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
(Approximately 9:00 a.m.
Pacific Daylight Time
Monday, October 24, 1966)




Savings Flows And Public Policy

Remarks by J. Dewey Daane
Member, Board of Governors of the Federal Reserve System
Before the Annual Meeting of the Savings Division
American Bankers Association
San Francisco, California
on Monday, October 24, 1966

Savings Flows And Public Policy

lThe savings business during the past year has
f
been one of discouragement*

Vicious political attacks,

popular hysteria, widespread unemployment and depreciation
of security prices have tended not only to cause new
deposits to lag, but also to make deep inroads in
previous deposits.

People could scarcely be expected

to think clearly or to act with moderation in a period
of such widespread stress and uncertainty.”
Saying these particular words makes me very much aware of how little
new there is under the sun, for these blunt words on the troubles
afflicting the savings business xvere spoken from a similar podium almost
exactly 33 years ago by my father, Gilbert L. Daane, when, as president
of your Division, he addressed its annual meeting in Chicago on
September 5, 1933.
Despite the ironic similarity of the complaints voiced by savings
bankers in these two separate eras, however, in point of fact the under­
lying problems were markedly different*

My father and his colleagues

had to wrestle with the worst troubles of the Great Depression.

In com­

parison, our problems today are chiefly those of prosperity--and if they
are often just as trying technically, they involve only a fraction of
the human misery.

And for that we can all be deeply grateful.

The savings business, ancient though it is, has rarely been the
focus of as much attention as it has received this past year or two.
The basic reason is simple:

savings are needed to finance investment,

and right now investment demands are intense, probably too intense both




-

2

-

in the United States and throughout the world»

The public’s demands for

goods have burgeoned, bolstered by expanding populations and rising
levels of income.

Technological advances are exploding across the

business scene, stimulating new wants and creating new methods to meet
them.

Governments, too, are eager to add to social capital, in the form

of such long-term investments as schools, water and power facilities,
highways and housing.

All these uses have one thing in common:

savings

are needed to finance them.
In marshaling savings to meet these demands, the United States is
often the envy of the rest of the world.

Why?

Not because we save a

greater share of each income dollar than others; a good many European
and Asian countries can boast a greater savings rate than we do.

Not

just because it is easier for Americans, with their more affluent incomes,
to give up a little more marginal current consumption for larger future
returns.

Surely it is partly because of the sheer dollar size of America's

savings potential, which allows much more room for saving and investment
decisions to work themselves out amicably.
But the most important comparative advantage we have in the savings
business, I submit, consists of our financial assembly lines--the powerful
array of financial intermediaries and service institutions dedicated to
assembling, packaging, and marketing the nation's financial savings in
the most efficient (and hence to them the most rewarding) way.

Other

countries cannot boast the great number and variety of financial inter­
mediaries that dot our landscape.

If the proliferation of intermediaries

may occasionally seem to be a competitor's despair, or a regulator's
nightmare, it also comes close to being a saver's paradise.




-

3

-

What does the economy gain in return?

Recent studies by teams of

international experts suggest that, in comparison with most other
countries, the United States benefits from its heavy layer of financial
intermediation in four major ways:

(1)

efficient mobilization of

myriad pockets of small savings making them available to a wide range
of borrowers; (2)

flexibility in shifting the uses of such funds in

conformity with changing investment demands,

(3) stabilization of important

portions of savings flows through long-term contractual relationships;
and (4) a high rate of return to savers

relative to the cost to borrowers

of obtaining funds.
Some of these benefits accrue principally from the very size of U. S.
savings flows; they represent, in some sense, the benefits from economies
of scale.

But to an important degree, these benefits stem from a wide

range of governmental policies; policies designed to encourage savers'
confidence in the stability of the value of their savings, policies
designed to encourage the confidence of savers in the solvency of savings
entrusted to financial institutions, and policies designed to foster
competition among institutions--competition for both savings inflows
and investment outlets.

It is true, of course, that the U. S. is not

alone in having governmental policies oriented to one or more of these
objectives.

But it is true, I believe, that \ e have pursued all of
*

these policies more vigorously than most other countries, and have
reaped the benefits in the form of a large, diversified, efficient and-generally--smoothly functioning financial structure that facilitates
the financing of investment objectives.




