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NEWS RELEASE PR-66-74 (11-6-74) FOR IMMEDIATE RELEASE Address By George A. LeMaistre Director Federal Deposit Insurance Corporation "BANK LIQUIDITY AND THE CHALLENGES OF 1974" Before the Earning Assets Conference Pennsylvania Bankers Association Hershey, Pennsylvania November 6, 1974 FEDERAL DEPOSIT INSURANCE CORPORATION, 550 Seventeenth St. N.W ., Washington, D. C. 20429 • 202-389-42 N in eteen s e v e n ty -fo u r h a s b e en a d iffic u lt y e a r fo r th e banking in d u s try . D uring the m o n th s o f A u g u st, S e p te m b e r and e a r ly O c to b e r a g en uin e s e n s e o f c r i s i s p re v a ile d , and , m o r e th an a t any tim e s in c e th e t h i r t i e s , co n fid e n ce w as sh ak en . T h e re h a s b e e n a m p le r e a s o n fo r c o n c e r n . W e hav e n e v e r e x p e r ie n c e d in fla tio n at th e c u r r e n t r a t e and c e r ta in ly not w hen co m b in ed w ith a r e c e s s io n . M o r e o v e r, su ch f a c t o r s a s th e p r o tr a c t e d o r d e a l o f F r a n k lin N a tio n a l B an k , in t e r e s t r a te s u n p re ce d e n te d in th e h is t o r y o f m o d e rn A m e r ic a n b an k in g, th e sudden d e m is e o f A m e r ic a n B an k and T r u s t in South C a r o lin a , n o to r ie ty given r e c e n t bank f a ilu r e s in E u ro p e , sh o c k s in th e fo r e ig n c u r r e n c y m a r k e t s , and e n o rm o u s flow s of funds to th e M id d le E a s t could h a rd ly h elp c r e a tin g an a ir o f u n c e r ta in ty . F o r tu n a te ly , th e a tm o s p h e r e o f doubt w ith r e s p e c t to th e banking s y s te m h as ab ated in r e c e n t w e e k s . T he f a c t th a t in t e r e s t r a t e s hav e d im in ish e d a s a r e s u lt of th e sla c k e n in g dem and fo r b u s in e s s lo a n s and th e F e d ’ s s ig n a llin g o f a m o d e ra tio n o f it s p o lic y o f m o n e ta r y r e s t r a i n t h a s s e r v e d to r e lie v e so m e of th e s t r e s s th a t h a s b e e n p la c e d on th e s y s te m . A t th e s a m e tim e , r e s o lu tio n of th e p r o b le m s of F r a n k lin and A m e r ic a n B an k and T r u s t s e r v e d to d e m o n s tra te th at th e in s o lv e n c y o f a m a jo r ban k in g in s titu tio n can b e m a n a g ed in su ch a w ay th at n eed ed ban k in g s e r v ic e s a r e not in te r r u p te d and c o n fid e n c e in th e tro u b le d in s titu tio n 's b r o th e r and s i s t e r ban k s is u n a ffe c te d . M o r e o v e r , even in th e fa c e of s t r a in s u n lik e any e x p e r ie n c e d s in c e th e D e p r e s s io n , th e r e h a s n o t b e e n a r a s h o f f a ilu r e s o r th e h in t o f any p a n ic . F in a lly , th e r e a r e s ig n ific a n t in d ic a tio n s th a t b a n k e rs a r e p r e p a r e d to fo llo w th e p o lic y o f ca u tio n and r e s t r a i n t w h ich the tim e s dem and . In s h o r t, th e s t r e s s e s o f r e c e n t m o n th s hav e th e m s e lv e s p ro d u ced c o n c r e te e v id e n c e o f r e s i l i e n c y and s tre n g th in our ban k s and th e fr a m e w o r k of re g u la tio n . B e c a u s e liq u id ity --b o th o f in d iv id u al b an k s and th e s y s te m a s a w h o le - - lie s a t the h e a r t o f p r o b le m s w h ich hav e p lagu ed th e in d u s try , it s e r v e s a s a u s e fu l fo cu s fo r d is c u s s io n o f so m e of th e a d ju s tm e n ts in in d u s try p r a c t ic e and p u b lic p o lic y , w h ich , in m y ju d g m e n t, a r e r e q u ir e d by p ru d e n ce and p r e s e n t e co n o m ic co n d itio n s. I a p p ro a ch e d th is s u b je c t w ith so m e tr e p id a tio n b e c a u s e , though a t th e v e r y c o r e of th e b u s in e s s o f b an k in g, it is a d iffic u lt o n e. P a r t o f th e d iffic u lty in d efin in g the t e r m w ith g r e a t p r e c is io n l i e s in th e f a c t th a t it m a y be u sed to d e s c r ib e th e co n d itio n