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PR-75-74 ( 1 2 - 1 3 - 7 4 ) FOR IMMEDIATE RELEASE Address by George A. LeMaistre Director Federal Deposit Insurance Corporation Before the ( Executive Seminar of Carter H. Golem.be Associates, Inc. Scottsdale, Arizona December 1 3 , 1974 FEDERAL DEPOSIT INSURANCE CORPORATION, 550 Seventeenth St. N. W., Washington, D. C. 20429 202-389-4221 We a r e in th e m id s t o f a p e rio d in w h ich th e r e l ie s p o te n tia l fo r ra p id and fu n d am en tal ch a n g e . A s th e in d u s try , th e a g e n c ie s and C o n g re s s f a c e the fu tu re t h e r e a r e two p o s s ib le c o u r s e s o f a c tio n fo r d e a lin g w ith th e ch a n g e s th at a r e o c c u r r in g o r w ill o c c u r . T h e r e ca n b e a co m m o n and c o n c e r te d e ffo r t to c o n tr o l and sh ap e e v e n ts w ith th e o b je c tiv e o f c r e a tin g a m o r e sound, fle x ib le fin a n c ia l s y s te m b e tt e r a b le to m e e t th e c r e d it n e e d s o f our econ om y and m o r e r e s i l i e n t in th e fa c e of fre q u e n t and v a r ie d s h o c k s . O r, th e r e ca n be a fra g m e n te d r e a c tio n to e a c h ch an g e a s h a s b e en c h a r a c t e r i s t i c o f th e p a st. The p a s t fifte e n y e a r s h av e b e e n by fa r th e m o s t e x c itin g and in n o v a tiv e p e rio d in bankin g h is t o r y . R esponding to c o m p e titio n and th e n e e d s of c u s to m e r s , banking h a s b u r s t out o f its stod gy and c o n s e r v a tiv e s h e ll. G e o g ra p h ic b a r r i e r s to c o m p e titio n f e ll a s th e holding co m p an y m e c h a n is m allo w ed a m u ltis ta te p r e s e n c e , b ra n c h in g r e s t r i c t i o n s w e r e m o d ifie d and ban k s d ev elo p ed e x te n s iv e in te r n a tio n a l o p e r a tio n s . In n o v ativ e te c h n iq u e s in s tr u c tu r in g and m an ag in g a s s e t s and l i a b i l i t i e s h av e allo w ed ban k s to re sp o n d to both th e in c r e a s e d dem and fo r c o n s u m e r s e r v ic e s and th e s o p h is tic a te d r e q u ir e m e n ts of b u s in e s s c u s to m e r s . A ll th is h a s b e e n fa c ilit a te d by te c h n o lo g ic a l b r e a k th ro u g h s in th e p r o c e s s in g and t r a n s m is s io n o f in fo r m a tio n , w ith fu r th e r ch an ge p r o m is e d th ro u g h im p le m e n ta tio n o f E F T s y s te m s . In s h o r t, b a n k s have b e e n in tu ne w ith and re sp o n d e d a g g r e s s iv e ly to th e n eed s of a c o m p le x , p r o s p e r o u s and expand ing eco n o m y . C om ing on th e h e e ls of m an y y e a r s o f o p tim is m and g row th, 1 9 7 4 h a s b e en a d iffic u lt y e a r fo r th e in d u s try w ith th e ou tlo ok fo r 197 5 r e fle c t in g a le v e l o f p e s s im is m n o t f e lt s in c e th e t h i r t i e s . Su ch f a c t o r s a s th e p r o tr a c te d o r d e a l of F r a n k lin N a tio n a l B a n k , i n t e r e s t r a t e s u n p re ce d e n te d in the h is t o r y o f m o d e rn A m e r ic a n b a n 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 g iv en r e c e n t bank f a ilu r e s in E u ro p e , in s ta b ility in th e fo r e ig n c u r r e n c y m a r k e ts and th e s itu a tio n in th e M id d le E a s t could h a rd ly h elp but c r e a t e an a ir o f u n c e r ta in ty . M o r e o v e r , it is now c le a r th at our eco n o m y is in w o r s e s t r a i t s than m an y im a g in ed p o s s ib le a few m o n th s ago. The d e b a te now is n o t abo u t w h e th e r w e a r e in a r e c e s s i o n , bu t w h e th er its shap e w ill b e a " Y " , a " U " , o r an " L " . N e v e r t h e le s s , I a m co n fid e n t th a t th e ban k in g s y s te m a s a w h o le is c a p a b le of su s ta in in g s t r a in s s ig n ific a n tly m o r e s e v e r e th an th o s e p r e s e n tly e n v isio n e d . A g en cy and in d u s try r e s p o n s e to th e liq u id ity sq u e e z e of th e s u m m e r and e a r ly f a ll and th e r e s o lu tio n o f F r a n k lin 's and A m e r ic a n B an k and T r u s t 's p r o b le m s h av e 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 o f r e g u la tio n . T h a t e v id e n c e is b u tt r e s s e d by th e f a c t th a t in th e f a c e o f 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 b e e n no r a s h o f f a ilu r e s o r th e h in t of p a n ic . C e r ta