-

4

-

While a whole range of policies is needed to achieve such a standard
of financial performance, it seems to me none is more important than the
policies designed to foster a high degree of flexibility in both savings
forms and investment outlets.

Flexibility is needed to permit prompt

adaptation to the significant shifts in investment opportunities and
saver desires that can be generated in a dynamic society.

Flexibility

in these respects, in turn, is most assuredly provided by a combination
of minimal regulatory inhibitions, on the one hand, and a lively spirit
of competition, on the other.

What this comes down to, in effect, is

placing the maximum practical reliance upon the workings of competitive
market forces in order to encourage the kind of performance that we want
from our financial system.
All this may sound rather trite to you--a pledge of allegiance to
obvious virtues.

But lest you think these virtues dull, let me remind

those of you who were nodding perfunctorily as I recited these policy
objectives that you were nodding approval to a set of guidelines that
could comprehend, among other things:

the ultimate removal, or con­

version to a standby basis, of Regulation Q ceilings; greater interest
rate fluctuations; broader lending powers not only for banks but also
for mutual savings banks and savings and loan associations; more wide­
spread bank chartering and branching; and probably a few more disappearances
from the ranks of financial institutions, both by failure or takeover.
Do the principles I have cited still sound dull?

And are you still sure

you agree with them?
I x;ould urge that we not shrink from the general thrust of these
principles, viewed broadly and over the longer run as "guides to




-

5

-

navigation" for the policy maker, so to speak.

At the same time, realism

forces us to recognize that today's world is not perfect, and that
oftentimes problems or excesses can arise that threaten sufficiently
harmful effects to warrant remedies or restraints being imposed either
by law or regulation.

What is important, in these instances, is to

try to deal effectively with such problems and imperfections in ways
congenial to an evolution toward the long-range market objectives that
I have cited.
Examples of the kinds of problems that I have in mind--and of the
kind of orientation I would advocate in dealing with them--can be found
in abundance in recent savings experience.

Let me call your attention

to three particularly crucial examples to illustrate the point I am
trying to make.
Certainly the savings problem that had the lion's share of the
headlines in 1966 was the so-called "rate war" among savings inter­
mediaries,

I feel sure that no bank represented in this meeting has

gone unaffected by the marked increases in interest rates available to
savers.

The basic cause for this intense rate competition, it should

be remembered, was the extraordinary strength of credit demands generated
by our overheating economy.

These swelling demands for funds served

to bid up interest rates very substantially in all sectors of the
credit market, and the resulting attraction of savers' and investors'
funds into higher yielding bonds and other market instruments served to
slow up very sharply the flow of new financial savings into depositary
institutions.




At the same time, loan demands from the customers of these same
institutions were growing stronger and stronger.

In these circumstances,

all depositary institutions tended to raise rates of return to savers to
try to maintain their net new inflows— but only commercial banks as a
group were particularly successful in this respect.

In contrast to their

behavior in past postwar periods of strong credit demand, banks this time
were both more willing to bid for time money--and also more able to do so-reason of the greater leeway provided in Regulation Q ceilings on time
deposit rates.

Furthermore, many banks could hold down the cost of such

strong bidding for time accounts by offering the highest rates only on
CDs or other special instruments sold primarily to the margin of most
interest-sensitive customers.
Other depositary institutions were simply not able to keep pace with
commercial bank activities in this area.

Why?

Not because they were any

less interested in meeting customer loan demands, but chiefly because they
were not as flexible as banks in the interest rates attaching to either
the assets or the liabilities in their balance sheets.
Mutual savings institutions of all types, wedded to the idea of
making all interest and dividend rate increases applicable across-theboard, while holding earning assets that take a good many years to turn
over at new rate levels, are exposed to much more serious earnings
squeezes than banks when interest rates rise sharply.

These facts were

painfully obvious to managements of many mutual savings institutions
this year, and also to the responsible regulatory authorities, and led
to important restraints on the aggressiveness with which such institutions
raised their rates proffered to savers in an endeavor to keep and attract
loanable funds.




The consequences, however, were sharp shrinkages in new savings
inflows to these institutions, and resulting drastic cutbacks in new
lending to their chief customer, the housing market*

While some cutback

in housing, as well as other key sectors of demand, was implicit in a
tightening of monetary policy, the housing industry was hit especially
hard by the impact of such cutbacks, coming as they did on top of a
major shift of new commitments by insurance companies away from mortgages
in favor of corporate bonds*
These circumstances were, therefore, generating severe distress in
the housing field.