o f a n a s s e t , a grou p o f a s s e t s , a s in g le in s titu tio n , th e ban k in g s y s te m o r th e eco n o m y g e n e r a lly . F o r e x a m p le , in th e ir r e c e n t a r t i c l e , " T h e P a in fu l S q u e e z e on B an k L iq u id ity , " G e o rg e W. M cK in n ey , J r . and Jo h n M c C r a c k e n of th e Irv in g T r u s t Com pany sta te d : In r e c e n t y e a r s , to ta l c r e d it h a s expanded a t an e x p lo s iv e p a c e . S in c e th e end o f th e 1970 r e c e s s i o n , th e co m b in ed o b lig a tio n s of - 2 - c o n s u m e r s , b u s in e s s and g o v e rn m e n t h av e s o a r e d a lm o s t 40% , jf to a c u r r e n tly e s tim a te d $ 2 t r i llio n . Y e t in th e m id s t o f th is liq u id ity e x p lo s io n , w e a r e fa c e d w ith th e a n o m a ly of a liq u id ity s h o r ta g e . R e c o r d i n t e r e s t r a t e s and g row in g f e a r s o f c r e d it s h o r ta g e s a t t e s t th a t even th is m a s s iv e in c r e a s e in liq u id ity h a s b e e n in s u ffic ie n t to m e e t dem and . R ap id liq u id ity exp an sio n h a s now b e en sw am ped by an in fla tio n a r y dem and fo r c r e d it of even g r e a t e r m o m en tu m . H e re th e t e r m " liq u id ity " is u se d w ith r e f e r e n c e to th e f in a n c ia l s y s te m taken in th e a g g r e g a te . In th is s e n s e , " liq u id ity " is s u b s ta n tia lly d e te rm in e d by the le v e l o f r e s e r v e r e q u ir e m e n ts and by th e e ffic ie n c y w ith w h ich th o s e r e s e r v e s a r e put to w o rk . W hen th e a u th o rs r e f e r to a "liq u id ity s h o r ta g e " th ey m ean th e s h o r tf a ll b etw een th e dem and fo r c r e d it and th a t w h ich is a v a ila b le . W ith r e f e r e n c e to an in d iv id u al bank o r o th e r fin a n c ia l in s titu tio n , liq u id ity h a s b e en d efin ed a s th e " . . . a b ility n o t only to m e e t p o s s ib le d e p o sit withdrawals but a ls o to p ro v id e fo r th e le g itim a te c r e d it n e ed s o f th e co m m u n ity . . . . " The f i r s t p u rp o se is " d e f e n s iv e " and s u g g e s ts a cu sh io n fo r th e im p a c t of a reduction o f a b a n k 's l i a b i l i t i e s , w h ile the se co n d is " a g g r e s s i v e , " in v o lv in g ca p a c ity of th e bank to a c q u ir e e a rn in g a s s e t s . L iq u id ity h a s a ls o b e en d efin ed a s "th e a b ility to r a i s e c a s h on s h o r t n o tic e w ith s m a ll r i s k of lo s s . " T h e r e a r e two s o u r c e s of liq u id ity fo r an in d iv id u al in s titu tio n . The f i r s t is its ! a s s e t s . C e r ta in a s s e t s a r e h ig h ly liq u id . C a sh and U. S. g o v e rn m e n t secu rities a r e tr a d itio n a lly v iew ed a s the "liq u id a s s e t s " o f a ban k . In m an y in s ta n c e s , h o w e v e r, th e s e m a y b e o f no u se in s a tis fy in g a b a n k 's liq u id ity n e e d s . The c a s h a cco u n t o f a bank is u s u a lly h eld a t an ir r e d u c ib le o p e ra tin g m in im u m and, to th e e x te n t th a t it is h eld fo r r e q u ir e d r e s e r v e s , it is a v a ila b le fo r liq u id ity p u rp o s e s only to a lim ite d e x te n t. S im ila r ly , g o v e rn m e n t s e c u r i t ie s a r e not liq u id if th ey a r e pled ged a g a in s t p u b lic d e p o s its o r o th e r w is e c o m m itte d within th e bank. A b a n k 's a s s e t s a r e a ls o a s o u r c e o f liq u id ity in th a t th e m a tu rin g of lo a n s o r o th e r in v e s tm e n ts and th e r e c e ip t o f i n t e r e s t giv e r i s e to liq u id ity . T he se co n d s o u r c e of liq u id ity l ie s in a b a n k 's a b ility to b o rro w o r p u rch a se fu nds. T r a d itio n a l bankin g p r a c t ic e view ed a b a n k 's a s s e t s a s the p r im a r y s o u r c e of liq u id ity . B o rro w in g e ith e r fr o m the F e d e r a l R e s e r v e S y s te m o r o th e r banks w as u sed to m e e t e m e r