i s t o r i c a l l y , b a n k e r s have done this well, and under changed c i r c u m s t a n c e s they have quickly r e l e a r n e d half-for gotten t e c h n i q u e s . This r e a l , d o w n - t o - e a r t h function of b a n k e r s r e q u i r e s skill, know-how, and c o u r a g e . In emphasizing, at the beginning of my r e m a r k s , the c r u c i a l role of c o m m e r c i a l b a n k e r s in determining the r e c i p i e n t s of c r e d i t , I did not m e a n to imply that the b u r d e n r e s t s exclusively upon the c o m m e r c i a l banks or that the c e n t r a l bank can or should avoid p a r t i c i p a t i o n in the allocation p r o c e s s . It i s to the function of the F e d e r a l R e s e r v e System in this r e g a r d that I would next invite your attention. - 5 Some weeks ago a m e m b e r of the staff of the F e d e r a l R e s e r v e Bank of St. Louis d i s c u s s e d with your Louisville AIB group the m e a n s by which the c e n t r a l bank can affect the r e s e r v e s of c o m m e r c i a l banks and thus influence the supply,, availability, and cost of c r e d i t . Through changes in the r e q u i r e d r e s e r v e r a t i o s of m e m b e r b a n k s , by open m a r k e t o p e r a t i o n s , and, to a limited extent,, by changes in the r e discount r a t e it is a m a t t e r of financial m e c h a n i c s to effect changes in the r e s e r v e position of the c o m m e r c i a l banking system 0 A c o m p r e h e n s i o n of t h e s e t e c h n i c a l i t i e s i s e s s e n t i a l to an understanding of the vital control function of the c e n t r a l bank. I would speak a word of caution. Yet We must not fall into the e r r o r of thinking that the m o n e t a r y a u t h o r i t i e s , in taking d e c i s i o n s to i n c r e a s e or d e c r e a s e m e m b e r bank r e s e r v e s , need consider only the quantitative effects of these changes along with their proper timing. F e d e r a l R e s e r v e a u t h o r i t i e s , as well as c o m m e r c i a l b a n k e r s , m u s t accept the r e s p o n s i b i l i t y of bestowing c r e d i t where c r e d i t is due. That the F e d e r a l R e s e r v e a u t h o r i t i e s must s h a r e this responsibility follows in p a r t f r o m what I have just said about the r e s p o n s i v e n e s s of b a n k e r s to changes in the availability of c r e d i t . It i s true that the F e d e r a l R e s e r v e achieves its objectives of maintaining a stable and growing economy by affecting d i r e c t l y the amount of r e s e r v e s available to the banking s y s t e m and indirectly the r a t e of i n t e r e s t . But when the c e n t r a l bank t a k e s steps to i m p o s e r e s t r a i n t s on the granting of c r e d i t , it cannot avoid imposing on c o m m e r c i a l b a n k e r s the n e c e s s i t y of being m o r e s e l e c t i v e . And, c o n t r a r i w i s e , an easing of r e s e r v e positions and a lowering of i n t e r e s t r a t e s r e l i e v e s the b a n k e r ' s p r o b l e m of c r e d i t rationing. In short, c o m m e r c i a l bank s e l e c - tivity i s r e l a t e d closely to F e d e r a l R e s e r v e policy d e c i s i o n s . . 6 In the m a r k e t for l o n g - t e r m funds the effects of c e n t r a l bank action a r e even m o r e r e a d i l y apparent, as w i t n e s s the effects on both b o r r o w e r s and l e n d e r s of the c r e d i t r e s t r a i n t s of l a s t s p r i n g . A r i s e of only l / 2 of 1 p e r cent in the yields of i n t e r m e d i a t e and l o n g - t e r m Government s e c u r i t i e s during late 1952 and the f i r s t half of 1953 r e s u l t e d in c o n s t r i c t e d capital and m o r t g a g e m a r k e t s . State and local g o v e r n m e n t units and p r i v a t e f i r m s w e r e forced to postpone contemplated i n v e s t m e n t , for so s m a l l an absolute change in the cost of l o n g - t e r m funds meant l a r g e additions to total i n t e r e s t changes over a p e r i o d of y e a r s . The i m p a c t on the u r b a n r e s i d e n t i a l m o r t g a g e m a r k e t was e s p e c i a l l y pronounced. On the other hand, as the policy of m o n e t a r y e a s e inaugurated in the late spring of 1953 began to take effect, b o r r o w e r s sensitive to r a t e changes have come back into the m a r k e t for l o n g - t e r m funds. B u s i n e s s e s with high i n v e s t m e n t - s a l e s r a t i o s , such as r a i l r o a d s and public u t i l i t i e s , as well as municipal and state g o v e r n m e n t s , have been encouraged to b o r r o w in o r d e r to c a r r y out t h e i r plans for expansion. As bond yields s t a r t e d to decline in the fall of 1953, the yields of u r b a n r e s i d e n t i a l m o r t g a g e s b e c a m e m o r e a t t r a c t i v e to institutional i n v e s t o r s e By e a r l y this y e a r the m o r t g a g e m a r k e t had e a s e d p e r c e p t i b l y , and since M a r c h m o r t g a g e money h a s b e c o m e r e a d i l y available. It is in the m a r k e t for l o n g - t e r m funds, p e r h a p s m o r e than in any other a r e a , that F e d e r a l R e s e r v e a u t h o r i t i e s e x e r c i s e the m o s t d i r e c t influence on the allocation of c r e d i t among a l t e r n a t i v e u s e s . We m u s t r e m i n d o u r s e l v e s , however, that the actual d e c i s i o n s a r e made by individuals in their p r i v a t e c a p a c i t i e s a s b o r r o w e r s and l e n d e r s . - 7 L e t me s u m m a r i z e briefly. Both c o m m e r c i a l b a n k e r s and c e n t r a l b a n k e r s play t h e i r r o l e s in giving c r e d i t to