Some public remedial action was called for--but i f a
tht

should be its design?

Some spokesmen, aiming at the symptoms rather than

the cause of the troubles, favored regulatory roll-back of interest rates
to the substantially lower levels that had been appropriate for a less
strained economy.
market forces.

But such a course would have flown in the face of

Rolling back the maximum rates for some or all depositary

institutions alone would have accelerated the movement of funds away from
these institutional outlets toward more attractively priced market
instruments--and any effort to roll back all rates, in the market and at
depositaries alike, would have accommodated still greater credit-financed
spending that would have aggravated basic inflationary pressures.
Instead of engaging in such self-defeating actions, the authorities
tried to move carefully, in a variety of wa^fe, to moderate the situation
and achieve a more orderly adjustment.

The Federal Reserve, for its

part, raised reserve requirements on time deposits to add a marginal
cost and reserve restraint on bank issuance of CDs, and amended Regulation
Q several times to hold down permissible rates payable by commercial




banks on those kinds o£ tine deposits most directly competitive with mutual
savings institutions. Rollbacks of existing offering rates were held
to a minimum.

The aim was rather to prevent further competitive rate

escalation, looking over the longer run to gradual development of the
ability among savings institutions to set more flexible and competitively
viable interest rates, thereby fostering less unstable shifts in savings
flows and fever instances of a sort of "now-you-see-it, now-you-don't"
credit availability.

The evolution of institutions toward positions

of greater flexibility ’’
.ill represent a fundamental adaptation to market
.
forces that \iill make Regulation Q itself less necessary as anything other
than a standby control.

This is precisely the kind o l evolution I would
i

hope for over time.
A second major credit problem this year grew out of something that
the banks were doing too well; namely, taking care of their good business
customers.

Business spending intentions became very strong during 1966,

as ebullient market prospects made new capital investment projects attractive
and possibilities of price increases and shortages whetted corporate
appetites for inventories.

Business cash inflows fell far short of enough

to finance outlays, particularly after the acceleration of Federal tax
payments by cor-orations began to take effect.

In these circumstances,

and with bond market rates near historic highs, businesses turned heavily
to their most dependable short-term source of funds, the banking system.
Such demand for accommodation drew force from the years of good customer
relationships that could be cited by many firms, and, more subtly, from
the posture of eager solicitation of attractive business customers that
had become almost a way of life for the current generation of jank lending




officers.

In truth, most banks wefe already sufficiently loaned up

by early 1S66, so that they were not delighted to have much further
loan expansion thrust upon them.

But the tradition of good customer

relationships made it hard to say "No" to such requests; and the pricing
conventions of uniform prime rate and compensating balance requirements
proved too inflexible to be used to deter much loan demand.

Thus, the

banking system, tied to the customer conventions that had grown out of
decades of generally easy money, found its own efforts insufficient and itself
short of tools to deal with an undesirably large bulge of loan demands.
The consequences were unhappy, from several points of view.

Bank

loans to business rose sharply as 1966 progressed, financing bulges in
business spending that not only were unsustainably large but also had
the effect of sharpening short-run pressures on prices in an environment
already fraught with inflationary pressures because of rising Government
spending.

In trying to raise the funds to meet such loan increases,

banks cut back drastically on other loans.

They also began to dump

holdings of State and local Government obligations, creating incipient
disorderly conditions in a market in which their buying had in recent
years been a mainstay.

And they pushed even harder their efforts to

raise more time deposit money, with the consequences that I have already
mentioned for the housing market and other savings institutions.
Here, again, the results of so uneven a credit flow--an unevenness
clearly reflecting the incidence of monetary policy being called upon
to carry too much of the burden of restraint— were judged to be tandesirable.

To be more explicit, the possible immediate consequences

♦in terms of damage to financial institutions and to financial and real




-

10

-

estate markets began to clearly outweigh the longer-range disadvantages
that might be expected to flow from some temporary remedial action that
would seem to interfere with usual market processes,

A critical decision,

however, concerned the form that remedial policy action should take*
It could have taken the form of a long list of approved purposes:

purposes

for which business loans could be made, and perhaps even purposes for
which securities could be disposed of, or time deposit interest rates
raised*

But such an approach would have presumed to supersede private

with public judgment in every such category of decision-making.

