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■oik. W \ FEDERAL DEPOSIT INSURANCE CORPORATION FO R R E L E A SE ON D E L IV E R Y t tl t P R -4 5 -7 4 ( 7 -2 4 -7 4 ) & ^ ■0 AUG3 0 1974 pnfRM rôPOSIt INSURANCE tUjwl Institutions and the C om p etition fo r L endable Funds Statem ent by O F rank W ille , C hairm an F e d e r a l D e p o sit Insuran ce C o rp o ra tio n b e fo r e the S u bcom m ittee on F in a n cia l Institutions o f the C om m ittee on B anking, H ousing and Urban A ffa ir s United States Senate July 24, 1974 FEDERAL DEPOSIT INSURANCE CORPORATION, 550 Seventeenth St. N.W., Washington, D. C. 20429 • 202-389-4221 The p r o c e s s o f d isin te rm e d ia tio n , w h e re b y fin a n cia l institu tion s lo s e d e p o sits o r p oten tial d e p o sits to n on d ep osit in v e stm e n ts, is again a fa ct o f life fo r m any o f the n a tio n 's fin a n cia l institu tion s - - the fourth tim e this has happened in eight y e a r s . F o r m any in v e s t o r s , d e p o sits lo s e th e ir a ttra ctiv e n e s s when s ig n ifica n tly h igh er ra te s o f retu rn a re a v a ila b le on n on d ep osit in v estm en ts and when this im b a la n ce p e r s is ts fo r m o r e than a few m onths o r even w e e k s. O v er the past few m on th s, u n p reced en ted ra te s o f in te r e s t have b een a v a ila b le on both taxable and t a x -e x e m p t in stru m en ts and on s h o r t -t e r m as w e ll as lo n g -t e r m o b lig a tio n s . T h ese ra te s r e fle c t the com b in ed e ffe c t s o f the p u b lic 's e x p e c ta tion s about in fla tion in the future as w e ll as the e ffo r t s o f the F e d e ra l R e s e r v e S y stem to r e s tr a in th ose in fla tio n a ry e x p e c ta tio n s. F or d e p o s ita r y in stitu tio n s, the p ro b le m s o f high in te re s t rate p e rio d s a re com pounded b y the lo w e r ra tes o f in te r e s t a llow ed to be paid under R egu la tion Q on d e p o sits o f le s s than $100, 000 and by the d e fic ie n c ie s in ea rn in gs p ow er w h ich a fflic t the n a tion 's th rift in stitu tion s and la r g e ly d eterm in e the le v e ls at w h ich c e ilin g ra tes a re set fo r both c o m m e r c ia l banks and th rift in stitu tio n s. T e m p o r a r y , stopgap m e a s u r e s a re alw ays ask ed o f the C o n g re ss when the e ffe c t s o f s e v e r e d isin te rm e d ia tio n , e s p e c ia lly on housing and - 2 - the funds a v a ila b le fo r hom e m o r t g a g e s , a re fe lt. But u n less the key is s u e is ta ck le d , n a m ely the ea rn in g s p ow er o f the n a tion 's th rift in stitu tio n s, we w ill on ly have m o r e o f the sam e p e r io d ic a lly in the fu tu re. I know the S u bcom m ittee is aw are o f this lo n g e r t e r m need fo r r e fo r m , even as it g ra p p le s with a w ide v a r ie ty o f su g g estion s fo r m o r e im m e d ia te r e lie f fr o m som e o f the r e p e r c u s s io n s o f ou r p re se n t d is in te rm e d ia tio n , but the point n eeds to be d riv e n hom e and rep ea ted as you fa ce the co m p e tin g and co n flictin g cla im s o f th ose with evident s e lf-in t e r e s t in the o u tco m e . O v e r the y e a r s , the n a tio n 's th rift in stitu tion s and s m a lle r c o m m e r c ia l banks have b e e n the p rin cip a l su p p lie rs o f funds fo r re s id e n tia l hom e m o r t g a g e s , with savin gs and loan a s s o c ia tio n s having the h igh est p e rce n ta g e o f the th ree ty p es o f institution s in tota l a s s e ts com m itted to r e s id e n tia l hom e m o rtg a g e s arid m utual savin gs banks the secon d h igh est p e rce n ta g e o f a s s e ts so co m m itte d . In the ca se o f m utual savin gs banks (m ost o f w h om a re su p e rv ise d and exam in ed at the F e d e