in ly , th e r e is no r e a s o n to e x p e c t th e s o r t o f ch a o s and sh a k e o u t th a t is o c c u r r in g in th e s e c u r i t ie s in d u s try . T h is i s n o t to s a y , h o w e v e r, th a t th e e f fe c t s o f c u r r e n t e c o n o m ic d iffic u ltie s \j w ill be in s ig n ific a n t. A lr e a d y , th e s t r a in s o f 1 9 7 4 hav e u n d e r s c o r e d r i s k and J s h o r tc o m in g s in c e r t a in banking p r a c t i c e s , in clu d in g th e ho ld in g com p an y m o v e m e n t, in te r n a tio n a l o p e r a tio n s and lia b ilit y m a n a g e m e n t, w h ich m ay not hav e b e e n a p p r e c ia te d p r e v io u s ly . In co m in g m o n th s lo a n l o s s e s a r e c e rta in to r i s e , and , if th e r e c e s s i o n p r o v e s v e r y s e v e r e , th e in c id e n c e o f bank failures o r c o n s o lid a tio n s cou ld i n c r e a s e so m ew h a t. A c c o r d in g ly , it s e e m s c le a r that our c u r r e n t e c o n o m ic d i s t r e s s w ill a f f e c t b an k in g , a s w e ll a s o th e r in d u stries, to an e x te n t and in w ay s n o t y et d e te r m in e d . M o r e o v e r , it is w e ll to r e c a l l th e o ft-m a d e o b s e r v a tio n th a t s ig n ific a n t changes in ou r fin a n c ia l s y s te m o c c u r only in tim e s o f c r i s i s . R e f le c tin g th e m ood of th e co u n try , th e C o n g re s s ju s t e le c te d is lik e ly to be one o f th e m o s t r e fo r m m in d ed and c o n s u m e r - o r ie n t e d in th e n a tio n 's h is t o r y and m a y b e im p a tie n t w ith old s o lu tio n s th a t do n o t w o r k - - e v e n w hen th e a lt e r n a t iv e s a r e l e s s than c le a r . In th e c o n te x t o f w hat s e e m to be c o n v e rg in g c u r r e n ts o f ch a n g e it is im portant to n o te th a t th e le v e l o f r i s k in th e bankin g s y s te m h a s in c r e a s e d sig n ific a n tly a s a r e s u lt o f th e a g g r e s s iv e n e s s and in n o v atio n th a t h a s c h a r a c t e r iz e d m a jo r s e g m e n ts o f th e in d u stry in r e c e n t y e a r s . A r e v ie w o f s o m e o f th e e le m e n ts of r i s k th a t hav e grow n out o f th is p e rio d o f c r e a t iv it y and e x p a n sio n underscore th e n e ed fo r b a n k e r s , th e a g e n c ie s and C o n g re s s to re sp o n d in d is c ip lin e d and g c o o rd in a te d w ay s to th e p r o b le m s and is s u e s a t hand. J R e c e n t a c tio n s o f th e F e d w ith r e g a r d to hold in g c o m p a n ie s hav e s e r v e d to h ig h lig h t one su ch a r e a o f in c r e a s e d r i s k . W h ile th e to ta l e q u ity o f so m e h o ld in g co m p an y s y s te m s is s ig n ific a n tly g r e a t e r th an th a t o f th e ir banking s u b s id ia r ie s , th a t is not a lw a y s th e c a s e . E q u ity c a p ita l m a y a c tu a lly be le s s w hen co m p u ted on a c o n s o lid a te d b a s is than fo r th e bank a lo n e . A s a r e s u lt, th e am o u n t o f eq u ity w h ich o n ce su p p o rted th e r i s k s o f a s in g le ban k in g sy stem now su p p o rts th e b an k p lu s a v a r ie t y o f e n t e r p r is e s . T h e r a p id ity w ith which ch an g e h a s o c c u r r e d is s e e n in r e c e n t S a lo m o n B r o th e r s s t a t i s t i c s w h ich show ed th a t th e c o m p o s ite r a tio o f to ta l c a p ita l funds to to ta l a s s e t s , le s s c a s h and due fr o m b a n k s , o f th e tw e n ty -fiv e l a r g e s t bank h old in g co m p a n ies d e c lin e d fr o m 8 .8 p e r c e n t in 1972 to 7, 7 p e r c e n t in 1 9 7 3 . A t th e s a m e tim e th e r a tio o f eq u ity c a p ita l to n o n - c a s h a s s e t s d e c lin e d f r o m 7. 2 p e r c e n t in 1972 to 6. 2 p e r c e n t. P o te n tia lly m o r e tr o u b le s o m e is th e f a c t th a t th e f a ilu r e o r d i s t r e s s o f an a f f ilia t e in th e ho ld in g co m p an y s y s te m m a y a f f e c t th e bank i t s e l f . T h e danger is tw ofo ld . F i r s t o f a ll, th e r e w ill b e g r e a t te m p ta tio n to tap th e bank a s an a n s w e r to th e p r o b le m s o r n e e d s o f a f f i l i a t e s . S e co n d ly , even w h e re the bank is e ffe c t iv e ly in s u la te d fr o m d ir e c t f in a n c ia l d r a in , hold in g co m p an y p ro b le m s a r e o fte n r e f le c t e d in m a r k e t ju d g m e n ts abou t th e b a n k i t s e l f . T h is is e n co u ra g e d by th e f a c t th a t m a n y hold in g co m p an y e x e c u tiv e s w ould a g r e e - 3 w ith R o n ald T e r r y , P r e s id e n t of F i r s t T e n n e s s e e N a tio n a l C o rp o r a tio n , who sta te d : " I th in k w e should k e e p th e b a n k 's p r e s t ig e behind th e c a p ita l m a r k e t is s u e s of a f f ilia t e s , k T he d a rk s id e of th is a p p ro a ch w as g r a p h ic a lly illu s tr a t e d in th e B e v e r ly H ills B a n c o rp c a s e --u n d o u b te d ly a s o u r c e of F e d c o n c e r n in th is a r e a . An a f f ilia t e o f th e B e v e r ly H ills B a n c o r p , th e B e v e r ly H ills N a tio n a l Bank, had b e e n s e llin g so m e of its p a r e n t c o m p a n y 's c o m m e r c ia l p a p e r . W hen the tro u b le d p a r e n t w a s u n a b le to m e e t i n t e r e s t p a y m e n ts on th e p a p e r, a ru n on th e o th e r w is e sound bank w a s tr ig g e r e d . A s a r e s u lt , th e holding co m p an y w as fo r c e d to liq u id a te th e b a n k 's a s s e t s th ro u g h s a le to W e lls F a r g o . The g r e a t e x p a n sio n o f in te r n a tio n a l bankin g o p e r a tio n s is a se co n d s o u r c e of in c r e a s e d r i s k . F o r e ig n a s s e t s ra n g e b etw een 4 2 . 8 and 30. 4 p e r c e n t of the to ta l a s s e t s o f ou r fiv e l a r g e s t b a n k s , and th ey a r e , in m an y c a s e s , r e s p o n s ib le fo r th e d r a m a tic d rop w h ich h a s b e e n s e e n in th e c a p ita l r a tio s of so m e o f our l a r g e r b a n k s . F o r e x a m p le , one m o n ey c e n t e r bank h a s a r a tio o f equ ity p lu s r e s e r v e s to to ta l a s s e t s o f 6. 6 p e r c e n t w hen com p u ted on d o m e s tic b a s is and 2. 9 p e r c e n t w hen in te r n a tio n a l o p e r a tio n s a r e in clu d ed . In ad d itio n to s p re a d in g m o r e th in ly th e s y s t e m 's c a p ita l r e s o u r c e s , su ch o p e ra tio n s c o n ta in th e ir own p e r i l , e s p e c ia lly fo r th e a g g r e s s iv e u n in itia te . F r a n k lin N a tio n a l B a n k 's e x p e r ie n c e in th e fo r e ig n e x ch a n g e m a r k e t is a c a s e in p o in t, but th e l o s s e s of L lo y d 's S w is s b r a n c h in th e fo r e ig n c u r r e n c y a r e a d e m o n s tra te th a t ev en th e m o s t e s ta b lis h e d and p ru d en t of in s titu tio n s ca n be b u rn ed . F u r t h e r m o r e , th e p r e c a r io u s s ta te of th e in te r n a tio n a l p a y m e n ts s y s te m , th e d is r u p tiv e e f fe c t s o f th e flo od o f p e tr o d o lla r s and the fin a n c ia l p ro b le m s of c o u n tr ie s w h ich a r e s u b s ta n tia l d e b to rs to A m e r ic a n ban k s h av e each s e r v e d to g r e a tly in c r e a s e th e r i s k of in te r n a tio n a l o p e r a tio n s . P a r a lle lin g and to a s ig n ific a n t d e g r e e funding e x p a n sio n a b ro a d h a s b e en an a p p lic a tio n o f th e lia b ilit y m a n a g e m e n t th e o r y o f bank liq u id ity . 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 nd s. T he new view w as d e s c r ib e d by L e h m a n B r o th e r s e c o n o m is t L e o n a r d Santow w hen he s ta te d : T he p r a g m a tic v iew of b an k s is th a t you c a n 't lo o k a t th e old r a t i o s . T hey d o n 't apply a n y m o re w hen p eo p le can buy a ll th e liq u id ity th ey w ant in th e m a r k e tp la c e if th ey a r e w illin g to pay th e p r ic e . The b e n e fits of th is a p p ro a ch a r e s u b s ta n tia l. Not c o n s tr a in e d by th e le v e l of d e p o s its g row ing out o f n o r m a l c u s to m e r r e la tio n s h ip s , m o n ey c e n t e r and r e g io n a l b an k s re sp o n d e d to b u rg eo n in g c r e d it d e m a n d s. It a ls o a llo 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 th e ir in te r n a tio n a l a m b itio n s . S m a lle r b a n k s h av e 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 e ly a s n e t le n d e r s o f fe d e r a l fu n d s. T he r a p id ity o f ch a n g e in th is a r e a i s r e f le c t e d in - 4 th e f a c t th a t th e r a tio o f p u r c h a s e d funds to a s s e t s fo r l a r g e r b a n k s grew fr o m 7. 8 p e r c e n t in 1 9 6 5 to 14. 3 p e r c e n t in 1 9 7 0 , and to 2 6 . 