g e n c y r e q u ir e m e n ts o r fo r l a s t m in u te r e s e r v e a d ju s t m e n ts . T he le v e l o f d e p o s its w a s , in e s s e n c e , ta k e n a s given and the volum e and c o s t o f c r e d it su p p lied by a bank a d ju s te d in r e s p o n s e to th a t le v e l and to r e s e r v e r e q u ir e m e n ts . L iq u id ity w as depend ent p r im a r ily upon th e m a tu rity s ch e d u le and th e s a la b ility o f th e a s s e t s and th e in c o m e s t r e a m g e n e ra te d by th o s e a s s e t s . In th e la te f if t i e s and e a r ly s ix t ie s ban k s d e p a rte d fr o m th is tr a d itio n a l - 3 a p p ro a ch . In o r d e r to m e e t th e c r e d it d em and s o f a boom ing eco n o m y , ban k s tap ped , in d r a m a tic a lly in c r e a s in g a m o u n ts, th e se co n d s o u r c e of bank liq u id ity --b o r r o w e d o r p u rc h a s e d funds. T he b a s is o f th is a p p ro a ch to banking i s , o f c o u r s e , known a s " lia b il it y m a n a g e m e n t. I It w a s ap tly d e s c r ib e d by L . G. G a b le , V ic e P r e s id e n t o f th e F e d e r a l R e s e r v e B an k of M in n e a p o lis, who sta te d : T he t e r m " L i a b i l i t y M a n a g e m e n t" a s a b a n k -m a n a g e m e n t p h ilo so p h y r e la t e s to bank liq u id ity . M o re s p e c if ic a lly , it r e l a t e s to th e s o u r c e o f fu nds. . . . In a s im p le s e n s e , th e p h ilo so p h y o f " L ia b i lit y M a n a g e m e n t" m e a n s to c r e a t e , (i. e. , a c c e p t, lo c a t e , and p u r c h a s e ) a d d itio n a l l ia b i lit ie s to m e e t lo a n r e q u e s t s , c o m m itm e n ts and d e p o s ito r - c r e d it o r d em an d s. The h is t o r y o f lia b ility m a n a g e m e n t should p ro b a b ly b e g in w ith th e re ju v e n a tio n of th e f e d e r a l funds m a r k e t in th e 1 9 5 0 's . A se co n d m a jo r d is c r e t io n a r y s o u r c e of liq u id ity w as m a d e a v a ila b le w ith th e d ev elo p m en t of th e n e g o tia b le CD. It h as b e en n o ted th a t "[W ]h ile th e [ F e d e r a l F u n d s] M a r k e t gave la r g e banks d is c r e t io n a r y a c c e s s to th e liq u id ity of th e bankin g s y s te m , the n e g o tia b le CD gave th e s e ban k s d is c r e t io n a r y a c c e s s to th e liq u id ity o f th e nonbank s e c to r o f th e m o v in g m a r k e t. . . . " T he liq u id ity o f th is in s tr u m e n t w as g r e a tly en h an ced w ith th e d e v elo p m e n t in 1961 o f a s e c o n d a ry m a r k e t fo r n e g o tia b le C D 's and la t e r w ith th e r e m o v a l o f R e g u la tio n Q c e ilin g s on la r g e C D 's. In e s s e n c e , lia b ility m a n a g e m e n t m e a n t th a t ban k s w e r e no lo n g e r s u b s ta n tia lly lim ite d in th e ir s o u r c e s o f fu n d s. T he new v iew w as d e s c r ib e d by L eh m a n B r o th e r s e c o n o m is t L e o n a rd Santow w hen he sta te d : T h e p r a g m a tic v iew o f b a n k s is th a t you ca n 't lo o k a t th e old r a t i o s . T h ey d o n 't apply any m o r e w hen p e o p le ca n buy a ll th e liq u id ity th ey w ant in th e m a r k e t p la c e i f th ey a r e w illin g to pay th e p r ic e . Am ong th e s o u r c e s added to th e s e two w e r e a g r e e m e n ts , c o m m e r c ia l p a p e r and fin a n c e in s tr u m e n ts is r e f le c t e d in th e f a c t th a t th e fo r l a r g e r ban k s g rew fr o m 7. 8% in 1965 to Ju n e 1 9 7 4 . E u r o d o lla r b o r r o w in g s , r e p u r c h a s e b i l l s . T h e im p o r ta n c e o f th e s e r a tio of p u rc h a s e d funds to a s s e t s 14. 3% in 1970 and to 2 6 . 