ra l le v e l b y the F D IC ), th ere can be no doubt that th ere has b een a sig n ifica n t slow dow n o f in co m in g funds a v a ila b le fo r hou sing in v estm en t. P r e lim in a r y d e p o sit p r o je c tio n s fo r July in d icate r e c o r d net ou tflow s o f funds. A d d itio n a lly , th ese banks su ffe re d a net outflow - 3 * o f a p p ro x im a te ly $350 m illio n la st m onth - - the w o r s t June fig u re s e v e r r e c o r d e d - - and o f $190 m illio n in M ay and $645 m illio n in A p r il. E ven taking into a ccou n t in te re s t cre d ite d in e a ch o f these th ree m on th s, the funds a v a ila b le fo r housing in v estm en t have fa llen o ff sh a rp ly co m p a re d to the sam e m onths in past y e a r s . Savings banks a re keeping th eir liq u id ity up and th e ir co m m itm en ts fo r future m o rtg a g e m on ey down as they fa ce continuing d e p o sit d ra in s. In som e sta tes, w h ere low u su ry c e ilin g s m ay be in e ffe c t with r e s p e c t to re sid e n tia l m o rtg a g e lo a n s, the funds a v a ila b le fo r housing in vestm en t a re even m o r e lim ite d . A s you know, R egu lation Q and co m p a ra b le p r o v is io n s o f FDIC and FHLBB reg u la tion s p re se n tly lim it the rates o f in te re s t w hich can be paid b y m o s t d e p o s ita ry institutions to th eir d e p o sit c u s to m e r s . R ates o f in te re s t on d e p o sits o f $ 1 0 0 ,0 0 0 o r m o re a re p re se n tly u n reg u la ted , but p a ssb o o k savings rates b elow that am ount cannot e x c e e d 5% p e r annum fo r c o m m e r c ia l banks and 5 1/4% fo r the n ation 's th rift in stitu tion s. C e rtifica te a ccou n ts pay m o r e , depending on m a tu rity and d en om in a tion , ranging up to 7 1/4% p er annum fo r c o m m e r c ia l bank tim e d e p o sits o f $ 1 ,0 0 0 o r m o re held on d e p o sit fo r four y e a rs o r m o r e and up to 7 1/2% p er annum fo r a co m p a ra b le tn rift - 4 - in stitu tion c e r t ific a t e . Substantial in te r e s t rate p en alties a re im p o se d i f the d e p o s ito r seek s e a r ly re d e m p tio n . In a dd ition , under the r e g u la tion s o f a ll th ree r a te -s e ttin g a g e n c ie s , the c e ilin g ra tes apply to n on d ep osit ob lig a tio n s o f in su red banks and a s s o c ia tio n s u n less they fa ll into ce rta in s p e c ifie d c a t e g o r ie s , such as a subordinated ca p ita l deben tu re o r note o f $500 o r m o r e w h ich has an o rig in a l m a tu rity of sev en y e a r s o r m o r e . A s o f to d a y , if the u n d erw ritin g goes fo rw a rd as planned, C it ic o r p w ill is s u e $850 m illio n p rin cip a l am ount o f u n se cu re d notes at an in itia l in te r e s t rate o f 9. 70% p er annum with in te re s t a fte r next June 1 set e v e r y s ix m onths at 1% p e r annum o v e r s e le c te d T r e a s u r y b ill r a te s . T h rift in stitu tion s and banks w h ich have a lre a d y found th e m s e lv e s unable to a ttra ct funds e ffe c t iv e ly in the cu r re n t high in te r e s t rate e n v iron m en t w ill then fa ce the added co m p e titiv e ch a llen ge o f oth er s im ila r is s u e s w h ich w ill have undoubted app eal to th e ir t r a d i tion a l d e p o s ito r s . C it ic o r p 's note is not a d e p o s it, but it w ill o b v io u s ly com p ete w ith d e p o sits along with oth er n on d ep osit m a rk e t in stru m en ts p re se n tly a v a ila b le to the p u b lic. What m a k es the C itic o r p note look m o r e lik e a d e p o sit than oth er m a rk e t in stru m en ts is (i) its r e la tiv e ly low d e n o m i nation ($ 1 ,0 0 0 with a m in im u m su b s c rip tio n o f $5, 000), (ii) its - 5 - iss u a n ce b y a bank holding com p an y w h ose p u blic id e n tifica tio