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Statement by
J. Charles Partee
Managing Director for Research and Economic Policy,
Board of Governors of the Federal Reserve System
before the
Subcommittee on Economic Stabilization
of the
Committee on Banking, Currency and Housing
U.S. House of Representatives
October 21, 1975

I am happy to appear before this Committee today to discuss
the implications for financial markets of the New York City fiscal
crisis.

My comments will be confined to its possible effects on the

banking system, since Chairman Burns will be covering some of the
broader aspects of the problem in his testimony before the Committee
later this week.
A possible default by New York City on some of its debt
obligations— and the recent difficulties of the municipal securities
market more generally— has caused concern in some quarters regarding
the stability of our banking system.

This concern apparently stems

from the fact that commercial banks long have been major investors
in State and local obligations, including those of New York State
and New York City.

As of mid-year, the commercial banks as a group

had total investments in tax exempt securities of $102 billion.

These

holdings accounted for 47 per cent of all State and local indebtedness,
and for 15 per cent of total bank loans and investments.

The aggregate

investment in this class of securities considerably exceeds the capital
and reserves of the banking system, which amount to nearly $75 billion.
Very few of these investments, of course, are in any question.
For the most part they represent the securities of highly rated States
and localities, the repayment of which rests upon the general power to
tax the private economic base of these jurisdictions.

Over the years,

the record of repayment for such bonds has been extraordinarily good.
Even when there have been some defaults in payments of interest or




-2-

principal on these so-called general obligation bonds, as during
the depression years of the 1930's, the defaults have almost always
subsequently been cured and investors have suffered little if any
ultimate loss of principal.
It would be a mistake, therefore, to conclude that a default
on a general obligation bond will mean a total, or even partial, loss
on the investment.

In contrast to a business firm, which may not

survive a financial default, a governmental entity will continue 1n
existence, its economic tax base will remain as a source of revenue,
and the default will need to be cured in one way or another before
the borrower can hope to reenter the credit markets.

Even if New

York City should default on some or all of its $12 billion in
Indebtedness, what this would be likely to mean for the investor
would be a temporary loss of liquidity, and perhaps some loss of
current earnings, rather than a permanent loss of face value on the
security held.
In view of the high probability of ultimate repayment— which
means that the securities should continue to have a substantial market
value— the Federal bank supervisory agencies have agreed that a
reasonable length of time will be permitted, If there Is a default
by a major municipality, before bank examiners will require that banks
write down the book value of the defaulted holdings to market.

During

this interim period of up to 6 months, the default might well be cured
and markets return to normal.




But even if a full restoration of value

-3does not occur, it is important to recognize that the amount charged
off against a bank's capital account 1s not a projection of ultimate
loss, but a conservative judgment to assure that the bank's capital
is adequate for the other purposes to be served.

In any event, such

a charge-off would undoubtedly be far less than the book value of the
security holdings involved.

A review by Federal Reserve staff of the

most recent examination reports of State member banks last summer
indicated that very few had such large concentrations of New York City
Issues that a writedown would threaten Impairment of their capital;
I am attaching a summary of that study for the Committee's information.
A more likely problem for the banking system, In the event
of a New York City default, is the possibility that financial flows
could become distorted for a time.

Some commercial banks might suffer

deposit outflows, or have unusual demands for funds to meet their
needs and the needs of their customers.

In the event that such'a

temporary liquidity squeeze should develop, the Federal Reserve has
ample power to provide additional funds to its member banks— and to
nonmember institutions when other sources of funds are not availablethrough loans at the Federal Reserve Bank discount windows.

The

Board has adapted Its contingency plans to deal with such an eventuality
arising from a disturbance in the municipal securities market, and is
prepared to act promptly and in whatever scale deemed necessary to
assure an orderly financial environment.




-4-

In conclusion, I firmly believe that there is no need for
concern by the public about the viability of our banking system.
Some few institutions do appear to have heavy concentrations in
New York City investments relative to capital, but I doubt that any
writeoffs that might eventually be required would be too large for
the banking system to handle.

Liquidity pressures on particular

banks and on some of their customers— including municipalities— might
develop for a time, but the powers of the Federal Reserve System to
liquify both individual banks and the banking system as a whole are
ample to accommodate such needs.