5 p e r c e n t in Ju n e 1 9 7 4 . F o r m a n y in s titu tio n s , grow th w a s f a r m o r e d r a m a tic . N otw ith stan d in g its b e n e f its , r e s o r t to th e m o n ey m a r k e ts a s a s o u r c e of liq u id ity w as not w ith ou t its p e r ils and s e r v e d to add a n o th e r e le m e n t of r i s k to th e s y s te m . T h e s e w e r e d r a m a tiz e d by e v e n ts in 1 9 7 4 , w h ich in clu d ed the f a ilu r e s o f F r a n k lin and A m e r ic a n B an k and T r u s t and th e s t r e s s e s c a u s e d 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 b u s in e s s b o rro w in g fr o m b a n k s, th a t g rew a t an annu al r a t e o f m o r e than 25 p e r c e n t th ro u g h th e s u m m e r . F r a n k lin , o f c o u r s e , is th e c l e a r e s t e x a m p le o f an in s titu tio n w h ich re lie d fa r too h e a v ily on p u rc h a s e d funds a s a b a s is f o r ra p id e x p a n sio n . Anxious to a c h ie v e s ta tu s a s a m o n ey c e n t e r in s titu tio n , th e bank p u rc h a s e d funds in in c r e a s in g p ro p o r tio n s to su p p o rt r is k y a s s e t s . M o re im p o r ta n tly , as th e bank p e n e tr a te d new m a r k e t s , grow th f a r o u ts trip p e d m a n a g e m e n t sk ill. W hat w as o n ce a r e la t iv e l y sound L ong Isla n d in s titu tio n b e c a m e a m u lti n a tio n a l e n t e r p r is e situ a te d in la v is h ly ap p o in ted M a n h a tta n q u a r t e r s y et la c k in g th e depth and m a n a g e r ia l e x p e r t is e r e q u ir e d to ru n th e suddenly c o m p le x o p e r a tio n . U n able to c o n tr o l e x p e n s e s , m a n a g e m e n t soon fa ce d a s e r io u s e a r n in g s p r o b le m , w h ich w a s p ro b a b ly th e u ltim a te c a u s e o f the b a n k ’ s d o w n fall. Ind eed , one m ig h t s p e c u la te th a t F r a n k lin 's w e ll-p u b lic iz r fo r e ig n e x ch a n g e l o s s e s w e r e th e r e s u l t o f a tte m p ts to re c o u p l o s s e s . T he m o s t d r a m a tic e le m e n t o f r i s k in v o lv ed in th e view o f b a n k e r s th a t they ca n buy a ll th e liq u id ity th ey w ant in th e m a r k e tp la c e i f th ey a r e w illin g to pay the p r i c e " l i e s in th e f a c t th a t a c c e s s to the m o n e y m a r k e ts c a n b e lost. 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, once th e liq u id ity p ro v id 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 ^ im p o s s ib le to r e g a in . In e a c h c a s e a s e tb a c k w h ich o th e r w is e m igh t n o t h av e p ro v e n c o m p le te ly d is a s tr o u s tr ig g e r e d a lo s s o f co n fid e n c e and th e outflow o f " h o t" fu nd s. T h e r e is e v id e n c e w h ich s u g g e s ts th a t w h ile d e p o sit in s u r a n c 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 s ito r s in the f a 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 th e le n d e r o f la 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 not s tim u la te th e co 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 r s . A n o th e r p itfa ll is r e f l e c t e d in th e r e c e n t e a rn in g p e r f o r m a n c e o f a n u m ber of in s titu tio n s w h o se ra p id grow th w a s b a s e d on th e u s e o f p u r c h a s e d funds to su p p o rt m e d iu m o r lo n g - t e r m a s s e t s . E v en w h e re o th e r o p e ra tin g exp en ses a r e c o n tr o lle d , r e c o r d i n t e r e s t r a t e s hav e p u shed the c o s t- o f - f u n d s to high le v e ls . T he p r o b le m is p a r t ic u la r ly a c u te am ong b a n k s , su ch a s A m e ric a n B an k and T r u s t , w ith a hig h p ro p o rtio n o f r e a l e s t a t e - r e l a t e d lo a n s . T h at su ch r i s k s and s h o r tc o m in g s hav e s u r fa c e d in m o d e rn ban k in g p r a c tic e - 5 does n o t m e a n th a t th ey should b e c u r ta ile d n o r th e c lo c k tu rn e d b a c k . T h at is n e ith e r p r a c t i c a l n o r d e s ir a b le . R a t h e r , a s I h av e in d ic a te d , th e p r e s e n c e of su ch r i s k s s ig n a ls th e n e ed fo r b a n k e r s , th e r e g u la to r y a g e n c ie s and C o n g re s s to c o m e to g r ip s w ith c e r t a in is s u e s and to do so w ithou t d e la y . B a n k e rs shou ld m o v e im m e d ia te ly to apply th e le s s o n s o f th e p a s t y e a r . C e rta in ly n e ith e r e x p a n sio n nor c r e d it c o m m itm e n t ca n any lo n g e r b e b a s e d on th e p