n is synon ym ous with its p rin cip a l a ffilia te , the n a tio n 's se co n d la r g e s t in su red bank, and (iii) its op tion al re d e m p tio n fe a tu re s w h ich a re a v a ila b le to an in v e s to r long b e fo r e its p oten tial 15-y e a r m a tu rity. W hile a ll o f th ese fe a tu re s have a b e a rin g on the co m p e titiv e th reat w h ich som e o f the n a tio n 's d e p o s ita ry institution s see in this type o f in stru m en t, it is the e a r ly re d e m p tio n fea tu re at the h o ld e r 's option w h ich m o s t d ir e c t ly co m p e te s with the tim e d e p o sits that can p re se n tly be o ffe r e d b y the n a tion 's th rift institution s and banks. T o illu s t r a te , a tim e d e p o sit o f a m utual savin gs bank o r a F e d e r a lly in su red savings and loan a s s o c ia t io n , issu e d fo r the 23 m onths b etw een now and the e a r lie s t p erm itted re d e m p tio n o f the C it ic o r p n o te , cou ld c a r r y a m a xim u m in te re s t rate o f 6 1/2% p er annum fo r th irfts and a m a xim u m in te re s t rate o f 6% p e r annum fo r c o m m e r c ia l banks under R egu la tion Q. E ven if the e a r lie s t p erm itted re d em p tion on s im ila r notes w e re to be fo u r y e a r s ra th er than 23 m on th s, the m a xim u m p erm itted rate under R egu la tion Q would be 7 1 /2% fo r th rifts and 7 1/4% fo r c o m m e r c ia l banks. Under ou r p re se n t re g u la tio n s , it is on ly w h ere the e a r lie s t p o s s ib le re d e m p tio n is sev en y e a rs away that a th rift in stitu tion o r - 6 - a c o m m e r c ia l bank w ould be able to o ffe r a subordinated note w hose oth er te rm s w e re id e n tica l to th ose o f the C itic o r p note. T his is b e c a u s e su bord in ated notes o f le s s than seven y e a r s ' m a tu rity a re d eem ed to be d e p o sits and a re su b je ct to a ll the in te re s t rate lim it a tion s o f R egu la tion Q. The banking a g e n c ie s co u ld , o f c o u r s e , r e a c t to the " C it ic o r p note p r o b le m " b y am ending th e ir reg u la tion s to p ro v id e fo r a s h o r te r a cce p ta b le m a tu rity p e rio d on subord in ated n o te s. But with m any tim e d e p o sits b e a rin g m a tu ritie s in the fo u r - o r f iv e - y e a r ra n g e , th ere is on ly lim ite d r o o m within w h ich the a g e n cie s can m o v e if they seek to reta in som e r e c o g n iz a b le d iffe r e n c e b etw een s h o r t e r -t e r m " d e p o s it s " and g e n e r a lly lo n g e r -t e r m "c a p ita l. " The banking a g e n c ie s cou ld a ls o p e rm it a v a ria b le rate tim e d e p o s it, with c e ilin g ra te s set m on th ly o r q u a rte rly b y the a g e n cie s in the light o f so m e m a rk e t in d ica to r o f a v a ila b le in te re s t r a t e s , such as the a v era g e y ie ld on th r e e -m o n th T r e a s u r y b ills . In M ay o f this y e a r , I r e le a s e d fo r co m m e n t an FDIC sta ff p r o p o s a l along th ese lin es w h ich is now under a ctiv e co n s id e r a tio n b y the r a te -s e ttin g a g e n c ie s . A co p y o f that r e le a s e is a tta ch ed. T h is p r o p o s a l d iffe r e d , h o w e v e r, in s e v e r a l b a s ic r e s p e c t s fr o m the te r m s o f the C itic o r p note is s u e . - 7 - F ir s t , the p ro p o s e d rate o f in te re s t on the d e p o sit would be p egg ed , fo r m u tu a ls, to the e x a ct a v e ra g e o f the y ie ld s announced b y the T r e a s u r y e a ch M onday fo r n o n co m p e titiv e b id s on th re e -m o n th T r e a s u r y b ills and fo r c o m m e r c ia l b a n k s, to a ce ilin g 25 o r 50 b a s is points b e lo w that (the in te r e s t rate on C it ic o r p 's n ote, at le a s t a fte r the f ir s t y e a r , w ould be set e v