It x^ould

shortly have become an administrative nightmare, and it would have risked
the stultification of private decision-making capacity.

To every man

concerned for the workability of the market system, this course must be
an anathema,
A far preferable avenue seemed to be that of public action to
strengthen private allocative procedures at the "weakest link in the
chain," so to speak, in the hope that over the longer run the private
market processes would themselves develop sufficient strength to assume
the burden.

One example of such public assistance was the special

authorization voted this summer to permit special additional purchases
of home mortgages by FNMA to relieve the worst of the pinch in the
secondary mortgage market.

Ideally, such FNMA operations would serve

as a conduit temporarily siphoning an extra volume of funds from the
central money market in which FNMA money is raised to the mortgage lending
institutions hardest hit by adverse shifts of savings funds.

In time,

such institutions ought to be expected to re-achieve the kind of balance
in flows of funds and interest rates earned and offered that will enable
them to reassume their roles as active mortgage lenders.




-

11

-

Another action aimed at strengthening a "weak link in the chain”
X7as the Federal Reserve letter of September 1 to all member banks, urging
them to moderate loan expansion, and particularly business loan expansion,
in the national interest in the stability of financial markets and sus­
tainable, noninflationary economic growth.

That letter stressed the

relative desirability of banks adjusting their positions through loan
curtailment but recognized that curtailing loans could well take longer
to accomplish than the alternative adjustment route of liquidating
securities and might necessitate a longer period of discount accommodation.
At the same time the letter also made clear that the discount facility
regained available as in the past to help banks meet seasonal or un­
usual needs for funds in accordance with Regulation A.
This letter was very careful not to say to whom a bank should lend,
nor for what purposes, nor for how much, nor for how long.

It was aimed

rather at giving banks additional impetus for curtailing a larger fraction
of business loan demand, leaving to the banks themselves the choice of
means as to how to accomplish such greater restraint.

If, out of this

experience, banks develop the wherewithal to moderate changes in their
own business loan total in the future more effectively, then the next
period of monetary restraint should entail no resort to a counterpart
of the September 1 letter.

Market processes will once again have re­

asserted themselves, with sufficient force to keep credit flows
reasonably balanced.
There is one more arena of savings activity from which I would like
to draw an example for our consideration.

I am thinking of the great

flows of financial savings across national boundaries; in a variety of




-

12

-

forms which together make up the capital account in a country's balance
of payments.

For some years, the United States has been a large exporter

of long-term capital.

A number of causative factors have been at work,

but most important are the tendencies for American rates of return on
long-term debt and equity to be lower than abroad, and the comparative
skill and adaptability of the large U* S. capital market institutions
in handling long-term financing, foreign as well as domestic.

Many con­

sequences that are socially desirable in the long run result from the
large U. S. long-term capital outflows, but two shorter-run consequences
have proved particularly troublesome:

(1)

their contribution to the

persistent U. S. balance of payments deficit, and (2)

an aggravation

of foreign concern over the greater and greater role played by American
commercial and financial interest in the economic life of other countries.
Of these two problems, the first is essentially economic, and the other
more political; the first is a tangible problem, the second somewhat
more nebulous.

Yet both problems have become of such dimensions that the

U. S. has had to take them into account, and to devise policy measures
to alleviate them.
A great deal of advice has been advanced as to how to handle these
problems.

One idea advanced is that of rationing long-term capital out­

flows by instituting a "capital issues'* committee, of the European type,
to control which long-run capital transactions take place.

Others have

advocated temporary or partial capital embargoes, as a swift and effective
means of bringing capital outflows under control.

I have no doubt that

one or another of such devices could be made to work for a time, but my
reservations are deep and abiding that such actions eventually deny




-

13

-

the role that market forces should fill, and can most effectively fill*
in the allocation of capital resources.
I am gratified that we moved in none of these directions when the
pressures of these problems became overriding, but instead chose to
introduce an interest equilization tax (IET) program to moderate our
long-term capital outflow.

The IET program is objective.

By that I

mean it makes use of the price system and the role of prices and costs
in private decision-making.
transactions is involved.