re s u m e d a v a ila b ility o f p u rc h a s e d funds a t an a c c e p ta b le c o a t. S im ila r ly , v o la tile and p o te n tia lly h ig h -p r ic e d funds ought not to be u sed to fund r is k y o r lo n g -r a n g e a s s e t s to a c h ie v e m a r k e t p e n e tr a tio n . R a th e r , e x p a n sio n should b e a fu n ctio n of th e n a tu r a l le v e l of d e p o s its , ad d itio n of c a p ita l and r e te n tio n o f in c o m e , and th e c o m m itm e n t of r e s o u r c e s b a s e d on c a r e f u l p lan n in g b a la n cin g p r e s e n t and fu tu re c r e d it d em and s w ith a n tic ip a te d r e s o u r c e s . B an k s shou ld a ls o r e c o g n iz e th a t, in th e s h o r t- to - m e d iu m ru n , a t l e a s t , c a p ita l n e c e s s a r y to su p p o rt e x p a n sio n m u s t be g e n e ra te d fr o m e a r n in g s . T h is flo w s fr o m th e f a c t th a t th e p r e s e n t p r ic e s o f bank s to c k s and th e c o s t and u n s u ita b ility o f d ebt fin a n c in g f o r e c lo s e th e c a p ita l m a r k e ts fo r a g r e a t m an y b a n k s. A c c o r d in g ly , ban k s w ish in g to expand w ill h av e to r e ly on th e b a s i c s o f sound b an k in g . G r e a te r a tte n tio n m u s t be paid to c o s t s , the p r ic in g o f s e r v i c e s and th e p r o f ita b ility o f lin e s o f s e r v ic e s and la r g e c u s to m e r a c c o u n ts . Y e t th e le s s o n is n o t th a t e x p a n sio n o r a g g r e s s iv e bankin g is bad. N or should th e f a c t th a t so m e in s titu tio n s h av e b e en o v e r z e a lo u s m e a n th a t it is now a p p r o p r ia te fo r a ll to p u ll in th e ir h o r n s , ad opting an u l t r a r e s t r i c t i v e a ttitu d e to w a rd th e p r o v is io n o f c r e d it . It is tr u e th a t m an y in s titu tio n s a r e s tr e tc h e d to th e ir lim it and should be r e s t r a in e d ; th e d a ta , h o w e v e r, w h ich I re v ie w in d ic a te s o th e r in s titu tio n s a r e m o r e than a d e q u a tely c a p ita liz e d and hav e s e c u r e and p ro d u ctiv e p o r tf o lio s . In th e p r e s e n t r e c e s s io n a r y e n v ir o n m e n t, th e s e shou ld m o v e a g g r e s s iv e ly to re sp o n d to th e n e ed s o f c re d itw o rth y b o r r o w e r s . Ind eed , fo r so m e in s titu tio n s , th e a s s u m p tio n o f a h ig h e r le v e l o f r i s k w ould not b e a t a ll in a p p r o p r ia te . W hat is r e q u ir e d o f b a n k e r s a t th e p r e s e n t is not n e c e s s a r i l y r e tr e n c h m e n t. In ste a d o f u n ifo r m r e a c tio n to th e glo om y p ic tu r e p r e s e n te d by th e eco n o m y and th e c a u tio n a r y n o te s tr u c k by s u p e r v is o r y a u th o r it ie s , b a n k e r s should sim p ly apply in d is c ip lin e d fa s h io n th e to o ls of m o d e rn a s s e t and lia b ility m a n a g e m e n t. T he w id e s p re a d f a ilu r e o f s o lid in s titu tio n s to re sp o n d in th is m a n n e r cou ld h a v e th e e f fe c t o f r e in f o r c in g th e r e c e s s i o n a r y s p ir a l. T h is p o in t is p a r t ic u la r ly w o rth y o f n o te b e c a u s e it r e f l e c t s th e need fo r b a n k e rs to re s p o n d in d ep en d en tly to th e f a c t s and c ir c u m s t a n c e s o f th e ir own m a r k e t e n v iro n m e n t in lig h t o f th e p e c u lia r s tr e n g th s and w e a k n e s s e s of th e ir own in s titu tio n , and n o t to r e a c t to th e fad o f th e m o m e n t o r r e g u la to r y jaw b o n in g w h ich is n o t r e a lly a p p lic a b le to th e ir c a s e . - 6 M any 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 the adjus m e n ts r e q u ir e d by th e ir b a n k ’ s c ir c u m s t a n c e s . B a n k a m e r ic a 's p re sid 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 ts 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 : E c o n o m ic g ro w th m a n s h ip --w ith o u t eq u a l c o n c e r n fo r q u a lity and sta 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 th an 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 fin a n c ia l r e a l i t i e s o f th is co u n try . and: G iv en 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 c e 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 the p u b lic a t la r g e a ll a r e b e tt e 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 r n 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 alo n e. T h is a p p ro a ch m u s t be applauded. 