e r y s ix m onths at 1% a bove a s e le c te d 2 1 -d a y a v e ra g e o f y ie ld s on th re e -m o n th T r e a s u r y b ills ) . S econ d , the FDIC sta ff p ro p o s e d a m in im u m t e r m fo r the new d e p o sit o f fo u r y e a r s , with su b stan tial p en a lties fo r e a r ly red em p tion (C it ic o r p 's n ote, although it c a r r ie s a 1 5 -y e a r m a tu rity , can be re d e e m e d on June 1, 1976, at par and th e re a fte r at s ix -m o n th in te rv a ls ; in ad d ition , a s e co n d a ry m a rk et w ill e x is t through listin g o f the notes on the New Y o rk Stock E xch a n g e). T h ir d , the FDIC sta ff p ro p o s e d a guaranty that the rate o f in te re s t w ould not fa ll b e lo w so m e m in im u m le v e l, such as 4. 5% p e r annum (the C itic o r p note c a r r ie s no f lo o r , but the in itia l rate o f 9. 7% p er annum is guaranteed until next June 1), F o r the p u b lic, the c r it ic a l d iffe r e n c e m a y w e ll p ro v e to be the r e s p e c tiv e ra te s at w h ich the p ro p o s e d tim e d e p o sit o r a note like C it ic o r p 's is in itia lly is s u e d . The FDIC p r o p o s a l r e fle c t e d our a w a re n e ss that the ea rn in g s p o sitio n and p oten tial o f the n a tio n 's m utual - sa vin gs banks is lim ite d . 8 - We know that the o c c a s io n a l a ttra ctiv e n e s s o f T r e a s u r y b ills o r the ch a llen ge o f a note is s u e like C it ic o r p 's cannot be r e a lis t ic a lly a n sw e re d b y som e d r a m a tic , a c r o s s - t h e -b o a r d in c r e a s e in d e p o sit rate c e ilin g s under R egu la tion Q b e ca u se the ea rn in g s o f such in stitu tion s w ould not p e rm it the p aym ent, a c r o s s the b o a r d , o f the m u ch h igh er ra tes that w ould now be re q u ire d to a ttra ct d e p o sit funds. E ven if a lim ited change under R egu la tion Q w e re to be a u th orized to p e rm it the o ffe r in g o f a v a ria b le rate tim e d e p o s it, such as the one FDIC p ro p o se d in M ay, we know that a lm o s t no th rift institution would have the ea rn in gs p ow er to pay a 9. 7% p er annum rate fo r long on any sig n ifica n t p ortion o f its tota l d e p o s its . So in the end, w hile a m e lio r a tiv e steps can be taken on a t e m p o r a r y , stopgap b a s is to stem the outflow o f funds fr o m h ou sin g orie n te d in stitu tio n s, we re tu rn to the b a s ic need fo r in c r e a s e d ea rn in gs p ow er on the part o f the n a tion 's th rift in stitu tion s. Any b a s ic r e fo r m s in this a re a m u st, o f c o u r s e , be adopted with an ey e to th e ir e ffe c t on the funds a v a ila b le fo r housing and hom e m o r t g a g e s , and then s u f fic ie n t tim e m u st be p rov id ed th e re a fte r fo r the im p lem en ta tion o f such new p o w e r s . But we w ill not e s ca p e the rep ea ted c r i s e s o f d is in te r m e d ia tion until such lo n g -r a n g e step s a re taken. - 9 - The p ro p o s e d F in a n cia l Institutions A c t re p r e s e n ts one such a p p ro a ch to lo n g -ra n g e r e fo r m . It w ould b ro a d e n the a s s e t and lia b ility p ow ers o f th rift in stitu tion s op era tin g under a F e d e r a l ch a rte r w hile at the sam e tim e m aking p r o v is io n fo r a phaseout o f R egu la tion Q ce ilin g s on a gra du al b a s is r - the o b je c tiv e b e in g to enable m an agem en t to b e tte r s e rv e the needs o f its d e p o s ito r s and oth er c u s to m e r s under a wide v a r ie ty o f e c o n o m ic co n d itio n s . The FDIC b e lie v e s that this o b je c tiv e is com m en d a b le and h opes that this S u b com m ittee w ill turn its attention to the d e ta ils o f such lo n g -r u n r e fo r m e a r ly in the next s e s s io n o f the C on gress.