5% in The b e n e fits o f th is a p p ro a ch w e r e s u b s ta n tia l. T he d e v elo p m e n t o f lia b ility m a n a g e m e n t a s a to o l fo r en h an cin g bank liq u id ity allo w ed m o n ey c e n te r and r e g io n a l b an k s to re sp o n d to a ra p id ly expanding e co n o m y . It a ls o allo w ed r e g io n a l b an k s to a c h ie v e o r b e g in to r e a l i z e n a tio n a l and in te r n a tio n a l a m b itio n s . T he p henom enon p a r a lle le d the holding co m p an y m o v e m e n t, ex p an sio n a b ro a d and a chipping aw ay a t r e s t r i c t i o n s on b r a n c h in g , fa c ilita tin g - 4 th e m o s t in n o v a tiv e and e x c itin g p e rio d in banking h is to r y . S m a lle r banks b e n e fite d a s w e ll s in c e m an y p r o fite d h a n d so m ely a s n e t le n d e r s o f fe d e r a l fu n d s. N otw ith stand ing its b e n e f its , th e p r a c t ic e o f lia b ilit y m a n a g e m e n t is not w ith o u t p e r i l s . T h e s e w e r e h ig h lig h ted by e v e n ts in 1 9 7 4 , in clu d in g th e f a ilu r e s o f F r a n k lin and A m e r ic a n B a n k and T r u s t and the s t r e s s e s ca u sed by th e liq u id ity s q u e e z e e n g en d ere d by tig h t m o n ey and u n p re ce d e n te d bu siness b o rro w in g fr o m b a n k s , w h ich th rou g h th e s u m m e r had b e e n g row in g a t an annu al r a t e o f m o r e th an 25% . One d iffic u lty w ith th e view o f b a n k e r s th a t th ey " c a n buy a ll the liq u id ity they w ant in th e m a r k e t p la c e if th ey a r e w illin g to pay th e p r i c e " l i e s in th e fa c t th a t a c c e s s to th e m o n ey m a r k e ts ca n b e lo s t. And, a s th e F r a n k lin and A m e r ic a n B an k and T r u s t e x p e r ie n c e s s u g g e s t, o n ce th e liq u id ity provid ed by th e a c c e s s to su ch m a r k e ts is lo s t , it is d iffic u lt if not im p o s s ib le to regain. Ind eed , w h at o c c u r r e d in th e s e two s itu a tio n s w as a m o d e rn kind o f " r u n " on th e bank. A s e tb a c k w h ich o th e r w is e m ig h t n o t hav e b e en p ro v e n d is a s tro u s le d to a lo s s o f c o n fid e n c e and th e outflow o f " h o t" funds. W h ile d e p o sit in s u r a n c e s e e m s to h av e m a in ta in e d th e co n fid e n c e o f m o s t s m a ll d e p o sito rs in th e fa c e o f th e w o r s t s o r t o f a d v e r s e p u b lic ity , w illin g n e s s o f the le n d e r of l a s t r e s o r t to p ro v id e funds and th e s ta b iliz in g e f fo r t s o f o th e r a g e n c ie s did n o t s tim u la te th e c o n fid e n c e o f la r g e in d iv id u al and in s titu tio n a l d e p o s ito rs . T h u s, i t would a p p e a r th a t th e g r e a t e s t d a n g er to a f in a n c ia l in s titu tio n today l i e s not in a lo s s o f co n fid e n c e by th e p u b lic a t la r g e , but r a th e r illiq u id ity r e s u ltin g fr o m th e m i s t r u s t o f p r o v id e r s o f m o n ey m a r k e t fu nd s. It iS: even c o n c e iv a b le th a t a r e la t iv e ly sound in s titu tio n w h ich had r e lie d h e a v ily on p u rc h a s e d funds co u ld b e b ro u g h t to it s k n e e s by an u n w a rra n te d lo s s o f co n fid e n c e r e s u ltin g f r o m r u m o r o r a w e ll-p u b lic iz e d but not o th e r w is e c rip p lin g s e tb a c k . A n o th er p itf a ll w as r e f le c t e d in r e c e n t m o n th s ' e a rn in g p e r fo r m a n c e o f a n u m b e r o f in s titu tio n s w h o se ra p id grow th w a s b a s e d on p u rc h a s e d funds w h ich su p p o rted m e d iu m o r lo n g - te r m a s s e t s . A s a r e s u lt o f r e c o r d in te re s t r a t e s th e ir e a r n in g s d e c lin e d w h ile b an k in g e a r n in g s g e n e r a lly stood a t high le v e ls . T h is p r o b le m w a s p a r t ic u la r ly a c u te am ong th o s e b an k s w ith a high p ro p o rtio n o f r e a l e s t a t e r e la te d lo a n s . S im ila r ly , th o s e ban k s w h ich had in v e s te d h e a v ily in s e c u r i t ie s found th e m s e lv e s w ith d e p r e c ia te d a s s e t s y ie ld in g s ig n ific a n tly l e s s th an the c o s t o f fu n d s. Su ch co n d itio n s w e r e e x a c e r b a te d by th e a p p e a r a n c e of m u lt i- t ie r e d m a r k e t