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 es 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 s e r v e s - -w h e th e r it b e a r u r a l co m m u n ity o r th e w o rld w id e m a r k e ts o f our m o n ey 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 is a v a ila b le , w h ich p e rv a d e d 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, allow ed b a n k e r s to a v o id d iffic u lt c h o ic e s . The tim e o f th a t lu x u ry is p ro b a b ly past. In annou ncin g B a n k a m e r ic a C o r p o r a tio n 's p o lic y o f r e s t r a i n t , C la u se 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 flo w s fr o m su ch a p o licy . He sta 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 . 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 i r e m e n ts o f e s ta b lis h e d c u s t o 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 b e m a d e in th e co m in g m o n th s h a s a ls o been! r e f l e c t e d in th e g row in g d e b a te o v e r th e is s u e o f c r e d it a llo c a tio n . Som e m e m b e r s o f C o n g r e s s and r e s p e c te d e c o n o m is ts h a v e a rg u e d w ith f o r c e th a t a m a n d a to ry s y s te m a im e d a t d ir e c tin g th e flow o f funds is r e q u ir e d to in s u r e th e p r o p e r a llo c a tio n o f c r e d it . In a r e c e n t s ta te m e n t C ongressm an H en ry R e u s s in d ic a te d th a t he w ill p r e s s fo r m a n d a to ry c r e d it g u id e lin e s in I th e n e x t C o n g r e s s . To d a te , 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 , e m p h a s iz in g in s te a d bank] c o o p e r a tio n w ith v o lu n ta ry g u id e lin e s . - 7 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 16, 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 th e c o n c lu s io n s o f th e s ta te m e n t of th e F e d e r a l A d v is o ry C o u n cil to th e B o a rd in th is r e s p e c t . T h e 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 len d 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 ffo 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 se d in w ay s th a t e n co u ra g e ex p a n sio n o f p ro d u ctiv e c a p a c ity , s u s ta in k ey 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 in to a cco u n t le g itim a te n e ed s of 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 e n 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 f a c e h a rd q u e s tio n s w h ich p e r ta in not 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 iv en a s s e t but to w hat is good and 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 even th a t th e r e w ill b e a r ig h t a n s w e r in e a c h 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 be 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 of b a n k e rs 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. M o r e o v e r , in m y ju d g m e n t, th e F e d 's g u id e lin e s and th e J o in t E c o n o m ic C o m m itte e s c o n c e r n m u s t b e ta k e n s e r io u s ly . It is not enough m e r e ly to op p o se c o n tr o ls a rg u in g th a t th ey c o n s titu te an u n w o rk a b le in t e r f e r e n c e w ith th e o p e ra tio n of th e m a r k e tp la c e . T h ey m u s t d e m o n s tr a te w ith c o n c r e te r e s u lt s th a t th e p u b lic i n t e r e s t , and not m e r e ly th a t o f ban k s o r th e ir good c u s to m e r s , is b e s t s e r v e d by a s y s te m w h ich r e l i e s on in d iv id u al e x e r c i s e o f r e s p o n s ib ility . G iven c u r r e n t e c o n o m ic co n d itio n s and th e c o n c e r n th a t th ey e n g e n d e r, the fa ilu r e o f b a n k e r s to s e e th a t funds a r e a v a ila b le fo r p r o je c t s w h ich a r e p ro d u c tiv e and n e c e s s a r y fo r co m m u n ity w e lf a r e should and w ill le a d to fe d e r a l in te r v e n tio n . In c a llin g fo r g r e a t e r d is c ip lin e and s e l f - r e s t r a i n t in the in d u s tr y , th e s u p e r v is o r y a g e n c ie s m u s t a ls o ta k e c a r e to u n d erg o th e ir own p r o c e s s o f c r i t i c a l s e lf-e x a m in a t io n . B an 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 c o n o m ic e n v iro n m e n t and th e g r e a tly in c r e a s e d c o m p le x ity and im p o r ta n c e of bankin g th a t h as r e s u lt e d fr o m th e in n o v a tio n and e x p a n sio n of th e p a s t fifte e n y e a r s . It m a y be 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 ic e . H o w ev er, it w ould b e u n fa ir n o t to ack n o w led g e fr a n k ly th a t th e p h ilo so p h y and p r a c t i c e s w h ich h av e c h a r a c t e r iz e d ban k in g d u rin g th e p a s t d ozen y e a r s did ta k e p la c e u n d er the s u p e r v is io n o f the 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 , not in c o n s is te n t w ith th e 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 . 