ATTACHMENT I

COMMERCIAL BANK HOLDINGS OF STATE AND LOCAL GOVERNMENT DEBT
(End of year totals except where indicated)
State and Local
Government Debt Outstanding
Bank Share
(Per Cent)

Commercial Bank Credit
Holdings of State &
S tate & Local
Local Government Debt
Debt Share
(Per Cent
($ billions)

Year

Amount
($ billions)

1960

70.8

25.0

203.7

17.7

8.7

1965

100.3

38.8

310.4

38.9

12.5

1970

144.4

48.6

459.2

70.2

15.3

1975
(6/30/75)

216.2

47.3

708.9

102.3

14.4

Increase from
12/60 to
6/3G/75

Total

Amount
($ billions)

Per Cent
Increase

State & Local Govt.
Debt Outstanding

145.4

205.4

Commercial Bank
Holdings of State &
Local Govt. Debt

84.6

478.0

Bank share of
Increase in State &
Local Debt Outstanding

Source:

Federal Reserve Flow-of-Funds Accounts.




58.2

ATTACHMENT II
REPORT OF A SURVEY Of'SIGNIFICANT STATE
MEMBER BASK HOLDINGS OF THE OBLIGATIONS
OF NEW YORK CITY, NEW YORK STATE, AND
N E W YORK STATE AGENCIES

September, 1975
In order to determine the potential exposure among State
member banks to adverse developments in the market for municipal and
State obligations of New York, each Federal Reserve Bank in August
of this year was requested to provide information about State member
banks which held concentrations of New York City, New York State»
or New York State Agency securities as of the last examination
report.

For this purpose, a concentration was defined as holdings

amounting to more than 10 per cent of a bank's capital for any of
the three groups, or to more than 20 per cent of capital for the
three groups combined.

Principal New York State agencies included the

Housing Finance Agency, the College Dormitory Authority, and the
Urban Development Corporation.
The selection of the 10 per cent lower cutoff of holdings
of a single group of securities relative to capital was made in view
of the fact that loans to a single borrower are normally limited to
10 per cent of capital. While the limitation does not specifically
apply to a bank's holdings of municipal securities, it was deemed
appropriate for the purpose of assessing any possible points of
potential bank exposure.
It should be noted that the data on securities were reported
at par value, and were taken from examination worksheets on hand at the
Reserve Banks that were not necessarily current but may date from as




-

long as a year ago.

2-

Over the intervening period, it seems probable

that institutional holders had lightened their investments in New York
obligations, on balance, especially since the Urban Development
Corporation default on February 25, 1975.

Moreover, the data on

securities holdings were not broken down by maturities.

Many holdings

could have been short-term debt and by now have been liquidated.
Of the 1,064 State member banks, 130 or about 12 per cent
of the total fell vithin the survey guidelines.

Fifty-one of the

banks reported are located in the State of New York.

The remaining

banks are scattered throughout the‘
country.
Table I reflects data for 112 of the survey banks which
held New York City obligations.

Seventy-seven of these banks held

debt of the City amounting to only 10 to 20 per cent of capital.

Of

the remaining 35 banks, six banks held New York City debt amounting
to over 50 per cent of capital; but five of the six were smaller banks—
with less than $10 million in total capital.
When holdings of New York State and New York State Agency
obligations are added to the analysis, the majority of banks fell
into the 20 to 50 per cent of capital category as shown in Table II.
This shift is primarily due to significant holdings of New York State
debt.

*

Seventeen banks were reported with total New York City, New

York State, and New York Agency obligations greater than 50 per cent
of capital.

However, 15 of these banks, again, were smaller banks—

with less than $10million in total capital.




On the whole, the State mmber banks with holdings of New
York obligations reported in the survey were rather small in size.
Moreover, the percentages of capital reported do not represent cause
for alarm and, as previously indicated, the incidence of potential
exposure has probably decreased since the last examination.

In the

view of the Division of Banking Supervision and Regulation though there
were a few State member banks with holdings of New York obligations
representing relatively high percentages of capital, the situation
on the whole appears to be quite manageable.




TABLE I. DISTRIBUTION OF STATE MEMBER BANKS
BY CAPITAL ACCOUNT AND BY HOLDINGS OF NEW
YORK CITY OBLIGATIONS AS A PER CENT OF CAPITAL
Capital Account
(In millions of dollars)

New York City Obligations as
_____ Per Cent of Capital____
Over 50%
10-20%
20-50%
(Number of banks)

Less than one

9

12

2

1 to 10

46

12

3

10 to 25

8

—

Over 25

14

5

1

77

29

6

Totals

—

TABLE II. DISTRIBUTION OF STATE MEMBER BANKS
BY CAPITAL ACCOUNT AND BY HOLDINGS OF TOTAL
NEW YORK CITY, NEW YORK STATE, AND NEW YORK
STATE AGENCY OBLIGATIONS AS A PER CENT OF
CAPITAL

Capital Account
(In millions of dollars)

Total New York City, .New York
State, and New York State
Agency Obligations as Per
Cent of Capital
10-20%
20-50%
Over 50%
(Number of banks)

Less than one

5

14

5

1-10

31

37

10

10-25

2

6

Over 25

3

15

2

41

72

17

Totals