s , p e n a liz in g in s titu tio n s w h ich only m o n th s b e f o r e had b e en r e s p e c te d a s in n o v a tiv e , a g g r e s s iv e and e s p e c ia lly w e ll-m a n a g e d . O th er e f f e c t s should b e n o ted a s w e ll. F i r s t o f a ll, th e r e ca n be lit t le doubt - 5 th at th e ra p id d e c lin e o f c a p ita l r e la t iv e to e ith e r a s s e t s o r d e p o s its is due in p a r t to th e a v a ila b ility o f m o n ey m a r k e t funds. S e co n d , so m e c r i t i c s have a ttrib u te d a d e c lin e in c r e d it q u a lity , a s r e f le c t e d by an in c r e a s e in lo a n l o s s e s , to la x ity ind u ced by th e e a s y a v a ila b ility of fu nds. W h ile I doubt th a t m o s t banks have e a s e d s ta n d a r d s , t h e r e ca n b e l it t le d isp u te th a t th e a s s u m p tio n o f u n lim ite d liq u id ity c a u s e d a r e la x a t io n o f d is c ip lin e in so m e b a n k s. F in a lly , it is p ro b a b ly a ls o tr u e th a t th e s a m e a s s u m p tio n s led to lo a n c o m m itm e n ts th a t a r e now p ro v in g e m b a r r a s s in g o r in c o n v e n ie n t. A s I h av e a lr e a d y in d ic a te d , it s e e m s to m e th a t our s y s te m of bankin g and bank r e g u la tio n h a s p e r fo r m e d r e m a r k a b ly d u ring th is p e rio d of s p e c ia l s t r e s s . N e v e r t h e le s s , th e s t r a in s o f liq u id ity h av e c r y s t a lliz e d th e n eed fo r b a n k e r s , the r e g u la to r y a g e n c ie s and C o n g re s s to co m e to g r ip s w ith c e r t a in b a s ic is s u e s and to do so w ith ou t d e la y . B a n k e rs should im m e d ia te ly m o v e to apply the le s s o n s of th e p a s t y e a r . It s e e m s c l e a r th a t so m e in s titu tio n s h a v e r e lie d f a r too h e a v ily on p u rc h a s e d funds a s a b a s is fo r g row th . T h is h a s p ro v e n u n w ise; in s te a d , ex p a n sio n should b e m o r e n e a r ly equ ated w ith th e n a tu r a l grow th of d e p o s its , ad d itio n of c a p ita l, and c o n c r e te e x p e c ta tio n o f in c o m e . Long r a n g e p lan ning b a la n c in g p r e s e n t and fu tu re c r e d it d em an d s w ith a n tic ip a te d r e s o u r c e s m u s t be im p le m e n te d . B a n k e r s should no lo n g e r re sp o n d to c r e d it n e ed s on a d a y -to -d a y b a s is n o r m a k e lo a n c o m m itm e n ts a s s u m in g th e a v a ila b ility o f v ir tu a lly u n lim ite d liq u id ity in th e m o n ey m a r k e t s . M o r e o v e r , w ith th e u n s e ttle d s ta te o f our own and th e w o rld e co n o m y , I s u s p e c t th a t in th e m e d iu m ru n a t le a s t , b a n k e r s should no lo n g e r e x p e c t th e lu x u ry o f r e la t iv e ly s ta b le co n d itio n s. F o r e x a m p le , m o s t a n a ly s ts a g r e e th a t a p e rio d o f r e c e s s i o n is r e q u ir e d to b rin g in fla tio n u n d er c o n tr o l. Ind eed , u n em p lo y m en t clim b e d to 6% l a s t w eek , a fig u r e r e a c h e d on ly o n ce in th e l a s t d e ca d e . And, w h ile .m a n y e c o n o m is ts a r e o p tim is tic , a ll r e c o g n iz e th e d a n g er o f a r e c e s s i o n a r y p h a se m o r e s e v e r e than th a t p r o je c te d by A d m in is tr a tio n e c o n o m is ts . In th is c lim a te , it is only r e a s o n a b le to e x p e c t th a t in m an y a r e a s o f th e co u n try , b u s in e s s e s w ill e x p e r ie n c e th e ir own liq u id ity p r o b le m s and th a t lo a n l o s s e s and d e lin q u e n c ie s w ill i n c r e a s e . B a n k e r s should not b e cau g h t u n p re p a re d if th is o c c u r s . A n ticip a tin g t h is , b a n k e r s should fo c u s on c r e d it and in v e s tm e n t q u a lity , av oid ing th e r i s k a s s o c ia t e d w ith high y ie ld in g but s p e c u la tiv e v e n tu r e s . At the sa m e tim e , e m p h a s is should b e p la c e d on sh o rin g up liq u id ity by m oving to