No approval or disapproval of individual
The program's purpose is clear; its effects

are reasonably calculable, and it can be changed or dropped when the
evidence suggests that market forces of themselves will produce a
satisfactory equilibrium.
I could give other examples from both our domestic and international
economic experiences but I am sure I have to say no more to persuade you
that I am a firm believer in the long-run efficacy of the market process.
I am sure most of you are also.
varied, as I judge so are yours.

My reasons for this belief are many and
Some go well beyond economics, into the

area of harmony with political democracy and a philosophy of personal
worth and responsibility.

But I suspect that for many purposes the most

persuasive reason is the most pragmatic one:

it works.

Year in and year

out, wartime aside, I submit that the market system hangs up a better
record than any other.

To be sure, it has its areas of inadequacy, where

we like to provide an overlay of justice or the milk of human kindness.
It has its failures in economic decision-making, but I would argue they
tend to be smaller than under authoritarian systems (perhaps related to
the fact that a man can be more stubborn when he's wrong than a market!)




.

14

-

Because I am convinced that markets have this long-run efficacy,
I am equally convinced that, whenever circumstances may compel inter­
ference with a market, for any of a variety of reasons, that interference
is best designed when it complements the market, rather than replacing
it; when it employs market decision-makers insofar as feasible rather
than dictating decisions to them.

Best of all is the kind of market

interference that fosters the development of market mechanisms that can
eventually replace it completely.

That I take as the surest proof that

a public policy has served the public interest.
Having said that, I would hasten to add to this paean of praise
for the market process that we should not, and cannot, call upon it to
exceed its own capacities, particularly when we are in a war.

Thus

whenever forced transfer of savings is required for our national
objectives, I think it can be best, and certainly most equitably, achieved
through a coordinated use of the tax system alongside of monetary policy
rather than through disproportionate reliance on monetary policy and the
consequential allocative process in terms of price and availability of
money.

Make no mistake about it:

the extraordinarily high interest

rate levels, and the distortion in rate relationships, requiring recent
public policy entrance into the allocative mechanism, reflected the
inadequacy of fiscal restraint.

That is why I for one favored a moderate

tax increase across the board early in 1966 and feel that the issue
remains open in view of the uncertainty about the acceleration of our
effort in Vietnam.
More than filial loyalty thus prompts me to return to my father's remarks
of more than thirty years ago, and to the peroration of those remarks:




-

15

-

"Hope of better days 15.es ahead for bankers
in the savings business.

Savings are the

great bulwark against the spectre of un­
employment, old age and dependency.

Pride,

a sturdy virtue, sustains the practice of
saving through banks.

When again prosperity

dwells among us savings undoubtedly will
resume their high place.1
'
Over the past thirty years this exalted view of the role of savings
has been buffeted by the Keynesian revolution and the recognition that
savings do not always constitute an unmitigated blessing in an advanced
economy.

But analysts (and perhaps even bankers) sometimes forget that

Keynes as a practical man consistently fused his economic analysis with
the then existing milieu--a milieu translated by my old friend and
mentor Alvin Hansen as one of secular stagnation.

But as was clearly

pointed out in the recent biography titled "The Age of Keynes" Keynes
himself "eloquently sketched the benefit of high saving1 in a period
1
when "capital was scarce, saving vital to economic expansion, and
employment full."

And in an economy at x*ar, or tinged with war, his

own analysis brought him not only to extol voluntary savings but even
forced savings not via inflation but through required deferment of
consumption.
In an economic milieu at times more fairly characterized as one of
secular inflation rather than semi-stagnation, Keynes undoubtedly would
have been in the forefront of those calling for adequate fiscal restraint
to avoid cyclical aggravation and might even have been found leading us
down the road to thrift, his arch enemy of thirty years ago.




-

16

-

But the real lesson to be drawn from Keynes, I believe, goes even
deeper for it lies in his fundamental approach to problems--an approach
rooted in rationality and lucidity and an approach which has real
significance for you as savings bankers as well as for policy-makers.
In Keynes' own words, "The next step forward must come not from political
agitation or premature experiments but from thought."

My father's

presidential address in 1933 was titled "A Year of Change" and 1933
was indeed that for the saver and the savings industry!

But so was 1966

and I can assure you that we in the Federal Reserve, as I am sure is the
case with all of you in the savings industry, are re-thinking our prob­
lems and potentials most carefully as we try in these difficult times to
meet the needs of monetary policy in a market economy.