8 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 , events q I th e p a s t y e a r u n d e r s c o r e the n e ed 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 would lik e to to u ch b r ie f ly on th r e e issuJ w h ich w ill p ro b a b ly b e 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 com ing m o n th s. F i r s t o f a ll, th e d e p r e s s io n in th e h o u sin g in d u s try and th e s u b s ta n tia l d is in te r m e d ia tio n fr o m th e t h r if t s w h ich o c c u r s in tim e s o f high in t e r e s t r a t e s in s u r e s th a t C o n g r e s s w ill o n ce a g a in a d d r e s s th e re co m m e n d a tio n s o f th e Hunt C o m m is s io n and in th e p r o c e s s th e q u e s tio n o f i n t e r e s t r a te c e ilin g s . A lre a d y S e n a to r M c I n ty r e ’ s s u b c o m m itte e h a s r e p o r te d to the fu ll C o m m itte e th e F in a n c ia l In s titu tio n s A c t. L e g is la tio n o f th is typ e and i t s g o a l o f open c o m p e titio n am ong f in a n c ia l in s titu tio n s d e s e r v e s our full su p p o rt. P e r h a p s th e m o s t c o n t r o v e r s ia l a s p e c t o f th is p a ck a g e r e l a t e s to th e ultimate r e m o v a l o f R e g u la tio n Q c e ilin g s . Y e t i t h a s b e e n d e m o n s tr a te d tim e and tim e 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 s in ou r f in a n c ia l m a r k e t s . D is in te r m e d ia tio n is one exam p le. It h a s a ls o b e e n a rg u e d w ith f o r c e th a t by v ir tu a lly e lim in a tin g co m p etitio n fo r d e p o s its , th e R e g u la tio n Q c e ilin g s in c r e a s e d th e n eed fo r b a n k e rs to r e s o r t to m o r e v o la tile m o n e y m a r k e t in s tr u m e n ts th e r e b y in c r e a s in g the le v e l o f r i s k in th e s y s te m . A ls o , by denying s m a ll s a v e r s a c c e s s to inter it ( r a t e s w h ich a f r e e l y fu n ctio n in g m a r k e t w ould s e t, R e g u la tio n Q c e ilin g s may h av e a c tu a lly d is c o u r a g e d s a v in g s w h ich m ig h t o th e r w is e h av e b e en put to p ro d u c tiv e u s e a s in v e s tm e n t. In ad d itio n to th e f a c t th a t i n t e r e s t r a t e c e ilin g s h av e b e en co u n terp ro d u ctiv e in p u r e ly e c o n o m ic t e r m s , th e r e is a n o th e r sid e o f R e g u la tio n Q th a t has r e c e iv e d too l i t t l e a tt e n tio n - - e v e n by th e m o s t ou tsp o k en a d v o c a te s on the p a r t o f c o n s u m e r s . R e g u la tio n Q c o n s titu te s a su b sid y o r s h e lt e r to the 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 h at 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 . T o ta lly a p a r t fr o m th e f a c t th a t th e device h a s d e m o n s tr a ta b ly fa ile d to p ro v id e a s ta b le flow o f h o u sin g , it is w rong th a t th e b u rd en fo r p ro v id in g th is su b sid y should f a ll on th e group w h ich can l e a s t a ffo rd it. W ith in fla tio n a t p r e s e n t le v e ls , th e in e q u ity is e s p e c ia lly sev ere. I a m w e ll a w a re th a t a b ru p t e lim in a tio n o f 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 would b e ir r e s p o n s ib le . Y e t su ch m e a s u r e s h av e b e e n d e fin e d . If o th e r o r t r a n s it io n a l m e a s u r e s a r e r e q u ir e d , they d e s e r v e ou r su p p o rt. T hey should n o t, h o w e v e r, p ro v id e an e x c u s e to delay e lim in a tio n o f an u n ju s t and in e f f ic ie n t in t e r f e r e n c e w ith th e o p e r a tio n o f the m a r k e t m e c h a n is m . - 9 S e co n d ly , C o n g re s s w ill undoubtedly e x a m in e v e r y c lo s e ly th e a c tio n s of e a ch o f th e ban k in g a g e n c ie s in v o lv ed in th e F r a n k