len g th en l i a b i l i t i e s ' m a t u r it ie s . T he in tro d u c tio n o f flo a tin g r a t e in s tr u m e n ts m ig h t a c c o m p lis h th is . C e r ta in ly , v o la tile m o n ey should not b e u sed to fund e s s e n t ia lly long r a n g e c o m m itm e n ts o f r e s o u r c e s . I should r e i t e r a t e th a t m an y b a n k e r s a r e a lr e a d y m o v in g ra p id ly and e f fe c tiv e ly to m a k e su ch a d ju s tm e n ts . B a n k a m e r ic a 's p r e s id e n t A. W. C la u s e n 's a n n o u n ce m e n t o f a fo r m a l p o lic y o f r e s t r a i n t r e p r e s e n t s a d r a m a tic in d ic a tio n th a t th is is th e c a s e . In p a r t he s ta te d : - 6 - E c o n o m ic g ro w th m a n sh ip --w ith o u t eq u al c o n c e r n fo r q u a lity and s ta y in g p o w e r -- h a s a lw a y s b e e n a fa u lty p h ilo so p h y . Today, m o r e than e v e r , i t is a p h ilo so p h y a t odds w ith th e e c o n o m ic n e e d s and f in a n c ia l r e a l i t i e s o f th is co u n try . and: G iven th e s e d iffic u lt f in a n c ia l tim e s o f high i n t e r e s t r a t e s and u n p re ce d e n te d lo a n d em and , w e a r e co n v in ce d th a t s h a r e h o ld e r s , d e p o s ito r s and th e p u b lic a t la r g e a ll a r e b e tte r s e r v e d by a p o lic y th a t g iv e s th e q u a lity o f a s s e t s and th e s ta b ility of e a rn in g s h ig h e r p r io r it y am ong c o r p o r a te g o a ls than s iz e a lo n e . T h is a p p ro a ch m u s t be applauded and m ig h t w e ll s e r v e a s a p o lic y sta te m e n t fo r th e in d u stry . A t th e s a m e tim e , ban k s u p e r v is io n m u s t ad ap t to th e p r e s e n t e co n o m ic e n v iro n m e n t. It m a y b e tr u e th a t so m e b a n k e r s w e r e " c a r e l e s s " in th e ir p u r s u it o f grow th a t any p r i c e ; c e r ta in ly th a t w ould b e an a c c u r a t e , and p ro b a b ly c h a r it a b le , c h a r a c t e r iz a t io n o f th e m a n a g e m e n t o f F r a n k lin N ational B an k in th e y e a r s im m e d ia te ly p r e c e d in g it s d e m is e . It a ls o m u s t be frankly ack n o w led g ed th a t th e p h ilo so p h y and p r a c t ic e s w h ich h av e c h a r a c t e r iz e d bankin g d u rin g th e p a s t d o zen y e a r s to o k p la c e u n d er th e c lo s e s u p e rv is io n o f th e r e g u la to r y a g e n c ie s and w a s , by and la r g e , n o t in c o n s is te n t w ith the m o n e ta r y p o lic ie s p u rsu e d by th e F e d e r a l R e s e r v e S y s te m . W ith a p o lic y o f r e s t r a i n t in th e g ra n tin g o f c r e d it g o e s a la r g e m e a s u r e of r e s p o n s ib ilit y fo r th e sh ap in g o f th e f a c e o f th e co m m u n ity w h ich a bank serves w h e th e r it b e a r u r a l f a r m co m m u n ity o r th e w o rld w ide m a r k e ts o f our money c e n t e r b a n k s. T he a s s u m p tio n th a t v ir tu a lly u n lim ite d liq u id ity i s a v a ila b le , w h ich p e rv a d ed th e p h ilo so p h y o f lia b ilit y m a n a g e m e n t, allo w ed b a n k e rs to av oid d iffic u lt c h o ic e s . In annou ncing B a n k a m e r ic a C o rp o r a tio n ’ s p o licy of r e s t r a i n t , M r. C la u s e n r e c o g n iz e d th a t a r a tio n in g p r o c e s s n e c e s s a r i l y flows fr o m su ch a p o lic y . He s ta te d : C le a r ly w e ca n n o t m e e t a ll th e c r e d it d em an d s w e now r e c e iv e . - 7 ( , W e s h a ll co n tin u e to h o n o r th e n o r m a l e s s e n t ia l c r e d it r e q u ir e m e n ts o f e s ta b lis h e d c u s to m e r s . B u t, a s w e co n tin u e to s e r v e th e ir n e e d s , o th e r b o r r o w e r s m a y find it d iffic u lt to o b ta in a ll th e funds d e s ir e d . The f a c t th a t h a rd c h o ic e s m u s t be m ad e in th e co m in g m o n th s h a s b e en r e fle c t e d in th e grow ing d e b a te o v e r th e is s u e of c r e d it a llo c a tio n . S o m e C o