those to whom c r e d i t i s due 6 you will keep c e r t a i n b r o a d p r i n c i p l e s in mindo As c o m m e r c i a l b a n k e r s , You will continue to finance sound and e s s e n t i a l p r o j e c t s ; you will be cautious about m a r g i n a l c r e d i t s and reluctant to go too far with m a r g i n a l p r o d u c e r s . As b a n k e r s you will never forget that the men of u t m o s t i m p o r t a n c e to your community, region, and nation a r e the efficient e n t r e p r e n e u r s „ Financing which helps make t h e m m o r e efficient, which helps t h e m become s t r o n g e r , i s the kind of financing that i s both profitable to your institutions and useful to the c o u n t r y . The economic strength of our nation r e s t s on the efficient p r o d u c e r in all his c o u n t e r p a r t s , be he f a r m e r , m a n u f a c t u r e r , w h o l e s a l e r , or r e t a i l e r , and b a n k e r s stand in b e t t e r position than anyone e l s e to d i s c o v e r t h e s e e l e m e n t s of s t r e n g t h in t h e i r c o m m u n i t i e s and to a s s i s t in their development through sound financing and sound advice 0 We who a r e a s s o c i a t e d with you in the whole institution of banking and working within the F e d e r a l R e s e r v e System m u s t likewise be conscious of the p r i n c i p l e s by which we a r e guided. The S y s t e m ' s r o l e today i s to provide for the nation the b e s t m o n e t a r y device it is p o s s i b l e to c r e a t e . The S y s t e m ' s objective, which i m p l i e s d e l i b - e r a t e c o u n t e r - c y c l i c a l adjustments in the money supply, is to p r o m o t e such economic growth a s i s consistent with economic stability. This objective we a r e striving to attain through adjustment of the total supply of r e s e r v e s available to m e m b e r b a n k s . The allocation of r e s e r v e s among banks and the rationing of c r e d i t to c u s t o m e r s we would leave as n e a r l y as p o s s i b l e to competitive m a r k e t p r o c e s s e s . NoWp suppose we stop and catch our b r e a t h . I have d e l i b e r a t e l y and with m a l i c e aforethought led you for the l a s t few minutes on an expedition into t e r r a i n over which - 8 the going can be p r e t t y rough. You may wonder why I did this to you on a beautiful evening in May when t h e r e a r e so many other things to be done, p e r h a p s m o r e pleasurable. The decision to do it was not e a s y . It would have been so much e a s i e r to indulge in a few minutes of r e l a x e d story telling and v e r b a l p l e a s a n t r i e s , followed s h o r t l y by music and dancing. Indeed I a m told that music and dancing a r e to follow, and I shall not much longer stand in their way. If I appear to r e g a r d with g r e a t s e r i o u s n e s s the duties and r e s p o n s i b i l i t i e s of banking and b a n k e r s in our t i m e and in the t i m e to c o m e , I do not object, for I do, and I have distinguished company., A few days ago I sat in an audience of b a n k e r s and listened to an a d d r e s s by the Vice P r e s i dent of A m e r i c a n B a n k e r s Association, who by t r a d i t i o n will succeed to the p r e s i d e n c y of the A s s o c i a t i o n next autumn. understanding. He i s a banker of outstanding a c c o m p l i s h m e n t and In the c o r e of his a d d r e s s he flung at his h e a r e r s a long l i s t of q u e s t i o n s , n D o you know this?™ ?rDo you know t h a t ? H n Do you k n o w ? " n Do you know? 1 1 One after another of those questions dealt with the things I have been talking to you about tonight and closely r e l a t e d s u b j e c t s . It was a resounding challenge to all of us who a s s u m e or a s p i r e to the proud title of b a n k e r . The point, as I see it, is that we who decide to make our c a r e e r s in the i n s t i t u tion of banking owe a duty, not alone to o u r s e l v e s and the banks we s e r v e , but to our c o m m u n i t i e s and the nation, to know as much a s we r e a s o n a b l y can about the c h a r a c t e r i s t i c s and the functions of our money s y s t e m and our banking s y s t e m . We m u s t not fall into the e r r o n e o u s belief that banking i s a m e r e housekeeping o p e r a t i o n . Of c o u r s e , b a n k e r s must know how to accept deposits and deal with d e p o s i t o r s , to c a s h and c l e a r c h e c k s , to make loans and collect t h e m . I do not u n d e r r a t e t h e s e things. . 9 They a r e t r e m e n d o u s l y important„ But u n l e s s we know also how our money s y s t e m w o r k s and what its i m p o r t a n c e and significance a r e to the economic, b u s i n e s s , and social life of our country, we shall be in g r a v e danger, I f e a r , of falling short of m a x i m u m usefulness to our b a n k s , our d e p o s i t o r s 5 our communities^ and the national w e l f a r e . If we who make money and banking our b u s i n e s s fall s h o r t , how shall the public i n t e r e s t in this a r e a be s e r v e d ? In this AIB group, before which I a m so proud to a p p e a r , I apprehend that the p r e s e n t g e n e r a t i o n and the succeeding one have found and will find their banking l e a d e r s h i p for the Louisville a r e a and doubtless e l s e w h e r e . That is so, in my judgment, b e c a u s e you a r e not content with what you now know but seek to expand and e n l a r g e your knowledge of the field in which you have c a s t your lot„ c o m m e n d you and give you c r e d i t , for it i s your just due. 0000OOOO0000 F o r that I
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