lin m a tte r and th e in s o lv e n c y of 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 o f 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 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 in 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 r e s p o n s ib ilit ie s and ta s k s am ong th e a g e n c ie s , th e r ig id ity of s ta tu to r y o p tio n s a v a ila b le u n d er S e c tio n 1 3 (c) and 13(e) o f it s A c t, and th e d isa d v a n ta g ed p o s itio n of s ta te n o n -m e m b e r b an 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 . F in a lly , it now s e e m s 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 th e 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 tte r of R e g u la tio n Q, w e a r e only begin n in g s e r io u s c o n s id e r a tio n of th is s u b je c t. T h e ra n g e of 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 th e i n t e r e s t s c o n flic tin g . T he p r o c e s s w ill r e q u ir e c a r e f u l th ou ght, c o m p r o m is e and a w illin g n e s s to fo r e g o v e s te d in te r e s ts . W h ile I h av e not r e s o lv e d in m y own m ind a ll o f the m o s t b a s ic q u e s tio n s , and c e r ta in ly h av e n o t begun to a d d r e s s th e m y r ia d of l e s s e r c o n s id e r a tio n s , it d o es s e e m c le a r to m e th a t e f fic ie n c y and co m m o n s e n s e dem and r e s t r u c t u r ing along fu n c tio n a l lin e s . F o r e x a m p le , I find it d iffic u lt to ju s tif y th e t r i p a r t i t e d iv is io n o f e ith e r e x a m in a tio n and s u p e r v is o r y fu n ctio n s o r o f th o se fu n ctio n s w h ich d e a l w ith s t r u c t u r e su ch a s c h a r t e r in g , m e r g e r s , hold in g co m p an y a c q u is itio n s and b r a n c h and f a c ilit y a p p r o v a ls . ^ S im ila r ly , it w ould s e e m to m e th a t fu n ctio n s d e a lin g w ith tro u b le d and fa ilin g in s titu tio n s should a ls o b e c o n s o lid a te d . W h ile no fo r m a l p r o p o s a ls h av e b e e n m a d e to C o n g r e s s , it h a s b e en su g g e ste d th a t a ll th e s e d u ties b e c e n t r a liz e d in th e F e d e r a l R e s e r v e S y s te m . I m u s t a d m it th a t I w ould h av e v e r y g ra v e r e s e r v a t io n s abou t a r e o r g a n iz a tio n w h ich v e s te d in one in d ep en d en t f e d e r a l a g e n cy s o le a u th o rity to r e g u la te both m o n e ta r y p o lic y and our n a tio n ’ s 14, 000 b a n k s . I sa y th is fo r two r e a s o n s . F i r s t o f a ll, r e c e n t m o n th s h a v e m a d e obviou s th e im p o r ta n c e o f c a r e f u l and e x p e r t e x e c u tio n o f m o n e ta r y p o lic y a s w e ll a s th e c o s ts th a t could r e s u l t f r o m it s m is m a n a g e m e n t. It s e e m s to m e th a t th e a g en t o f th is d e lic a t e and c r i t i c a l fu n ctio n should not be a s s ig n e d fu r th e r d u tie s of a lm o s t eq u a l m a g n itu d e and c o m p le x ity w ithou t a c le a r c u t d e m o n s tr a tio n o f both th e n eed to do so and the f a c t th a t th e r e s p o n s ib ilit ie s would n o t c o n flic t. S e co n d ly , w h ile th e p r e s e n t s y s te m is u n s a tis f a c to r y in m an y r e s p e c t s , it d o es p ro v id e c e r t a in c h e c k s and b a la n c e s . W h ile o th e r s m a y d if f e r , I w ould find v e r y d is tu rb in g th e v e s tin g o f su ch p e r v a s iv e pow er o v e r th e eco n o m y in a s in g le a g e n c y . p - 10 - In c o n c lu s io n , I should m e r e ly r e i t e r a t e w hat I s ta te d a t th e o u ts e t. Chari is upon u s w h e th e r w e lik e it o r n o t. T he sh ap e o f th a t ch a n g e w ill depend on w h e th e r th o s e o f u s in th e in d u s try , th e a g e n c ie s and C o n g re s s se e k to u n d e rsta n d and m a n a g e the f o r c e s a t w o rk o r m e r e ly r e a c t in tra d itio n a l w ay s to th e p r o b le m s and i s s u e s w h ich c o n fro n t u s in th e co m in g m onths. D u rin g p e r io d s o f abu nd an ce and ra p id e x p a n sio n , it is p o s s ib le and quite n a tu r a l to av oid o r p o stp o n e h a rd c h o ic e s , to t o le r a t e w a s te and in e ffic ie n c l and to b e n e fit fr o m th e o p e r a tio n o f f o r c e s only d im ly u n d e rsto o d . We no lo n g e r h av e th a t lu x u ry . -o -O -o - )
@FedFRASER