n g re s s m e n and r e s p e c te d e c o n o m is ts hav e a rg u ed w ith f o r c e th a t a m a n d a to ry fe d e r a l s y s te m a im e d a t d ir e c tin g th e flow of funds is r e q u ir e d to in s u r e th e p ro p e r a llo c a tio n of c r e d it and, u ltim a te ly , a ll* r e a l r e s o u r c e s in th e s o c ie ty . To d ate, th e F e d h a s r e je c t e d th e n o tio n th a t it should im p le m e n t m a n d a to ry c r e d it a llo c a tio n g u id e lin e s . R a th e r th e B o a rd h a s e m p h a siz e d bank co o p e ra tio n w ith v o lu n ta ry g u id e lin e s . In it s p r e s s r e l e a s e o f S e p te m b e r 1.6, 1 9 7 4 , th e B o a rd o f G o v e rn o rs s u m m a riz e d the c o n c lu s io n s o f th e s ta te m e n t o f th e F e d e r a l A d v iso ry C o u n cil to th e B o a rd in th is r e s p e c t . T he r e l e a s e s ta te d : T he B o a rd r e g a r d s r e s t r a i n t in lend in g p o lic ie s a s e s s e n t ia l to th e n a tio n a l e f fo r t to c o n tr o l in fla tio n . R e s t r a in t b e s t s e r v e s th e p u b lic i n t e r e s t w hen lim ite d c r e d it r e s o u r c e s a r e u sed in w ay s th a t e n c o u ra g e e x p a n sio n of p ro d u ctiv e c a p a c ity , s u s ta in k e y s e c t o r s o f n a tio n a l and lo c a l e c o n o m ic s , p ro v id e liq u id ity fo r sound b u s in e s s e s in te m p o r a r y d iffic u lty and ta k e into a c c o u n t le g itim a te n e ed s o f in d iv id u a ls and s m a ll a s w e ll a s la r g e b u s in e s s e s . E v en w ith in th e p a r a m e t e r s o f th e F e d 's g u id e lin e s d iffic u lt c h o ic e s a r e p o sed . A b a n k e r m u s t n e c e s s a r i l y f a c e h a rd q u e s tio n s w h ich p e r ta in n o t m e r e ly to an a n a ly s is o f th e y ie ld and c r e d it r i s k o f a g iven a s s e t but to w hat is good o r bad in th e long ru n fo r th e c o m m u n itie s s e r v e d by th e ir b a n k s. I do n o t p re te n d th a t th e a n s w e r s w ill b e e a s y o r ev en th a t t h e r e w ill b e a r ig h t a n sw e r in e a ch c a s e . I do b e lie v e , h o w e v e r, th a t su ch q u e s tio n s m u s t b e fa c e d and a n s w e r e d -e ith e r th ro u g h th e v o lu n ta ry e x e r c i s e o f r e s p o n s ib ilit y by b a n k e r s o r th rou g h c r e d it a llo c a tio n p o lic ie s im p le m e n te d a t th e f e d e r a l le v e l. In ad d itio n to th e c h a lle n g e s fa c in g b a n k e r s and bank s u p e r v is o r s , e v e n ts o f th e p a s t y e a r u n d e r s c o r e th e n eed fo r C o n g re s s to g iv e s e r io u s a tte n tio n to c e r t a in q u e s tio n s . In c o n c lu s io n , I w ould lik e to to u ch b r ie f ly on th r e e is s u e s w h ich w ill p ro b a b ly be th e s u b je c t o f C o n g r e s s io n a l s c r u tin y in th e co m in g m o n th s. F i r s t o f a ll, C o n g r e s s w ill u ndoubtedly e x a m in e v e r y c lo s e ly th e a c tio n s o f e a ch o f th e banking a g e n c ie s in v o lv ed in th e F r a n k lin m a t te r and th e in s o lv e n c y o f A m e r ic a n B an k and T r u s t in South C a r o lin a . W h ile th e s e c a s e s w e r e r e s o lv e d e x p e d itio u sly and w ith a m in im u m of i l l e f f e c t s , th ey p ro v id e in fo r m a tiv e c a s e - 8 - stu d ie s w h ich r e f l e c t th e o p tio n s and p r o c e d u r e s p r e s e n tly a v a ila b le ift d e a lin g w ith fa ilin g and tro u b le d b a n k s. A m ong th e is s u e s w h ich C o n g re s s m ig h t a d d r e s s a r e d iv is io n o f resp on sibilities and ta s k s am ong th e a g e n c ie s , th e r ig id ity o f th e s ta tu to r y o p tio n s a v a ila b le to F D IC u n d er S e c tio n 1 3 (c) and 1 3(e) o f it s A c t, and th e d isa d v a n ta g ed p o sitio n o f s ta te n o n -m e m b e r b a n k s w ith r e s p e c t to e m e r g e n c y a c c e s s to s h o r t - t e r m liq u id ity . In r a is in g th e s e q u e