View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release on delivery

Statement by
George W. Mitchell
Vice Chairman, Board of Governors of the Federal Reserve System




before the
Subcommittee on Commerce, Consumer and Monetary Affairs
of the
Committee on Government Operations
House of Representatives

June 25, 1975

Mr. Chairman:

I am pleased to appear before you today to present the
Board's views as to the use of Federal Reserve credit facilities in
providing emergency assistance to financially troubled cities.

I want

to state at the outset that we interpret the System's present powers
to engage in such lending operations, except as member banks are involved,
to be quite narrowly circumscribed by law.
The recent financing difficulties of New York City provide
a case in point.

These difficulties cumulated rapidly during this past

winter and spring, and reflected the growing reluctance of private
investors to purchase the City's short-term note issues.

Since the

City already had a very large amount of short-term debt outstanding,
and was incurring a substantial current operating deficit as well, any
inability to issue new debt raised immediate problems in finding the
cash to pay off maturing obligations and meet the City's current bills.
In searching for alternative means of resolving the developing financial
crisis, there were at times suggestions that the Federal Reserve might
be a possible source of credit in its role as an ultimate source of
liquidity to the economy.

However, no application for credit was

received from the City, either at the Federal Reserve Bank of New York
or the offices of the Board of Governors.




-2

If a formal request had been received by the Federal Reserve
for the emergency credit accommodation of New York City under the
circumstances that had prevailed, however, I am obliged to state
that, in my judgment, the Federal Reserve would have had to turn it
down.

The City had not fully exhausted possibilities for State

assistance, and its basic need for credit did not appear to be of a
temporary character since no near-term means of repayment--while
continuing to provide the City's basic services— appeared to be at
hand.
Direct extensions of emergency credit to institutions
that are not members of the Federal Reserve System can be provided
under either paragraph 3 or paragraph 13 of Section 13 of the
Federal Reserve Act.

Paragraph 13 provides that any Federal Reserve

Bank, subject to such regulations as the Board may prescribe, may
lend to any individual, partnership or corporation on promissory notes
secured by direct obligations of the U. S. Government or an agency
thereof.

Loans under this paragraph are limited to 90-day maturities.

Unless an entity in need of assistance possesses large amounts of
direct government obligations, the ability of a Reserve Bank to
provide credit assistance under this paragraph is very limited.
Paragraph 3 of the Act empowers the Board of Governors, in
"unusual and exigent circumstances" and by an affirmative vote of at
least five members of the Board, to authorize the Federal Reserve
Banks to make certain types of direct loans to individuals,




-3-

partnerships or corporations.

Paper discounted by Federal Reserve

Banks under this paragraph must be of the "kinds and maturities made
eligible for discount for member banks under other provisions" of
the Federal Reserve Act.

This means, among other things, that the

paper may not have a maturity of more than 90 days at the time of
discount.

The paragraph further provides that the paper shall be

"endorsed or otherwise secured to the satisfaction of the Federal
Reserve Bank," which the Board has construed to mean that a Reserve
Bank should ascertain that the security offered is adequate to protect
the Reserve Bank against the risk of loss.
In light of these restrictions in the law and the background
as to the intent of the law, the Board has concluded that, in con­
sidering the extension of emergency credit to particular borrowers,
the following conditions must be met:




(1) unusual and exigent circumstances exist;
(2) potential borrowers have exhausted other sources
of funds;
(3) the borrower is solvent and has adequate
collateral;
(4) the borrower's need is for short-term accommo­
dation and its basic financial position will
permit early repayment; and
(5) failure to obtain Reserve Bank credit would
have a significant detrimental economic and
financial impact on the surrounding area, the
region, or the nation.

-4 These criteria highlight the essentially low-risk and temporary
character of System emergency lending, as well as the general economic
purpose behind it.
liquidity.

Such lending is intended primarily to provide

Though short-term needs of this type can develop among

either large governmental units or business enterprises, in most cases
the need can be accommodated without relying directly on the Federal
Reserve

simply by turning to commercial banks— who will rely on their

own or Federal Reserve resources— to extend the needed credit.

When this

is not possible, as seemed to be the case with New York City, it is
likely that the difficulties encountered in the private credit markets
reflect more fundamental credit-risk problems and that temporary credit
accommodation will not be sufficient to correct the situation.
In addition to the emergency lending powers contained in
Section 13 of the Federal Reserve Act, Section 14(b) authorizes the
individual Federal Reserve Banks to purchase and sell obligations of
State and local governmental bodies.

The Act requires that these

governmental obligations mature in no more than six months from date of
purchase and that they be issued in anticipation of the collection of
taxes or in anticipation of the receipt of assured revenues.
The 14(b) authority had its origin in the original 1913 version
of the Federal Reserve Act.

The House Report on the Act indicated that

the provision was designed to open an outlet through which idle funds
of Federal Reserve Banks could be profitably channeled and to provide a
means to enable Federal Reserve Banks to make their discount rate




-5 -

effective in the market at those times when member bank borrowing was
slack.

There is nothing in the Act or its legislative history to

indicate that this authority was intended to be used as a channel
for financial assistance to public bodies.

Moreover, the authority

has not been used since 1933, since enactment of Section 10(b) per­
mitted the Federal Reserve to advance credit to member banks on the
strength of their own promissory notes, as well as through the dis­
count of eligible paper.

Given this background, the Board does not

believe that Section 14(b) contemplates the purchase of municipal
obligations as a means of aiding financially distressed communities.
In view of these existing constraints on System emergency
lending, it may be asked whether it would be desirable to legislate
broader powers that would permit Federal Reserve accommodation of
financially distressed communities.

While the Board has not con­

sidered any specific proposals toward this end, I would strongly
caiution against any proposals that would provide direct access to
central bank credit by hard-pressed governmental units.

My reasons

for reaching this judgment are as follows:
First, the critical issue for particular municipalities
is how governmental functions and sources of revenues are dispersed
between it and the State government.

Prospective sources of funds

must be commensurate with the projected costs and expenditure programs
in order to balance out over the longer run.

Access to a source of

temporary credit will not help to achieve such a balance, and it may




-6 -

tend to defer or prevent the remedial actions that are necessary,
difficult as they may be.
Second, central bank involvement in providing temporary
credit accommodation to State and local governmental bodies will
necessarily require that standards be set determining which localities
will be eligible or ineligible for credit accommodation.

This would

involve the System in making credit judgments on the finances of
numbers of State and municipal governments, thus subjecting the
Federal Reserve to intense political pressure to make exceptions for
tUs city or that because of special circumstances.

Moreover, the need

to exercise administrative discipline over borrowers in order to assure
timely repayment would tend to draw the System into political issues
of local budgetary policy.

A central bank, in our judgment, should

leave this issue to other agencies of the Government.
Third, increased access to central bank credit by munici­
palities suffering some degree of financial distress could lead to
similar urgent demands for credit by other kinds of borrowers.

If

central bank credit is extended to our cities, for example, why not
for a host of other purposes, such as the immense investment that
will be required to achieve energy independence?

A proliferation of

demands for credit from the central bank would drastically change the
character of the assets of the Federal Reserve System, from prime
paper of highest quality to an assortment of soft loans and, in the
process, severely damage the Government's access to financing.




It

-7-

could undermine our ability to control the volume of bank reserves
and hence the supply of money.

In the extreme, the result could be

a debasement of the nation's money and ruinous domestic inflation.
For these reasons, if your Committee should conclude that
the financial pressures on key municipalities requires the provision
of special Federal financing assistance in the period ahead, the
Board would strongly urge that this be done through a separate facility
rather than the Federal Reserve.

Federal monies or credits would

still be expended in any such venture, but it would not involve the
use of high-powered central bank funds.

Such a separation would thus

leave the Federal Reserve free to pursue its other responsibilities
for monetary and bank regulatory policies, which are difficult enough
in themselves.
I would urge caution, however, even in proposing the
establishment of a special Federal financing facility to assist with
the financing needs of our State and local governmental bodies.

Such

a facility must have sufficient oversight powers to permit it to play
an effective role in correcting the fundamental financial problems of
client communities, if the Federal assistance is to be productive.
This would be bound to create a Federal presence in local issues of
taxation and spending, a varied and shifting political and social
terrain indeed.
In the spirit of our traditional system of separation of
powers, it may well be better to leave local problems to local solutions.




-8 The special program of financial assistance which was developed for
New York City at the State level through the formation of a new agency-the Municipal Assistance Corporation--is an illustration of Statelocal resourcefulness.

The Corporation is authorized to provide up

to $3 billion in credit to the City and, as it does so, valuable time
will be gained in which the City can take the steps needed to restore
its credit standing with the private investment community.

I hope

that the City's actions will soon make it possible to carry on needed
refinancing and other debt operations in the normal maimer.