s tio n s , I do n o t m e a n to s u g g e s t e ith e r a p e r s o n a l position o r th e in a d eq u a cy o f th e p r e s e n t fr a m e w o r k . H o w ev er, in tim e s o f econ om ic u n c e r ta in ty in clu d in g th e p o s s ib ility o f fu tu re liq u id ity s t r a i n s , p ru d e n ce w ould s e e m to r e q u ir e c a r e f u l c o n s id e r a tio n o f th e to o ls a v a ila b le to th e r e s p o n s ib le a g e n c ie s fo r d e a lin g w ith tro u b le d f in a n c ia l in s titu tio n s and indeed w ith o th e r in s titu tio n s e s s e n t ia l to th e p u b lic. S e co n d ly , th e d e p r e s s io n in th e h o u sin g in d u stry and th e s u b s ta n tia l d is in t e r m e d ia tio n fr o m th e th r if ts w h ich o c c u r s in tim e s o f hig h i n t e r e s t r a t e s insures th a t C o n g re s s w ill o n ce a g a in a d d r e s s th e r e c o m m e n d a tio n s of th e Hunt C o m m is s io n . P r e d ic ta b ly , v e s te d in t e r e s t s a r e a lr e a d y jo c k e y in g to lobby fo r th a t p o rtio n o f th e p a ck a g e w h ich a p p e a r s fa v o r a b le to th em and a g a in s t th a t w h ich d o es n o t. In lig h t o f th e s e r io u s n e s s o f th e s t r a in s w h ich th e system h a s f e lt th e p a s t few m o n th s , i t s e e m s to m e th a t w e ca n n o t a ffo rd a b u sin e ssa s - u s u a l a p p ro a ch to th is p ie c e o f le g is la tio n . It h as b e en d e m o n s tr a te d tim e and a g a in th a t R e g u la tio n Q c e ilin g s a r e in e f f ic ie n t and c a u s e s e v e r e d y sfu n ctio n in th e o p e r a tio n o f ou r m o n ey m arkets. M o r e o v e r , and to m y m in d , even m o r e im p o r ta n tly , th e Q c e ilin g s co n stitu te a su b sid y o r s h e lte r to th e h o u sin g and t h r if t in d u s tr ie s w h ich is funded by w hat c o n s titu te s a ta x on low and m id d le -in c o m e s a v e r s . In tim e s of inflation w ith in t e r e s t r a t e s a t p r e s e n t le v e ls , th is ta x is u n w a rra n te d and u n fa ir. I am w e ll a w a r e th a t a b ru p t e lim in a tio n of R e g u la tio n Q w ith o u t s ig n ific a n t m e a s u r e s to av oid d is lo c a tio n w ould b e g r o s s ly ir r e s p o n s ib le . Y e t th o se m e a s u r e s h av e b e e n d efin ed and s o m e o f th e m r e q u ir e s ta te le g is la t iv e action. A ll o f th e m d e s e r v e our su p p o rt. T h e tim e h a s co m e fo r C o n g r e s s , th e a g e n c ie s and th e v a r io u s in d u s try grou p s to c o n fro n t and r e s o lv e th is question. F in a lly , th e r e is so m e in d ic a tio n th a t C o n g re s s w ill giv e c o n s id e r a tio n to the s u b je c t o f r e g u la to r y r e f o r m . U n lik e th e m a t te r o f R e g u la tio n Q , w e a r e only b eg in n in g s e r io u s c o n s id e r a tio n o f th is s u b je c t. T h e ra n g e o f so lu tio n s is b ro a d , th e q u e s tio n s c o m p le x and the in t e r e s t s c o n flic tin g . The p r o c e s s w ill r e q u ir e c a r e f u l thought, c o m p r o m is e and a w illin g n e s s to fo re g o n a rro w v e s te d i n t e r e s t s . I hav e not r e s o lv e d in m y own m ind so m e of th e m o s t b a sic q u e s tio n s and c e r ta in ly h a v e n o t begun to a d d r e s s th e m u ltitu d e o f l e s s e r c o n s id e r a tio n s , but I am co n v in ce d th a t th e tim e h as co m e to a d d r e s s and r e s o lv e th e s e q u e s tio n s . - 9 t *' <»:-'• /, In su rv e y in g th e fifte e n m o n th s o f m y te n u re a t th e F D IC , and p a r t ic u la r ly the l a s t s ix m o n th s , I a m re m in d e d o f th e C h in e se c u r s e , "M a y you liv e in in te r e s tin g t i m e s , f W e ll, w e do liv e in in te r e s tin g tim e s . Y e t, I am ju s t enough of an o p tim is t to b e lie v e th a t r a th e r than c u r s e d , w e a r e ch a lle n g e d . I am co n fid e n t th a t w e w ill re sp o n d . o O o
@FedFRASER